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When Chapter 7 “Straight Bankruptcy” is Not So Straightforward

How can you tell if your Chapter 7 case will be straightforward? Avoid 4 problems.

 

Most Chapter 7 cases ARE straightforward. Your bankruptcy documents are prepared by your attorney and filed at court, about a month later you go to a simple 10-minute hearing with your attorney, and then two more months later your debts are discharged—written off. There’s a lot going on behind the scenes but that’s usually the gist of it.

But some cases ARE more complicated. How can you tell if your case will likely be straightforward or instead will be one of the relatively few more complicated ones?

The four main problem areas are: 1) income, 2) assets, 3) creditor challenges, and 4) trustee challenges.

1) Income

Most people filing under Chapter 7 have less income than the median income amounts for their state and family size. That enables them to easily pass the “means test.” But if instead you made or received too much money during the precise period of 6 full calendar months before your case is filed, you can be disqualified from Chapter 7. Or you may have to jump through some more complicated steps to establish that you are not “abusing” Chapter 7. Otherwise you could be forced into a 3-to-5 year Chapter 13 case or your case could be dismissed—thrown out of court. These results can sometimes be avoided with careful timing of your case, or even by making change to your income before filing.

2) Assets

Under Chapter 7 if you have an asset which is not protected (“exempt”), the Chapter 7 trustee can take and sell that asset, and pay the proceeds to the creditors. You may be willing to surrender a particular asset you don’t need in return for the discharge of your debts. That could especially be true if the trustee would use those proceeds in part to pay a debt that you want and need to be paid anyway, such as back payments of child support or income taxes. Or you may want to pay off the trustee through monthly payments in return for the privilege of keeping that asset. In these “asset” scenarios, there are complications not present in the more common “no asset” cases.

3) Creditor Challenges to the Dischargeability of a Debt

Creditors have a limited right to raise objections to the discharge of their individual debts. This is limited to grounds such as fraud, misrepresentation, theft, intentional injury to person or property, and similar bad acts. With most of these, the creditor must raise such objections to dischargeability within about three months of the filing of your Chapter 7 case—precisely 60 days after your “Meeting of Creditors.” Once that deadline passes your creditors can no longer complain, assuming that they received notice of your bankruptcy case.

4) Trustee Challenges to the Discharge of All Debts

In rare circumstances, such as if you do not disclose all your assets or fail to answer other questions accurately, either in writing or orally at the trustee’s Meeting of Creditors, or if you don’t cooperate with the trustee’s review of your financial circumstances, you could possibly lose the right to discharge any of your debts. The bankruptcy system largely relies on the honesty and accuracy of debtors. So it is quite harsh towards those who abuse the system through deceit.

No Surprises

Most of the time, Chapter 7s are straightforward. The most important thing you can do towards that end is to be completely honest and thorough with your attorney during your meetings and through the information and documents you provide. That way you will find out if there are likely to be any complications, and if so whether they can be avoided, or, if not, how they can be addressed in the best way possible. 

 

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Discharge of Your Debts: THE Goal of Bankruptcy

Most debts are “discharged”—written off—in bankruptcy. But some may not be. Can we know in advance which will and will not be discharged?

 

 

Bankruptcy is about Discharge

The point of bankruptcy is to get you a fresh financial start through the legal discharge of your debts.

Both kinds of consumer bankruptcy—Chapter 7 “straight bankruptcy” and Chapter 13 “adjustment of debts”—can discharge debts. But most Chapter 13s tend to have other purposes as well, and the discharge usually occurs only 3 to 5 years after the case is filed.

In contrast, most Chapter 7 cases are filed for the single, or at least primary, purpose of discharging debts. Furthermore, in most Chapter 7 cases all debts that the debtors want to discharge are in fact discharged, and this happens within just three months or so after the case is filed.

This blog post focuses on Chapter 7 discharge of debts.

What Debts Get Discharged?

