Chapter 13 can be a stronger and more flexible tool for dealing with priority debts than Chapter 7.

The last blog explained how sometimes Chapter 7 can be a good tool to pay or reduce your priority debts. Priority debts are ones specially designated in bankruptcy law to be treated better than you ordinary debts.

For consumers, the most common priority debts are back child/spousal support payments and taxes. But as the last blog showed, you need to have a relatively unusual “asset” Chapter 7 case, meaning that you need to have an asset or assets that is not protected—not exempt—that you would surrender to the trustee.

It helps if when that asset is sold by the trustee the sale proceeds would be enough to pay off your priority debts, after paying any costs of sale (such as a broker’s commission) and the trustee’s fee.

Chapter 13 is much more likely to apply to your circumstances if you owe a bunch of priority debts.

Here are some ways that it is better than Chapter 7, and better than trying to pay your priority taxes or back support without any bankruptcy.

1. Be protected from the priority creditors: Tax authorities and state support agencies have been provided by law with extraordinarily aggressive collection powers against you. These often include the ability to seize your assets; garnish your wages, bank accounts, and business receivables without additional court proceedings; suspend your driving and occupational/professional licenses, and even hunting and fishing licenses.

Some of these collection efforts can even continue when you file a Chapter 7 case, and all can continue as soon as your Chapter 7 is completed, giving you just a three month or so break. In contrast, Chapter 13 stops virtually all of these collection efforts, so long as you comply with the terms of your payment plan, as well as keep current going forward.

2. Stop further accumulating interest and penalties: Usually in a Chapter 13 case, the interest and penalties on priority debt stops being added, and then is discharged at your successful completion of your case. If you have large income tax debt, this can significantly reduce the amount you would pay.

3. Get a more sensible budget: Your monthly obligation under Chapter 13 tends to be based on more realistic expenses than what the IRS or your support enforcement agency will allow..

4. Allows you to favor the priority debt over other debt: Usually you are able to and indeed must pay your priority debt ahead of and often instead of your “general unsecured creditors.” So you are able to concentrate your financial efforts on paying off the debts that are usually in your self-interest to pay anyway.

You may or may not know that all of your debts are not all treated equally in bankruptcy.

Most debts can be “discharged” (legally written-off), but some can’t be, or only in certain situations. Some debts have no collateral—they are unsecured—while other debts are secured by collateral.

A secured debt can be treated differently depending on how much the collateral is worth compared to the amount of the debt it secures, and depending on whether you intend to surrender or retain the collateral.

A handy starting point in understanding debts in bankruptcy is to divide all debts into three categories: secured debts, unsecured debts, and “priority” debts. Today’s blog is on this last category.

Priority debts are a list of special debts which Congress has decided deserve special treatment, and in certain circumstances should get paid through your bankruptcy case ahead of other debts.

For consumers this priority list only comes into play with “asset” Chapter 7 cases and with Chapter 13 cases. This blog will cover the “asset” Chapter 7 cases; the next one will cover Chapter 13.

10 Different Priority Debts

There are 10 different priority debts. They are listed in the Bankruptcy Code in order of priority. So not only do priority debts usually get paid in a bankruptcy case before debts that are not priority debts, the priority debts themselves get paid in the order that they show up on the list.

Most of the 10 different kinds of priority debts are not applicable to a conventional consumer bankruptcy. But two of them are quite common: 1) child and spousal support arrearage, and 2) tax debts of various kinds. The support debt is listed as a higher priority than taxes, and indeed is the highest one on the entire list.

Most Chapter 7 cases are “no asset” ones—all your assets are protected from creditors through “exemptions,” so you keep everything you own and nothing goes to the Chapter 7 trustee to distribute to your creditors.

But in an “asset” Chapter 7 case you own something that is not covered by any exemption, so the trustee can take, sell, and distribute its proceeds to your creditors.

If you have a particular “non-exempt” asset, perhaps something that you do not mind surrendering to the trustee, and if you owe a priority debt, a Chapter 7 case can be way to turn these to your benefit.

Most priority debts are not dischargeable in a Chapter 7 case—such as support arrearage and most debts—so it’s beneficial to have the trustee use your unprotected asset as the means to paying off or paying down a support arrearage or tax.

