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Pre-Bankruptcy Tax Strategies

Get the maximum benefit from your bankruptcy against your taxes by following these sophisticated strategies.

Pre-bankruptcy planning to position a debtor in the best way for discharging or for otherwise favorably dealing with tax debts is one of the more complicated tasks handled by a bankruptcy attorney. Do NOT attempt these strategies, including the five mentioned here, without an attorney, indeed frankly without an attorney who focuses his or her law practice on bankruptcy. Elsewhere in this website I make clear that you cannot take anything in this website, including what I write in these blogs, as legal advice. That’s especially true in this very sophisticated area. Also, I could write a chapter in a book on each of these five strategies, so all I’m doing here is introducing you to them, to begin the discussion when you come in to see me.

1st:  Wait out the appropriate legal periods before the filing of your bankruptcy case.

As you may know from elsewhere in these blogs, most (but not all) forms of income tax become dischargeable after the passing of specific periods of time. Much of pre-bankruptcy tax strategy turns on figuring out precisely when each of your tax liabilities will become dischargeable, and then either waiting to file bankruptcy until all those liabilities are dischargeable, or, when under serious time pressure to file, at least when the maximum amount will be discharged as is possible under the circumstances.

2nd:  File past-due returns to start the clock running on those as soon as possible.

If you know you owe taxes for prior years and don’t have the money to pay them, your gut feeling may well be to avoid filing those tax returns in an attempt to “fly under the radar” as long as you can. But irrespective of any other rules, you cannot discharge a tax debt until two years after the pertinent tax return has been filed. Get good advice about how to deal with the IRS or other taxing authority during those two years so that you take appropriate steps to protect yourself and your assets. You deserve a rational basis for getting beyond your understandable fears about this.

3rd:  Try to stay in compliance with the new tax year(s) while you wait to file your bankruptcy case, by designating tax payments to the more recent tax years instead of older ones.

Because recent tax year tax liabilities cannot be discharged in a Chapter 7 case and must be paid in full as a priority debt in a Chapter 13 case, you want to try to stay current on your most recent tax debts. It’s also usually a necessary step in keeping the IRS and its ilk from taking aggressive action against you, thus allowing you to wait longer and discharge more taxes. With the IRS in particular you can and should explicitly designate which tax account any particular tax payments are to be applied to achieve this purpose.

4th:  Avoid tax fraud and evasion, and whenever possible, withholding taxes.

Simply put, you can’t ever discharge any taxes related to fraud, fraudulent tax returns, or tax evasion, so avoid these kinds of illegal behavior. If you have any doubt, talk to a knowledgeable tax accountant or attorney. Unpaid tax withholdings also cannot be discharged, so either try to avoid them from accruing, focus your resources on paying them off, or just recognize that they will either have to be paid after your Chapter 7 case or as a priority debt during your Chapter 13 case.

5th:  Be aware of tax liens.

Tax lien claims have to be paid in full in Chapter 13, with interest, and can survive a Chapter 7 discharge. So try to avoid having the taxing authority record a tax lien against you—admittedly sometimes easier said than done. Or if that is not possible, at least refrain from building up equity in possessions or real estate. That equity, although often exempt from the clutches of the bankruptcy trustee and most creditors, is still subject to a tax lien. So any built up equity just increases what you will have to pay to the taxing authority on debt you might otherwise been able to discharge completely.

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To Win the Chapter 13 Tax Prize, You Have to Finish the Race

A Chapter 13 case can be such a good tool for dealing with income tax debt, especially if you owe more than just a year or two of taxes. BUT, you lose those benefits if you don’t successfully finish paying off the Chapter 13 plan. So, go into it only if you have both a burning desire to make it all the way and a truly feasible plan with which to do so.

Chapter 13 often enables you to tame the tax debt beast in a very tidy package. Often you can discharge (write off) some of your tax debts, and pay substantially less on the taxes you must pay, by avoiding or reducing interest and penalties. And you can usually do all this while paying less per month and while being protected from all the nasty collection mechanisms in the tax authorities’ arsenal.

