Three Big Ways Bankruptcy Helps with Income Taxes

Bankruptcy CAN 1) legally write off some income taxes; 2) stop IRS wage garnishments, bank account levies, and tax liens; and 3) enable a faster payoff of the taxes you must pay, by avoiding most ongoing interest and penalties.

In the last two blogs I explained what happens to tax refunds in Chapter 7 and 13. But what if instead you owe income taxes? The treatment of tax debts in bankruptcy is a complicated subject, but here today I’m covering the most basic and important powers of bankruptcy over taxes.

1) The ability to “discharge” (write-off) income taxes:

I’m not going into the detailed rules here, but let me clear up any possible confusion: income taxes can be discharged if they meet some very specific conditions. Among those conditions:

  • the age of the particular tax
  • whether and when the tax return was filed
  • whether there was any effort to enter into an “offer in compromise”
  • whether there is evidence of tax evasion

Generally the older the tax, the more likely it will be discharged, although some of the conditions are not time-based.  If you owe more than one year of income taxes, then each year of tax debt is analyzed separately. In fact portions of each tax year’s debt—tax, interest, and penalties—are treated differently in many situations. To be clear, taxes can be discharged under either Chapter 7 or Chapter 13. So determining which of these two options is better requires carefully comparing how each treats your tax debts, as well as all your other debts.

2) The “automatic stay” applies to the IRS, and to the state and local taxing authorities:

Changes in the law tend to cause confusion, to get blown out of proportion. The last major overhaul of the bankruptcy laws by Congress in 2005 allowed the IRS and other tax agencies to do certain very limited things in spite of the taxpayer having filed a bankruptcy. These limited exceptions to the automatic stay include:

  • conducting (or continuing) a tax audit (but not taking any action outside the bankruptcy court to collect the tax resulting from the audit)
  • issuing a notice of deficiency
  • assessing the taxes
  • issuing a “notice and demand” (although again without taking any collection action)

Otherwise, just like all other creditors, the IRS and its state and local cousins cannot pursue collection of any liabilities while your bankruptcy case is pending, except in the unusual event that the bankruptcy court gives special permission to do so.

3. As for taxes that cannot be discharged, Chapter 13 usually provides a way to avoid most ongoing interest and penalties, reducing the total amount of taxes to pay:

Back taxes often take a long time to pay off because interest and penalties keep accruing while you are making the payments. Especially if your payments are relatively small, the additional interest and penalties can greatly increase the total you end up paying. But in a Chapter 13 case, the penalties stop accruing as soon as soon as your case is filed. Even the earlier penalties are treated like normal debt and so are often paid little or not at all. And interest does not get added unless that tax debt is covered by a recorded tax lien.  In combination these benefits can save lots of money. This lack or reduction in accruing interest and penalties also allows you to pay other important debts before paying the taxes—such as vehicles or home mortgage arrears. This allows you to better protect those valuable possessions by paying their debts faster.

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Income Tax Refunds in a Chapter 13 Case

Chapter 13 gives you more flexibility about what you can do with your current income tax refund. But unlike Chapter 7 which doesn’t care about your future years’ refunds, Chapter 13 does.

As I said in my last blog, if you file a Chapter 7 bankruptcy after the beginning of the year, at a time when you’re still due a tax refund on the year that just passed, your trustee is going to be very interested in that refund. It’s your money that the government is simply holding for you until you claim it.  That’s true even if you haven’t yet filed your tax return, or don’t even know the amount of the refund. Whatever the amount, it’s still your money—you just haven’t yet claimed it or calculated the amount by filing the tax return. So unless that refund fits within an exemption, or is small enough to not be worth the trustee’s bother, the trustee is going to get that refund.

Chapter 13 comes with some good news and some bad news on tax refunds.

The good news comes from Chapter 13’s flexibility when it comes to assets that are not exempt. In a Chapter 7 case, non-exempt assets simply go to the trustee to be distributed to creditors according to a very rigid formula.  In Chapter 13, in contrast, you may be able to use that refund in two very beneficial ways.