Here’s an illustration. Assume you own a boat free and clear with a marketable value of $4,000 that you admit that you can’t afford to keep any longer, it is not exempt, and so you would surrender it to your Chapter 7 trustee.

You owe $1,000 in last year’s income taxes, plus $2,000 in back child support. Theoretically you could have sold the boat before filing bankruptcy and paid the taxes and support, but you may not have time if you were trying to stop a garnishment or some other creditor action.

In this case, the Chapter 7 trustee would sell the boat, pay herself a trustee fee (25% of the first $5000 collected, so $1,000 here), pay first the support obligation and then the tax debt. If the boat indeed sold for $4,000, you would finish your Chapter 7 case owing neither of those priority debts, and hopefully with all your other debts discharged.

You can see by this illustration that a carefully planned Chapter 7 can be a good tool in these kinds of situations.

One of the best sources of intelligent information on bankruptcy and related topics is a blog by a bunch of law professors called Credit Slips, “A Discussion on Credit, Finance and Bankruptcy.” (Well, OK, it can get a little heady, but they’re professors, after all.)

In a blog called “Debt Causes Bankruptcy (But Sometimes in Counter-Intuitive Ways) Prof. Robert Lawless, had this to say:

The long-term growth in U.S. consumer bankruptcies closely tracks the long-term growth in U.S. consumer debt. When the financial crisis hit, consumer credit dried up, and outstanding consumer debt experienced unprecedented declines.

There are fewer reasons to file bankruptcy today because there was less borrowing two to three years ago.

Consumer debt also has a profound but perhaps counter-intuitive short-term effect on consumer bankruptcy rates. In the short-run, a decline in consumer credit will lead to a bump in consumer bankruptcy filings.

As people run out of options–as they become less able to put this month’s grocery or utility bills on a credit card–bankruptcy becomes a more attractive option. People can and will continue to borrow to stave off the day of reckoning.

If a lender is willing to extend credit, further borrowing is a rational decision.

The take-away from this: 

1) Most debt is incurred because credit is available. So, more bankruptcies happen when more credit is granted. (The exceptions are debts not based on credit, such as lawsuits for personal injuries or other disputes.)

2) People with debt problems try to avoid filing bankruptcy if possible, so when credit is available to them they will tend to use it instead of filing bankruptcy, or at least will put off filing bankruptcy until they run out of credit. This indicates that people still generally hate filing bankruptcy, avoiding it when they can, even if it often only kicks the can further down the road.

This may sound commonsensical, but shows that the answer to the question in the title is a bit more complicated than it might seem.

The answer is that historically credit availability to consumers has resulted in higher bankruptcy filings, but a short-term increase in credit availability will lower bankruptcy filings on an immediate basis.

Bankruptcy can often help you deal effectively with business taxes. Here are three myths, and the truth exploding them.

Myth #1: Bankruptcy can’t write off taxes.

Truth: Some taxes can’t be written off. But many others CAN be through either a Chapter 7 “straight bankruptcy” or a Chapter 13 “adjustment of debts.” This depends on a number of rather complicated factors, including the following:

  • whether you filed a tax return for the tax year at issue
  • if so, when that tax return was filed
  • how long it’s been since that tax was first due
  • whether and when you asked to get a compromise of that tax
  • whether you tried to evade that tax in any way

So any particular tax you may owe has to be analyzed carefully with your attorney. But don’t start with the assumption that your taxes can’t be written off, or dealt with in some other favorable way.

Myth #2: Business taxes particularly can’t be written off.

Truth: Income that you pay yourself from your business is generally treated as your personal income. And particularly if your business is a sole proprietorship or a partnership, then your share of the business’ income (after expenses) flow through to you as personal income.

If your business is a corporation, then your salary or any other form of income you receive from the business is generally treated as personal income. The income tax on these various sources of “business” income can be written off just like any personal income tax from a conventional employer, depending on the same factors listed above.

If any of your taxes can’t be discharged in either a Chapter 7 or 13 case, Chapter 13 would nevertheless give you 3-to-5 years to pay those taxes, while under the protection of the IRS (and any applicable state tax authorities). Also, usually all interest and penalties which would otherwise have accumulated during this time would be waived, as long as you finished the case successfully.

Furthermore you can often pay less–and maybe even nothing—to your other creditors, allowing instead for your money to go to pay off the taxes. So at the completion of your case you would owe nothing in either taxes or any other debts.