However, the truth that you need to keep in the front and center of your mind is that it’s all conditional: you don’t get the prize until the end of the race. And if you don’t get to the end of the race, no prize for you. The prize is the discharge—the discharge of the debts for the tax years that can be discharged, and of the interest and penalties that you would owe if you weren’t in a Chapter 13 case. You have to get through the whole race–pay your plan payments as scheduled and meet the other requirements of your plan (such as sending yearly tax returns to your trustee, and keeping current on any ongoing child or spousal support payments).

Now this doesn’t mean that your Chapter 13 case is inflexible. Depending on the situation, an experienced attorney will likely be able to build some flexibility into the terms of your original plan. Or if your circumstances change, your plan can usually be amended accordingly.

But look at it this way: the IRS and any other tax authorities are put on hold and have to accept the reductions and the write-offs while your Chapter 13 case is proceeding. But in the background they continue tracking what you would owe—including accrued interest and penalties–if you weren’t in a Chapter 13 case.  If at any time during your case you do not comply with the terms of your plan and, after appropriate warnings, your case gets dismissed (thrown out), leaving the tax authorities no longer be prevented from chasing you. At that time all those taxes, interest and penalties that your Chapter 13 case would have avoided would come roaring back at you.

This is something you want to avoid at all cost. How do you avoid getting your Chapter 13 dismissed?

  • Be fully engaged in the process of putting your Chapter 13 plan together at the beginning of your case, so that you understand its terms and truly believe that you can consistently comply with them.
  • Keep track of your progress throughout your case, both to stay motivated and to catch any potential problems early.
  • Inform your attorney if your financial circumstances change, whether they improve, so that you can account for increased disposable income, or if they deteriorate, so that you can reduce your required plan payments or take other appropriate action.
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The Benefits of a “Short Tax Year Election” in an Asset Chapter 7 Case

Your Chapter 7 trustee can use your unneeded assets to pay current-year income taxes if you split the calendar tax year into two: the pre-bankruptcy and post-bankruptcy “short years.”

I’m closing this series on taxes and bankruptcy with three blogs on some relatively sophisticated topics. The tools I discuss do not apply to most cases. But when they do, they can save you a lot of amount of money, and better meet your goals. This first one is a good example.

Let’s first set the scene. If you have substantial income tax liabilities, especially if they are spread over a number of years, Chapter 13 is often the best tool for dealing with them. But a Chapter 13 takes three to five years. Sometimes a Chapter 7 case accomplishes enough so that it’s the better option. If your taxes are old enough and you meet a series of conditions (see my last blog about this), a Chapter 7 case could discharge (legally write off) most or all of your tax debts. But even if Chapter 7 would leave you with a significant nondischargeable tax debt, it might still make more sense as long as you could anticipate a reliable and manageable arrangement for satisfying that one last debt outside of bankruptcy. Getting in and out of bankruptcy in a matter of months instead of up to five years may be worth a lot to you.

The short year election could help just enough to make Chapter 7 a feasible option, and therefore the preferred option. That’s  because it can enable more of your nondischargeable taxes to be paid by the Chapter 7 trustee, leaving you owing less taxes at the completion of your bankruptcy case.

As I said in the first sentence of this blog, the short year election allows you to split your tax year into two tax portions, each of which is treated as its own tax year. The first “short year” covers from January 1 of that year to the day immediately before the filing of your Chapter 7 case, and the other “short year” is the rest of the year—from the date of filing your case until December 31.  

How can this possibly help? Two ways.

1. It allows any taxes you may owe for the short year before filing the Chapter 7 case to be a “priority” debt in your case, so that it can be paid from assets collected by the Chapter 7 trustee. This turns debt that would have been treated as incurred after the filing of the case, and thus wholly your obligation, into one that may be paid in whole or in part by the trustee. This can reduce or eliminate the current year tax debt, leaving you with either less or none to pay after your bankruptcy case is over.

2. It allows you to apply any loss carry forwards or credit carry forwards from the prior tax year to the income earned during that same pre-bankruptcy short year. The loss carry forwards reduce the tax for that short year, thus reducing any your potential tax debt owed after your case is finished. The credit carry forwards increase the tax for that short year, but that gives the trustee the opportunity to pay it if there are estate assets with which to do so. Each in their own way can increase the possibility that you will have less or no taxes to pay after your case is over.