First, you may be able to get permission to use the refund, or a part of it, for a necessary, one-time expense. A standard example is a critical vehicle repair, needed to be able to commute to work. The expense usually needs to be an extraordinary one, over and beyond what would be included in your standard monthly budget.

Second, to the extent that you are required to pay the refund over to the trustee, in a Chapter 13 case you usually have somewhat greater control over where that money will go. Your attorney might be able to explicitly earmark, through a specific provision in your Chapter 13 plan, where the trustee pay some or all of that refund. More likely, in certain cases, with careful wording of your plan, your attorney may be able to nudge that money in a particular direction that may be more favorable to you. For example, a vehicle that you need to keep could be paid off faster than otherwise, thus taking away from that creditor any grounds for objecting.    

Now the not-so-good news. One positive aspect of Chapter 7 is that it’s fixated on what assets you have a right to as of the moment your case is filed.  But Chapter 13 is by its very nature also interested in your future income during the three to five years that you are expecting to be in the case. And for most purposes future tax refunds are considered future income. So your Chapter 13 plan has to account for the tax refunds that you would be receiving during the years that you are in the case. In most cases that means that you must turn over your tax refunds to the trustee to be paid out according to the terms of your plan.

The truth is that this is not necessarily bad:

  • If you usually get large tax refunds, your withholdings should likely be adjusted so that you can put that money to use during the year for your regular living expenses. This is especially helpful if your budget is tight. Doing so would reduce the size of the refunds going to the trustee, minimizing this problem.
  • In some situations, a year or two into a case you may be able to get permission to use that year’s tax refund for a new special expense, such as ,again, for a new vehicle repair.
  •  Even if the refunds do just go to the trustee during the course of your case, sometimes that extra money flowing into your Chapter 13 plan finishes your case faster, in other cases it may result in important creditors being paid more quickly, and finally sometimes the refunds may enable you to pay off the plan within the mandatory maximum deadline.
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Income Tax Refunds in Chapter 7 Bankruptcy

Can you keep your tax refund if you file a Chapter 7 case? It’s mostly a matter of timing.

 

Here are the bullet points:

  • Everything you own at the time your Chapter 7 bankruptcy case is filed becomes your “bankruptcy estate.” Usually, most or all of that “estate” stays in your possession and you get to keep because it’s “exempt,” or protected.
  • That “estate” includes not only your tangible, physical possessions, but also intangible ones—assets you own that you can’t physically touch—such as money owed and not yet paid to you.
  • Depending on the timing, a tax refund can be an intangible asset that becomes part of your bankruptcy estate. Then whether you can keep it or not depends on whether it is exempt.
  • Because an income tax refund usually consists of the overpayment of payroll withholdings, the full amount of that refund has accrued by the time of your last payroll withholding of that tax year. So even though nobody knows the amount of your refund until your tax return is prepared a few weeks or months later, for bankruptcy purposes it is all yours as of the very beginning of the next year.
  • So if you file a Chapter 7 case after the beginning of the following year and before you have received your tax refund, it is part of your bankruptcy estate and the trustee can keep it if it is not exempt, or can keep as much of it as it not exempt. That’s also true if you have received the refund and not done anything with it.
  • You can avoid this by filing your tax return and receiving and appropriately spending the refund before your Chapter 7 case is filed. DO NOT do this without very specific advice from your attorney. The bankruptcy system is very interested in what money you receive and precisely how you spend it before filing bankruptcy, and you can very easily get into trouble if this is not all done very carefully.
  • If the bankruptcy is filed so that the refund is an asset of the bankruptcy estate, whether or not it is exempt depends on how large it is and how much of an exemption is allowed in your state. In some cases, using all or part of an exemption for the tax refund may reduce the availability of the exemption for other assets.
  • Some states have specific exemptions applicable to certain parts of the tax refund, or laws that exclude them from the bankruptcy estate altogether, particularly regarding the Child Tax Credit or the Earned Income Tax Credit. These likely do not exist in a majority of the states, but it’s worth checking.  
  • Even if the refund, or a portion of it, is not exempt, the Chapter 7 trustee may still NOT claim it if he or she determines the amount is not enough to open an “asset case.” That is, the amount of refund to be collected is so small that the benefit of distributing it to the creditors is outweighed by the administrative cost involved. You might hear a phrase similar to the amount being “insufficient for a meaningful distribution to the creditors.” This threshold amount can vary from one court to another, indeed from one trustee to another, so be sure to discuss this with your attorney. But note that if the trustee is collecting any other assets, then most likely he or she will want every dollar of tax refunds that are not exempt.
  • There is a risk that you will not be able to claim an exemption if you don’t list the tax refund to which the exemption applies. So be sure to always list any tax refund to which you may be entitled.
  • Although I’m focusing on this issue now because we are in tax season, the same principles apply year-round. Frankly, it can be a little harder to wrap your brain around this as applied to, say, filing a bankruptcy in the middle of the year. As of July 1, you’ve had a half-year of tax withholdings deducted from your paychecks and forwarded by your employer to the taxing authorities. So, assuming the same amounts were withheld throughout the year, if you end up getting a substantial refund the following spring, for bankruptcy purposes about half of that had accrued by mid-year. So a bankruptcy filed on July 1, needs to take that into account. Some Chapter 7 trustees don’t push this issue much until the last quarter of the year, when that much more of the refunds have accrued. But regardless, tell your attorney about income tax refunds anticipated the following year, particularly if you have a history of relatively large tax refunds.