Myth #3: Bankruptcy particularly does not help with unpaid employee withholding taxes that as an employer you were supposed to turn over to the IRS or state.

Truth: Although bankruptcy never discharges this category of taxes, in a Chapter 13 case these withholding taxes are basically treated just like other taxes that can’t be discharged, as discussed immediately above.

So you would have years to pay off those withholding taxes, all while being protected from the tax authorities, and usually with the interest and penalties not accruing.

Finally, usually you’d be allowed to pay these taxes while paying less or nothing to many of your other creditors. These are huge advantages.

Paying for the holidays with credit cards, even at a relatively modest amount, can mean that you will have to pay back those purchases if you file a bankruptcy. That could happen even if at the time you made those purchases you fully intended to repay that credit—in other words, even if you weren’t planning to file a bankruptcy.

The Bankruptcy Code contains some very specific rules about the consequences of using credit to buy “luxury goods or services” during the months before filing a bankruptcy.

If you use a credit card—or any other type of consumer credit—to buy at least $500 of consumer “luxury goods or services” through any single creditor within the 90 days before filing bankruptcy, there is a “presumption” that the debt incurred this way is nondischargeable—that it can’t be legally written off.

Don’t be fooled by the word “luxury” in that rule. That means anything not “reasonably necessary.” Arguably anything not used for survival in not “reasonably necessary.” So even modest Christmas and holiday gifts could be considered “luxuries” for this purpose.

Similar rules apply to the use of cash advances, except that the trigger dollar amount is $750 per creditor, and the period of time is within 70 days before filing bankruptcy, with the same “presumption” that the debt would not be dischargeable.

You may be thinking that these rules only create presumptions, which can be defeated. So that you can still discharge these kinds of debts by showing that you in fact you had every intention of paying them at the time you used the credit. Yes, that true, in theory but not likely in practice. First, coming up with that kind of evidence—proving your intent at some point of time in the past– is usually not easy. And second, and more important, the high cost to bring that kind of evidence to court usually makes trying to do so not worthwhile. Usually the amount of attorney fees it costs you to fight the issue is more than the amount being fought about.

What all this means that if during the holidays you use a credit card or other consumer credit exceeding these dollar limits, and then file bankruptcy within the applicable 70-day and 90-day periods, most likely you will still have to pay for whatever credit was incurred during those periods. You can avoid these presumptions by waiting to file the bankruptcy until after those periods of time have expired, but that’s not always possible. At best you’ll delay getting your bankruptcy filed, and so will delay the eventual resolution of your financial problems. And even if you wait, the creditor can still try to show your bad intention. Avoid all this by not using your credit cards and/or lines of credit whenever there is a sensible chance that you’ll have to file a bankruptcy in the near future.

Especially if you’re thinking about filing bankruptcy, resist the urge to rack up a big credit card bill for Christmas and other holiday gifts.  Otherwise you may find your hands tied about what debts you can write off in bankruptcy or even when you can file your case. But before getting to these legal reasons, there are some more basic ones.

When money is tight, your anxiety about paying for gifts and for special meals clouds the holidays. If you have room on your credit cards, and very little disposable income, the temptation to use the credit cards is just about irresistible. We live in a rather materialistic culture, so when we express our love and affection through gifts we tend to let their price carry too much meaning. We feel that an expensive gift shows how close we are to someone. We also let the gifts we give, and their price, define us and our own worth. We’re no good if you can’t give our loved ones nice gifts. That’s especially true with our spouse or that someone special, and with our kids. If we can’t give our sweetheart something really special, if we don’t fill under the Christmas tree for our kids, then we feel like we are not a very good spouse, friend, or parent. We don’t want to disappoint them, and have them be disappointed in us.

This feeling may be especially intense if there is tension in the marriage, or within the household, often the case when there are intense financial pressures. It can be a vicious cycle.

In our hearts we know that the price of gift is not a true measure of the extent of our love, and certainly that gifts don’t buy love. To help you follow your wiser impulses, here are three suggestions.

First, give gifts appropriate to your financial circumstances, no matter how modest those gifts may be.  That is the only responsible way, and in fact shows your love—especially to family members—a lot more than if you gave gifts you could not afford.