Is there a simple way of knowing what debts will and will not be discharged in a Chapter 7 case?

Yes and no.

We CAN give you a list of the categories of debts that can’t, or might not, be discharged (see below). But some of those categories are not always clear which situations they include and which they don’t. Sometimes whether a debt is discharged or not depends on whether the creditor challenges the discharge of the debt, on how hard it fights for this, and then on how a judge might rule.

Why Can’t It Be Simpler?

Laws in general are often not straightforward, both because life can get complicated and because laws are usually compromises between competing interests. Bankruptcy laws, and those about which debts can be discharged, are the result of a constant political tug of war between creditors and debtors over the last few centuries. There have been lots of compromises, which has resulted in a bunch of hair-splitting laws. 

To give some perspective, believe it or not the original bankruptcy laws in England—from which our bankruptcy laws came—did not include ANY discharge of debts. Bankruptcy was originally designed as a procedure to help creditors collect from debtors, not at all as a legal means of protecting debtors from creditors. So there was no perceived need for a discharge of debts—the creditors could just continue chasing their debtors after the bankruptcy procedure was done!

But Let’s Get Practical

The present reality is much more positive, and usually pretty straightforward:

#1:  All debts are discharged, EXCEPT those that fit within a specified exception.

#2:  There are quite a few of exceptions, and they may sound like they exclude many kinds of debts from being discharged. It may also seem like it’s hard to know if you will be able to discharge all your debts. But it’s almost always much easier than all that. As long as you are thorough and candid with your attorney, he or she will almost always be able to tell you whether you have any debts that will not, or may not, be discharged. Most of the time there are no surprises.

#3:  Some types of debts are never discharged. Examples are child or spousal support, criminal fines and fees, and withholding taxes.

#4:  Some other types of debts are never discharged, but only if the debt at issue fits certain conditions. An example is income tax, with the discharge of a particular tax debt depending on conditions like how long ago those taxes were due and when its tax return was received by the taxing authority.

#5:  Some debts are discharged, unless timely challenged by the creditor, followed by a judge’s ruling that the debt met certain conditions involving fraud, misrepresentation, larceny, embezzlement, or intentional injury to person or property.

#6:  A few debts can’t be discharged in Chapter 7, BUT can be in Chapter 13. An example is an obligation arising out of a divorce other than support (which  can never be discharged).

The Bottom Line

#1: For most people the debts they want to discharge WILL be discharged. #2: An experienced bankruptcy attorney will usually be able to predict whether all of your debts will be discharged. #3: If you have debts that can’t be discharged, Chapter 13 is often a decent way to keep those under control. More about that in my next blog post about Chapter 13.

 

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You Can Write Off Some Income Taxes with a “Straight Bankruptcy”

Chapter 13 can be a great way to deal with tax debts. But you don’t always need it, or its 3-to-5-year payment plan.

 

Chapter 7 vs. 13 for Income Taxes

Thinking that the only way to handle your income tax debts in bankruptcy is through Chapter 13 is a misunderstanding of the law. It’s an angle on the broader error thinking that you can’t write off taxes in a bankruptcy.

Both are understandable mistakes.

It is true that some taxes cannot be discharged (legally written off) in bankruptcy. But some can be.

And it is true that Chapter 13 can be the best way to solve many income tax problems. But that does not necessarily mean it is the best for you. Chapter 7 might be instead.

When Chapter 13 Is Better

Chapter 13 tends to be the better option if you owe a string of income tax debts, and especially if some are relatively recent ones. That’s because in these situations Chapter 13 solves two huge problems in one package.

First, if you owe recent income taxes which cannot be discharged, you get lots of advantages under Chapter 13, including paying less by avoiding most penalties and interest. That can be a huge savings, especially if you can afford only relatively small payments. Indeed the amount you pay each month is based on what you can afford to pay. You can often even hold off on paying anything towards the back taxes while you first pay even more important debts—such as back child support, or home mortgage arrearage.