 

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Business Disputes that Get Dragged Into Your Bankruptcy Case

Creditors can challenge your ability to legally discharge your debts in a bankruptcy case. These challenges happen more so in bankruptcy cases filed to clean up after the close of a business. Avoid the creditor challenges for a cleaner case.

Bankruptcies filed after the close of a business seem to attract more creditor challenges to the discharge of debts for a number of reasons:

1. The amounts at issue tend to be larger, making litigation more tempting for the creditor.

2. Certain debtor-creditor relationships can become deeply personal, and so when things go badly, can turn very antagonistic. So in debts between ex-business-partners, or between a business owner and his or her financial supporter or investor, or the buyer and the seller of a business, the aggrieved creditor is more reluctant to let the debt be discharged without a fight.

3. For business owners trying to keep their businesses afloat, desperate times call for desperate measures, so they edge into risky behavior that exposes them to future challenge in bankruptcy court.

4. In these kinds of close creditor-debtor relationships, the creditor often knows something about the debtor’s risky behavior, making it more likely to be raised later in court.

On the other hand, when former business owners considering bankruptcy hear that any creditor can raise challenges to the discharge of its debt, they often feel that will inevitably happen in their case. But such challenges are in fact relatively rare, for the following legal and practical reasons:

1. The legal grounds under which challenges to discharge can be raised are relatively narrow. Instead of just proving the existence of a valid debt—as in a conventional lawsuit to collect on a debt—the creditor has to prove that the debtor engaged in behavior such as fraud in incurring the debt, embezzlement, larceny, fraud as a fiduciary, or intentional and malicious injury to property.

2. In bankruptcy, the debtor files under oath a set of extensive documents about his or her finances, and is also subject to questioning by the creditors about those documents and about anything else relevant to the discharge of the debts. When these documents, along with any questioning, reveal that the debtor genuinely has nothing worth chasing—as is most often the case—this tends to cool the anger of most creditors. Only the most motivated of creditors will be willing to throw the proverbial good money after bad in the hopes of getting nothing more than a questionably collectible judgment.  

So in a closed-business bankruptcy case we have these two opposing tendencies—more likely to have challenges to the discharge of significant debts, especially by certain kinds of closely related creditors, but these challenges are still relatively rare because of the narrow legal grounds for them and the financial practicalities involved. It is impossible to predict perfectly something that is largely outside of the control of the debtor. But a good bankruptcy attorney will give you good counsel about this, prepare your paperwork in the best possible way to counter any such challenges, and may even be able to defuse them before they are raised. A dischargeability challenge is very expensive to defend and can turn a relatively simple bankruptcy case into a very involved one. So avoiding one if possible, or positioning well for it if it is raised, are important reasons to have an experienced and conscientious bankruptcy attorney in your corner. That’s all the more true if you have reason to believe that any of your business creditors are in fact considering raising such a challenge.