Second, put the energy that you would put into fretting about how to pay for a relatively expensive gift instead into creatively thinking about an appropriately priced perfect gift. Come up with something that reflects the connection between the two of you, one that the person will enjoy but also shows that you really put your heart into it.  

Third, whenever possible communicate honestly with your loved ones about your financial constraints. This has to be done the right way, preserving your own dignity, and appropriate for the relationship—different for extended family, spouse, your children. Instead of being negative, it can be a constructive conversation about priorities, honesty, and what love is really all about.

I know, this is lots easier said than done.

To help motivate you, in my next blog I’ll give you some legal reasons why piling holiday charges onto your credit cards can tie your hands in ways you don’t expect.

What if you are under threat of foreclosure, don’t want to keep your house, but just need a little more time to find another place to live? Or if you just need to finish a pending sale before the scheduled foreclosure happens?

Or maybe you don’t want or need the extra benefits of Chapter 13. Or you just want to put it all behind you in a few months instead of going through a 3-to-5 year Chapter 13 Plan. A Chapter 7 “straight” bankruptcy may give you just the right amount of help.

A Chapter 7 case:

1. Stops a pending foreclosure sale, at least temporarily. Depending on your situation, and the aggressiveness of the mortgage lender, it may buy you an extra few weeks or an extra few months. Chapter 7 does give you much less control over the situation than a Chapter 13, but the extra time it gives you may be enough in your particular situation.

2. It temporarily stops not just foreclosures by your mortgage company, but also by other creditors. This includes foreclosures for unpaid property taxes, homeowner assessments, or judgment lien creditors.

3. Prevents, at least briefly, most kinds of liens from attaching to your house, such as income tax liens, or judgment liens by creditors who have sued you and have not yet gotten a judgment.

So if you have a pending sale of a house which has less equity than your allowed homestead exemption, and need to buy enough time to close the sale before the foreclosure or before a new lien eats into your equity, and need to file some kind of bankruptcy to deal with your debts, filing Chapter 7 may be your best option. Or if you have resigned to losing your house but need to postpone the foreclosure to give you time to save money for rental and moving costs, again Chapter 7 could well be the best tool for you.

Because the amount of time a Chapter 7 will gain for you depends a great deal on the facts of your case, the anticipated actions of your creditors, and sometimes the behavior of your Chapter 7 trustee, be sure to discuss this thoroughly with your bankruptcy attorney. Find out if the comparatively modest help a straight bankruptcy provides is enough help for you.

In most consumer bankruptcy cases you hardly hear about the United States Trustee (UST). But when you do, he or she can make a lot of noise. And carries a big stick. All the more reason to understand this most easily misunderstood player on the bankruptcy stage.

As my title suggests, the UST has two primary roles—case administrator and bankruptcy law enforcer. These are reflected in this agency’s stated mission: “to promote integrity and efficiency in the nation’s bankruptcy system by enforcing bankruptcy laws, providing oversight of private trustees, and maintaining operational excellence.”

As a bankruptcy case administrator, the Office of the UST appoints and supervises the Chapter 7 and Chapter 13 trustees. It monitors cases so that they are “administered promptly and efficiently.” It reviews and can raise objections to fees charged by attorneys and other professionals in the bankruptcy process.

But it’s the enforcement role we care about, which arises mostly in Chapter 7s. We hear from the UST mostly when there is a question about whether a person in a Chapter 7 case should instead be in Chapter 13. This is mostly a matter of income, and whether the case meets a complex set of rules called the “means test.” The UST may assert that the case is an “abuse” of Chapter 7 law and should either be “dismissed” (thrown out) or “converted” to Chapter 13.

The rest of the time we hear from the UST usually involves some kind of alleged misrepresentation by the person filing bankruptcy. This can arise in many ways, but usually involves apparent contradictory information between the bankruptcy documents and other evidence, or between documents and your oral statements at the “meeting of creditors.” The UST may even receive information from outside parties, such as an ex-spouse or ex-business partner, or from public sources, such as real estate or vehicle ownership records.

Lots of times when we do hear from the UST about any of these things, the matter can be resolved favorably. Assuming that you have been completely honest with us, often we can anticipate and address these issues effectively if and when the UST contacts us. But especially if the challenge comes unexpectedly, it’s crucial to address it quickly, honestly, thoroughly.

Our goal is to have your bankruptcy case go as smoothly as possible, but when for whatever reason it does not, we are in your corner to advise and protect you.