The context that this works best in is a closed business or some other situation where the debtors have non-exempt assets that they do not mind surrendering to the trustee in return for a discharge of most of or all of the debts. Imagine a spouse who had been trying to run a business, and then had to close it down. The other spouse has a relatively high salary or other income but stopped paying withholdings or quarterly estimated taxes at the beginning of the year because of the lack of income from the other spouse closing down the business. By three-fourths of the way through the year, a substantial amount of tax liability could accrue. They may not be able to simply wait until after the end of the year because of pressure from creditors. The short year election allows the tax debt accrued through three-fourths of the year to be potentially paid by the trustee by liquidating the no longer needed business assets. The trustee may also have funds from other sources, such as preferential payments from a creditor or two.

So, through the benefit of the short year election, in the right circumstances the trustee could pay thousands of dollars of your nondischargeable tax debt by liquidating assets that you no longer need, instead of having this same money just going to your other creditors. And to the extent that the trustee would be getting some of that money through forced reimbursement of creditor’s preference payments, some of your taxes would be indirectly paid by those creditors. Not often that you can get somebody else to pay your taxes.

As I said at the beginning, the short year election is a tool which applies only limited cases, but when it does it can be extremely helpful.

 

NOTE: This election is available ONLY in asset Chapter 7 cases–not Chapter 13s or no-asset Chapter 7s.

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Writing Off Income Taxes Forever through Bankruptcy

What income taxes can a Chapter 7 bankruptcy completely write off?

My last blog ended saying how Chapter 13 lets you pay off certain income taxes much more conveniently because you’re protected from the tax collector and can usually avoid paying substantial amounts of interest and penalties. But that’s for taxes you can’t write off. What exactly does it take to write off a tax completely?

It takes meeting four main conditions.

But before I list and describe these, I have to emphasize that this whole area—dealing with tax debts in bankruptcy—is a very complex one. I present the information in these blogs to you because the more you know the better. But part of being informed is knowing when you definitely need an attorney’s help. So, part of my job is to make very clear when you are in a particularly difficult area, when you truly need the help of someone who spends his or her professional life thoroughly understanding the complex rules, and constantly applying them in the real world. This is clearly one of those areas.

And now on to those four main conditions for writing off income taxes.  

1. Have three years passed since the tax return was due?

This one is pretty straightforward, because every income tax debt has a due date for the filing of its tax return. The important twist here: if you requested an extension of time—usually from April 15 to October 15—the three-year period does not begin until the extended due date.  

2. Have two years passed since the applicable tax return was actually filed?

It does not matter how ancient the tax if at least two years have not passed since the return was in fact filed. And a “substitute for return”—the common procedure in which the IRS in effect prepares a tax return on your behalf based on the (usually incomplete) information it has available—that doesn’t count as a filed return for this purpose.  

3. Have 240 days passed since assessment of the tax?

In most situations an income tax is assessed within a few weeks after you file it. Assessment is the tax authority’s formal determination of your tax liability, usually through its review and acceptance of your tax return. But sometimes the amount of tax is in dispute because of a tax audit or litigation about the amount. By the time the accurate tax amount is finally assessed, the above three-year or two-year time periods may have passed, but that tax cannot be written off unless that bankruptcy case is filed more than 240 days after the assessment. This 240-day period is also put on hold while a taxpayer’s “offer in compromise” is pending. Just like it sounds, that’s an offer to the IRS to settle the tax for less money or for specific payment terms.

4. Have you filed a fraudulent tax return or intentionally attempted to evade the tax?

Even if all the required time periods have passed, if you were dishonest on your tax return—such as not including some of your income or claiming invalid deductions–or tried to avoid paying a tax in some other way, that tax will not be written off in bankruptcy.