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Taxes in a Closed-Business Bankruptcy Case

Dealing with taxes from a failed business through a bankruptcy—that sounds complicated. But I’m going to keep it simple here. What are your basic options if you owe taxes after closing down a small business?

You have two choices (once it’s clear that you need to file a bankruptcy because of the amount of your debts):

1. File a Chapter 7 case to discharge (legally write-off) all the debt that you can, perhaps including some of the taxes, and then deal directly with the taxing authorities about the remaining taxes.

2. File a Chapter 13 case to discharge all the debt that you can, perhaps including some of the taxes, and then pay the remaining taxes through that same Chapter 13 case.

In real life, especially after a messy situation like the shutting down of a business, many factors usually come into play in deciding whether a Chapter 7 or 13 is better for you. But focusing here only on the taxes, it comes down to this core question: Would the amount of tax that you would still owe after completing a Chapter 7 case be small enough so that you would reliably be able to make reasonable arrangements with the Internal Revenue Service (or other applicable taxing authority) to satisfy that obligation within the following two years or so?

Chapter 13 protects you from the collection powers of the taxing authorities during the usual three to five years while you are fulfilling your obligations under the case.  You should be in a Chapter 7 case only if you don’t need that protection. That means your attorney needs to be able to tell you 1) what tax debts will not be discharged in a Chapter 7 case, and 2) what payment or other arrangements will you likely be able to make to take care of those remaining taxes.  

How reliably anyone can predict how a particular taxing authority will respond about a surviving tax debt depends on the circumstances. For example, the IRS has some rather straightforward policies about how long a taxpayer has to pay off income tax obligations below a certain amount. In contrast, predicting whether or not the IRS will accept a certain “offer-in-compromise” can be much more difficult to predict.  If you cannot get rather strong assurances that you will be able to reasonably handle what the taxing authorities will require, you may well be better off within the protections of Chapter 13.

Not only does Chapter 13 give you protection from the tax authorities, you would likely be permitted to pay less to them per month towards the not-discharged taxes. That’s because your living expense budget in a Chapter 13 case will likely be more reasonable than when you’re dealing directly with the IRS after a Chapter 7 case. Furthermore, unlike the after-Chapter 7 situation, penalties would not continue to accrue, and in most cases neither would interest. As a result, in a Chapter 13 case most likely you would pay less money to finish off the tax debt.

Again, the bottom line: once you know how much tax debt will survive a Chapter 7 case, do you have a reasonable and reliable means of paying it off or settling it within about two years? If so, do the Chapter 7 case. Otherwise, take advantage of the greater protection and likely more reasonable budgeting in Chapter 13.  

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“Asset” and “No Asset” Closed-Business Chapter 7 Cases

When the sole proprietor of a just-closed business files a personal Chapter 7 bankruptcy case, the trustee may or may not have assets to liquidate and distribute to the creditors. If NOT, the case will more likely be finished faster. But if the trustee DOES collect some assets, the extra time may be worth it for the former business owner.  

If you’ve closed down your business and as a result are now personally liable on large debts that you cannot pay, you may well be wondering whether bankruptcy is your best option. Assuming that you qualify for a Chapter 7 “straight bankruptcy,” one important issue to consider is whether your case would likely be an “asset” or “no asset” one.  An “asset case” is one in which the Chapter 7 trustee collects assets from you to sell, and then distribute their proceeds to your creditors. A “no asset case” is one in which the trustee does not collect any assets from you because your assets are either protected by “exemptions” or are not worth the trustee’s efforts and expense to collect.

Generally a “no asset case” is simpler and quicker than an “asset case,” although not necessarily better. It’s simpler because it avoids the entire liquidation and distribution process. A simple “no asset case” can be completed about three months after it is filed (assuming other kinds of complication do not arise).  In contrast, it takes at least a number of additional months for a trustee to take possession of an asset, sell it in a fair and open manner with notice to all interested parties, give creditors the opportunity to file claims on the sale proceeds, object to any inappropriate claims, and then distribute the funds to the creditors.  Some assets—especially intangible ones such as a debtor’s disputed claims against a third party—can take several years for the trustee to negotiate and/or litigate in order to convert it into cash, with the bankruptcy case kept open throughout this time.