Your Chapter 13 trustee plays a huge role in the success or failure of your Chapter 13 case. Except he or she actually has at least a half-dozen different roles. Some of which are contradictory. Let me explain.

1) The trustee serves as the gatekeeper of your case, forcing us to play by the rules before allowing your Chapter 13 Plan to be approved by the bankruptcy judge.

2) As part of that role, the trustee’s job is to make you pay as much as possible to your creditors. Because each individual creditor often doesn’t have all that much to lose or gain compared to the cost of each of them hiring an attorney, the trustee is the creditors’ advocate in your case.

3) The trustee is your disbursal agent, taking in your money and paying it out exactly as your court-approved Plan specifies.

4) During the course of your case, the trustee is your Plan overseer, monitoring your Plan payments and your other obligations, and complaining to the court if you’re not in compliance.

5) The trustee is also your income monitor throughout the course of your case, mostly through annual tax returns that you must file on time and provide to his or her office, and sometimes through additional documentation. If your income rises significantly in a way not provided for in your Plan, the trustee can propose an “Amended Plan” to account for the increase.

6) Through all of this, believe it or not, the trustee is also legally required to be your helper through the Chapter 13 process. The Bankruptcy Code specifically says that the “trustee shall—advise, other than on legal matters, and assist the debtor under the plan.” Different trustees do this quite differently, taking on this helper role more or less seriously. At different points in your case, my staff and I may well suggest that you interact with the trustee’s office in certain specific ways. Always remember that they have a bunch of other roles besides helping you. But also note that on a personal level, the trustee genuinely wants you to have a successful Chapter 13 case, and can sometimes be a good resource to help get you there.

Here’s a good final word on this, from the website of one of the Chapter 13 trustees:

“The role of the chapter 13 trustee is unique. The trustee does not take into his or her possession or control property of the estate. The trustee does not operate the debtor’s business. Rather, the trustee receives payments from the debtor, and disburses those payments to the debtor’s creditors pursuant to the debtor’s plan. The chapter 13 trustee does, however, counsel with and advise the chapter 13 debtor on all matters relating to the plan other than legal matters. In short, the chapter 13 trustee is an amalgam of social worker and disbursing agent.”

My goal with our Chapter 7 clients is to provide a smooth path through bankruptcy to a fresh and clean start. The way to get there is to do what it takes to keep your Chapter 7 trustee happy. We keep the trustee happy by making it easy for him or her to do his or her job.

Think about the trustee being the green-yellow-red lights at two intersections in a row. The first intersection is about assets. The second one is about getting a “discharge,” a legal write-off of your debts. In most cases you’re going to get through both intersections—the trustee will claim none of your assets for distribution to your creditors and the trustee will raise no objections to your discharge. But you want to make sure you get through those intersections, and do so without any worry or delay. That’s our goal—two easy green lights.

The trustee can hit you with yellow caution lights or even prolonged red lights if you do not deal responsibly with your case. You may even lose assets that you did not expect to or, in unusual circumstances, lose your right to a discharge of your debts altogether. Here’s how to keep the trustee happy, and turning on those green lights:

1. Be completely honest and thorough with your attorney. If in doubt, tell me about it. Take the weight off your shoulders and tell me if you’re worried about something. I am on your side. That’s my job. I cannot do my job to protect you if I am blindsided by unexpected facts. And you can imagine how much the trustee is going to trust you if he or she sees that you’re not being honest with your own attorney.

2. When you review and sign the bankruptcy documents, don’t forget to take the “review” part of that very seriously. You are signing most of those documents under penalty of perjury. The trustee relies on their accuracy, and will be quite unhappy to later learn that they are incomplete or inaccurate in some material way. If in doubt about anything, ask me or my staff.

3. Provide information or documents we request from you as quickly as possible. Some of those go directly to the trustee. In most cases the trustee gets paid a measly $60 per case out of your filing fee. Helping to make the job easier for the trustee simply by getting the paperwork to him or her on time goes a long way towards having a happy trustee.

4. At the “meeting of creditors” (which is usually just a short hearing with the trustee), again be completely honest in answering the trustee’s questions. If you have any doubt, ask your attorney who will be with you there.

5. Finally, do what the trustee says. And do so by the deadline provided.

Let’s sail through your Chapter 7 case with two green lights!