This discussion should give you a good idea whether any or all of your income tax debts can be written off in a bankruptcy. And in some cases applying these four conditions will give you the accurate answer. But there are some other considerations that can come into play. What if the IRS recorded a tax lien against your home and on your personal possessions?  How would a prior bankruptcy affect these timing rules? What about your appeal of a tax? What’s considered an honest mistake on a tax return instead of an intentional tax evasion? When can the taxing authority add a 30-day “tack-on” to the 240-day rule?

Bankruptcy can certainly write off income taxes under the right circumstances, but you need to have an experienced attorney review your personal situation to see if you truly meet those circumstances.

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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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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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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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The Rigid “Means Test” Makes the Timing of Your Bankruptcy Filing Critical

Waiting just one day to file your Chapter 7 bankruptcy case can make qualifying for it much easier—or much harder!

How could such a small delay make such a big difference?

One of the main goals behind the huge amendment to the bankruptcy law in 2005 was to force more people to pay a portion of their debts through Chapter 13 payment plans instead of writing them off in a Chapter 7 “straight bankruptcy.” And the primary tool that is supposed to accomplish this is the means test. The rationale behind this test was that instead of allowing judges to make judgment calls about who was or was not abusing the bankruptcy system, a rigid financial test would ferret out who had the “means” to pay a meaningful amount to their creditors in a Chapter 13 case.

But in real life rigid rules can have unintended consequences. An experienced and conscientious lawyer will work to turn these consequences to your advantage, and avoid their disadvantages. Here’s an idea how this plays out with the means test.

In my last blog I explained the first part of the means test, which essentially compares the income you received during the six FULL CALENDAR months before filing bankruptcy to a standard median income amount for your state and your family size. If your income is at or under the applicable median income, then you get to file a Chapter 7 case (except in very unusual circumstances, which I’m not going to get into here). If your income is higher than the median amount, you may still be able to file a Chapter 7 case but you have to jump through a whole bunch of extra hoops to do so. And there’s a risk that you will be forced to go through a Chapter 13 payment plan.  So you can see that having income below the median income amount makes your case much simpler and less risky.

But how can filing the case a day earlier or later matter so much? Because of the means test’s fixation on those six prior full calendar months. And because the means test includes ALL income during that precise period (other than social security).  Virtually all money that comes into your hands during that period is counted, not just taxable income. 

So imagine that you received some irregular chunk of money, say an income tax refund, a few catch-up child support payments, or an insurance settlement or reimbursement.  Not a huge amount, say $3,000, received on July 15 of last year. Your only other income is from your job, where make a $42,000 salary, or $3,500 gross per month. Let’s say that the median annual income for your state and family size is $43,000.

So now we’re getting close to the end of January, your Chapter 7 bankruptcy paperwork is ready to file, and you’re anxious to get it filed so that you get protection from your aggressive creditors. BUT, if your case is filed on or before January 31, then the last six full calendar month period will be from July 1 through December 31 of last year, which includes that $3,000 extra money you received in mid-July. Your work income of 6 times $3,500 equals $21,000, plus that $3,000 totals $24,000 received during that 6-month period. Multiply that by 2 to make that an annual amount, and that equals $48,000, higher than the $42,000 median income. So you’d have failed the income portion of the means test.

But if you just wait to file until February 1, then the applicable 6-month period jumps forward by 1 full month to the period from August 1 of last year through January 31 of this year. Now that new period does NOT include the $3,000 you received in mid-July. So now your income during the 6-month period is $21,000, multiplied by 2 is $42,000. So now you’re under the $43,000 median income amount. You’ve passed the income portion of the means test, and you get to skip the awkward and risky expenses part of the means test. So you’re much more likely to breeze through your Chapter 7 case. Hooray!

Last thing: what if that $3,000 chunk of money was not conveniently received almost 6 months ago, but rather only a 2 or 3 months ago, and you’re desperate to file your case? You need to stop a garnishment or foreclosure and simply can’t wait another few months to file. Well if you file now, then you will be over the median income, and will need to go through the expenses part of the means test. You may still be saved there, or there may even be other ways of qualifying for Chapter 7. More about those in my next blog or two. But if you are concerned about this now, please call to set up a consultation with me right away. This blog should make clear that careful pre-bankruptcy planning is critical. The sooner we start, the more likely time will be on your side.

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