In spite of this seeming disadvantage, an “asset case” can be better for a former business owner in certain circumstances.

First, a business owner may decide to close down a business and file a bankruptcy quickly afterwards to hand over to the trustee the headaches of collecting and liquidating the remaining assets and paying the creditors in a fair and legally appropriate way. After fighting for a long time to try to save a business, the owner may well be emotionally spent and in no position to try to negotiate work-out terms with all the creditors. There is unlikely sufficient money available to pay an attorney to do this. And if there are relatively few assets compared to the amount of debts—the usual situation—it’s likely that after all that effort the former owner will still owe an impossible amount of debt.

And second, that former business owner may want his or her assets to go through the Chapter 7 liquidation process if the debts that the trustee will likely pay first are ones that the former business owner especially wants to be paid. The trustee pays creditors according to a legal list of priorities. Without going here into the details of that long priorities list, at the top of the list are child and spousal support arrearages. Also high on the list are certain employee wage, commission, and benefits claims, as well as certain tax claims. He or she may well feel a special responsibility to take care of the ex-spouse and children, former employees, and taxes. And the fact that he or she would likely continue being personally liable on these obligations after the bankruptcy is over undoubtedly adds some motivation.

A “no asset” personal Chapter 7 case can be a relatively quick and efficient way for a former sole proprietor to put the closed business legally into the past. While an “asset” case can take somewhat longer, it can help pay some of the special creditors you want to be paid anyway.

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Will You Benefit from the Just-Completed $26 Billion Home Mortgage and Foreclosure Settlement?

The long-awaited joint federal-state settlement with the major banks for their alleged fraudulent documentation and processing of mortgages and foreclosures was announced on Thursday, February 9. Will it help you, and if so, how?

I interrupt my ongoing series on small business bankruptcy to answer your most immediate questions about this huge settlement.

1. Who is included in this settlement?

  • Only five big banks are currently signed on: Bank of America, Wells Fargo, J.P. Morgan Chase, Ally Financial and Citigroup.  Only mortgages owned and held by them are directly affected.  Negotiations continue with nine other mortgage servicers, which if successful could bring the total amount of money involved to $30 billion.
  • 49 states joined in the settlement; only Oklahoma did not.
  • Mortgages held by Fannie Mae and Freddie Mac—consisting of the majority of U.S. mortgages—are NOT covered.

2. What does this settlement resolve and what is open for further negotiation and litigation? In other words, what liabilities are the banks escaping from for their $26 billion?

  • The claims against the banks that are released in this settlement are limited to mortgage servicing and foreclosure claims. Claims for a variety of other alleged wrongdoing are not covered and so remain open to being pursued by the federal and state regulators, investors, and homeowners. Claims that are NOT covered include those related to the securitization of mortgage-backed securities that were at the heart of the financial crisis, and those against or involving MERS (Mortgage Electronic Registration Systems).
  • Individuals’ rights to bring their own lawsuits or to be part of a class action against any banks for any claims are not affected by this settlement.
  • The settlement does not limit any potential criminal liability for any individuals or financial institutions; it provides no immunity from prosecution whatsoever.

3. How does the settlement help you if your mortgage is held by one of these five banks?

  • If you need a mortgage loan modification, these servicers will (finally!) be required to offer principal reductions, for first and second mortgages, to a value of up to $17 billion. This is where the bulk of the settlement funds are earmarked.
  • If you’re current on your mortgage but your home is worth less than the mortgage, $3 billion of the settlement is to provide refinancing relief.
  • If your home has already been foreclosed, $1.5 billion will be paid out by the banks as a penalty against them–around  $2,000 per homeowner–without you needing to show any damages or releasing any claims against the bank.