Second, if you have older back taxes, under Chapter 13 you pay these only to the extent that you can afford to do so after first paying your more recent taxes. Then whatever of these older taxes are not paid during your case are discharged at the end of it.

When Chapter 7 is Better

But you don’t need the Chapter 13 package if all or most of your income tax debts are dischargeable. In that situation, the generally much simpler Chapter 7 could be enough.

So, what makes an income tax debt dischargeable under Chapter 7?

The Conditions for Discharging Income Taxes

Some of the conditions for determining which taxes can be discharged are quite straightforward, but some are more complicated. It’s not as simple as applying a simple formula to any particular tax debt to see if it is dischargeable. Figuring out whether a particular tax debt will be discharged requires the careful judgment of an experienced attorney.

The conditions for discharging income taxes are listed here, and then will be explained in the next blog. As listed, they may well not make perfect sense, so make sure you see the next blog post.

To discharge an income tax debt in a Chapter 7 case, it must meet these conditions:

1) 3 years since tax return due: The tax return for the pertinent tax must have been due more than three years before you file your Chapter 7 case. Also, if you requested any extensions for filing the applicable tax returns, add that extra time to this three-year period.

2) 2 years since tax return actually filed: Regardless when the tax return was due, you must have filed at least two years before your bankruptcy is filed in court.

3) 240 days since “assessment”: The taxing authority must have assessed the tax more than 240 days before the bankruptcy filing.

4) Fraudulent tax returns and tax evasion: You cannot file a “fraudulent return” or “willfully attempt in any manner to evade or defeat such tax.”

These four conditions need clarification, which will be provided in the next blog post.

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The Persistent Myth About Taxes and Bankruptcy

Many people believe that bankruptcy can’t write off any income taxes. Even attorneys sometimes perpetuate this myth.


Occasional Attorney Misinformation

The following dialog was found on a video of a bankruptcy attorney’s website showing the attorney being interviewed. In response to a question by the interviewer whether there were some debts that can’t be “touched” in a bankruptcy, the attorney responded:  

“Absolutely. Things like child support, alimony, uh, tax debts, student loans. Those generally aren’t dischargeable.”

The interviewer: 

“So the government’s gonna help you eliminate some of the debt in a bankruptcy. But not the debt to them.”

The attorney quipped:

“Not theirs, of course!”

Putting tax debts in the same category as child support and alimony—which indeed cannot ever be legally written off, or discharged—is wrong because income taxes CAN be discharged, as soon as they are old enough.

It is at the very least highly misleading for the attorney to say that tax debts “generally aren’t dischargeable” while including it with support debts that are never dischargeable, or student loans which are very rarely dischargeable.

Upcoming Answers about Taxes and Bankruptcy

Through the next few blog posts, you’ll learn what taxes can be discharged and what can’t. The fact is that bankruptcy can discharge taxes of many types and in many situations. Sometimes ALL of a taxpayer’s taxes can be discharged, or most of them. But there ARE significant limitations, which I will explain carefully.

Bankruptcy Can Help Deal with Taxes in Many Ways Beyond Potentially Writing Them Off

Besides the possibility that you will be able to discharge some or all of your taxes, bankruptcy can also:

1. Stop the tax authorities from garnishing your wages and bank accounts, and levying on (seizing) your personal and business assets.

2. Prevent them from gaining greater leverage against you, through tax liens and cumulating penalties and interest.

3. Avoid being forced to pay monthly payments directly to the tax authorities, with the monthly amounts dictated without sufficiently considering your other legal obligations and reasonable living expense.

Overall, bankruptcy gives you unique leverage against the IRS and/or your state/local tax authority. It gives you a lot more control over a very powerful class of creditors. Your tax problems are resolved not piecemeal but rather as part of your entire financial package. So you don’t find yourself focusing on your taxes while worrying about the rest of your creditors. 

 

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