4. Where do you go for more information and to find out whether you will be helped in any of these ways?

  • Go to the new settlement website for current and upcoming information about it:

http://www.nationalmortgagesettlement.com

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Keeping It Simple in a Closed-Business Chapter 7 Case

Using a Chapter 7 case to clean up after closing down your business will be easy or not depending largely on three factors: business assets, taxes, and other nondischargeable debts. These three will usually also determine if you should be in a Chapter 7 case or instead in a Chapter 13 one.

Once you’ve closed down your business and decided to file bankruptcy, you may have a strong gut feeling about choosing the Chapter 7 option. After what you’ve been through, you just want a fresh, clean start. If you’d put years of blood, sweat and tears into trying to get your business to succeed, and then finally had to throw in the towel after resisting doing so for so long, at this point you likely feel like it’s time to put all that behind you. The last thing you likely feel like doing is dragging things along for the next three to five years that a Chapter 13 case usually lasts.

And you may well be ABLE to file a Chapter 7 case. The “means test” largely determines whether, given your income and expenses, you can file a Chapter 7 case. In my last blog I told you that you can avoid the “means test” altogether if more than half of your debts are business debts instead of consumer debts. But even if that does not apply to you, the “means test” will still not likely stand in your way, especially if you just closed down your business recently. That’s because the period of income that counts for the “means test” is the six full calendar months before your bankruptcy case is filed. An about-to-fail business usually isn’t generating much income.

But usually the question is not whether you are able to file a Chapter 7 case, but rather whether doing so is really better for you than a Chapter 13 one.

Many factors can come into play, but the following three seem to come up all the time:

1. Business assets: There are two kinds of Chapter 7 cases: “no asset” and “asset.” In the former, the Chapter 7 trustee decides—usually quite quickly—that none of your assets (which technically belong to your “bankruptcy estate”) are worth taking and selling to pay creditors. Either all those assets are “exempt” from the reach of the trustee, or are not worth enough for the trustee to bother. But with a recently closed business, there are more likely to be assets that are not exempt and are worth the trustee’s effort to collect and liquidate. If you have such collectable business assets, you will want to discuss with your attorney where the anticipated proceeds of the Chapter 7 trustee’s sale of those assets would likely go, and whether that is in your best interest compared to what would happen to those assets in a Chapter 13 case.

2. Taxes: Just about every closed-business bankruptcy seems to involve tax debts. Although some taxes CAN be discharged in a Chapter 7 case, most cannot. Chapter 13 is often a better way to deal with taxes. This will depend on the precise kind of tax—personal income tax, employee withholding tax, sales tax—and on a series of other factors such as when the tax became due, whether a tax return was filed, if so when, and whether a tax lien was recorded.

3. Other nondischargeable debts: Bankruptcies involving former businesses seem to get more than the usual amount of creditor challenges to the discharge of debts. These challenges are usually based on allegations that the business owner acted in some fraudulent fashion against a former business partner, a business landlord. or some other major creditor.  Such litigation, often started or at least threatened before the bankruptcy is filed, can turn an otherwise simple bankruptcy case into a long and expensive battle, regardless whether your case is a Chapter 7 or 13. But depending on the nature of the anticipated allegations, Chapter 13 may give you certain legal and tactical advantages over Chapter 7.

I’ll expand on these three one at a time in my next three blogs. From them you will be able to get a much better idea whether your business bankruptcy case should be in a Chapter 7 or not, and if so whether it will likely be relatively simple or not.

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Getting a Fresh Financial Start After Closing Down Your Small Business

Closing down a business can be messy. A bankruptcy filed to deal with its financial fallout is often more complicated than a normal consumer bankruptcy case. But not necessarily.  In one respect at least, a business bankruptcy can actually be much easier than a consumer one.  

If you’ve owned a small business that you have already shut down, or are about to, you may be afraid of filing bankruptcy because you’ve heard that “business bankruptcies” are terribly expensive and not a good way to wrap up the affairs of a business. In the next few blogs I will address this concern by showing ways that bankruptcy can be a relatively simple and effective solution.

Today I start with a little twist in the “means test” that favors certain former business owners over normal consumers.

The “means test” determines whether you may file a “straight” Chapter 7 case to discharge your debts in a matter of a few months, or instead must file a 3-to-5-year Chapter 13 payment case. Unless you need some of the other benefits of Chapter 13, Chapter 7 is usually preferred because it gets you to a fresh start much more quickly and cheaply.

In many situations, a former business owner will NOT be able to pass the means test and so will be required to go through Chapter 13. For example:

  • If, after closing her business a business owner succeeded in getting a good job before filing bankruptcy, the income from that job may be higher than the “median income” applicable to her state and family size. So she may well not pass the “means test.”
  • If the business was operated by one spouse while the other continued working and earning a decent income, that other spouse’s income alone may bump the couple above their applicable “median income,” again with the result of not passing the “means test.”
  • If a debtor’s income is higher than the applicable “median income,” he may still be able to pass the means test by deducting from his income his actual and/or approved expenses. But a former business owner will not be able to deduct monthly payments to secured creditors on business collateral he is surrendering—vehicles and equipment, for example—or for other business expenses, such as rent on the former business premises. This reduces the likelihood that he will have enough allowed expenses to pass the “means test.”

But here’s the good news for some former business owners: the “means test” only applies if your “debts are primarily consumer debts.” (See Section 707(b)(1) of the Bankruptcy Code.) So if your debts are primarily business debts—more than 50%–you essentially can skip the “means test.”

Careful, because by “debts” the law means all debts, including home mortgages and personal vehicle loans. So your business debts will usually have to be quite high to be more than all your consumer debts.

And to apply this law we must be very clear about the difference between these two types of debts. So what’s a “consumer debt”? The definition may sound familiar: it’s a “debt incurred by an individual primarily for a personal, family, or household purpose.” (Section 101(8).)  So, for example, if you took out a second mortgage on your home a few years ago explicitly to fund your business, the current balance on that second mortgage would not likely be a consumer debt.

Sometimes the line between these is not clear, so this is something you need to discuss thoroughly with your attorney if you want to avoid the “means test” under this “primarily business debts” exception.

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Massive Mortgage Settlement Finally Coming Together

The multibillion-dollar deal, more than a year in negotiations between the biggest home mortgage servicers on one side and the states’ attorneys general and federal agencies on the other, may be just days from being finished. The deadline for each state’s attorney general to decide whether to sign was Friday, February 3, but that has now been extended to Monday, February 6.

This settlement is to resolve allegations about an extensive series of foreclosure and mortgage loan-servicing abuses that came to light in the summer and fall of 2010. State and federal officials have since then been negotiating an agreement with five major mortgage servicers. It would provide some very specific mortgage relief to homeowners and would establish strict requirements for how banks could conduct foreclosures. The negotiations have gone back and forth, with various proposals being floated, resulting in very public displays of protest by various bank-friendly sets of attorneys general on one hand and by other more aggressive attorneys general on the other. A settlement now looks imminent, in large part because of the timing of the current election cycle, as well as the dire need for progress on the never-ending home foreclosure front —and because this has dragged on for so long.

Since this story is evolving every day, I’m going to provide you with a few recent news articles about it, introducing each one to help you decide if you want to look at it.

This USA Today article gets right to what we all care about, “Who benefits from possible $25B mortgage settlement?”  It’s actually a good summary—in a Q&A format—of the likely terms of the settlement and its effects on homeowners and the housing market. Some of the questions include: “How might the $25B be spent?” “Who will get [mortgage] principal reductions?” “How tough are the potential settlement terms on the banks?

“Mortgage deal would give states enforcement clout” from Reuters addresses the concern “that banks have not adequately followed through on prior settlements, a concern that has pushed government negotiators to establish more forceful enforcement mechanisms in this deal than have been used in the past.” So this deal gives the states, along with a separate “monitoring committee,” the power to go to court to enforce the terms of the settlement and to ask for penalties of up to $5 million per violation.

And if you want to get a taste of how complicated these negotiations have been on the technical side (without even accounting for the intense political pressures), here is a letter dated January 27, 2012 from the Nevada Attorney General to the officials who have been spearheading the settlement. In the letter, she asks for written answers to 38 questions so that her state can decide whether or not to sign on to the settlement. It’ll make your head spin. Don’t say I didn’t warn you.

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