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Stepping Over the “Means Test” Hurdle Without Breaking Your Stride

Are you among the large majority of people whose income easily qualifies them for Chapter 7 “straight bankruptcy”? You can find out right here and now.

As you’ve likely heard, a few years ago Congress passed a major set of changes to the bankruptcy laws intended to make it harder for some people to file Chapter 7.  The idea was that those who have the means to pay a meaningful amount of their debt to their creditors in a three-to-five-year Chapter 13 payment plan ought to do so. So they shouldn’t be able to just write off all their debts in a Chapter 7 case. At least that’s the theory behind the means test.

In practice, for many people it’s quite an easy hurdle to step right over.  Most people who want to file a straight bankruptcy can still do so.

The means test is truly an odd one. It has two parts. The income part—the one I’m addressing here today—is relatively easy to figure out.

But the second part, involving living expenses, is one of the most complicated formulas imaginable. This law was worded so poorly that more than six years after it became effective there’s still a lot of debate about how it’s supposed to work. Fortunately, most people don’t need to get to that part of the test, and we won’t here.

That’s because if you pass the income part of the test, you can totally skip the expenses part.

So, the income part of the means test compares your income to a published “median income” for a household of your size in your state. If your income is no more than that median, then right away you’ve passed the test—you get to file a Chapter 7 case.

But even this easy part of the test has its quirkiness.

1. It is NOT based on your taxable income for the previous calendar year, or anything that simple. Instead it is based on the precise amount of income you received during the six full calendar months before your case is filed. So, for example, if your case is filed on January 25, 2012, we look at every dollar you received during the six-month period from July 1 through December 31, 2011. Then take that six-month total and divide it by six to come up with a monthly average.

2.The income included for this purpose is not just your “taxable income,” but rather every bit of income you’ve gotten from all sources during that period of time, including irregular ones like child and spousal support payments, insurance settlements, unemployment benefits, and bonuses. The exception: exclude all social security income.

Then multiply your six-month average monthly income by 12 to come up with your annual income. The last step is to compare that amount to the median income for your state and your size of family. You can find that median income in the table that you can access through this website. (This median income information gets updated every few months, so make sure you’re using the current table.)

If your income, as calculated in this precise way, is no more than the median income applicable to your state and family size, then you can file a Chapter 7 case. Congratulations—you’ve cleared the means test hurdle!

If your income is MORE than the applicable median amount, don’t despair. You may well still be able to file a Chapter 7 case. More on that in my next blog.  

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In a Chapter 7 Case, “The Only Thing We Have to Fear is Fear Itself”

There’s a lot you can do to help make your “straight bankruptcy” Chapter 7 case a straightforward one, but one thing you can’t control is your creditors’ reactions to it. You know that creditors can sometimes try to prevent you from discharging (legally writing off) your debts, so naturally you worry about this. Here’s why you shouldn’t worry.

Let’s first be clear that I’m not talking here about the kinds of debts that simply can’t be discharged, and don’t require any creditor objection for that to happen—for example, back child and spousal support, many taxes, and criminal fines. Instead I’m talking about the right of any creditor to object to the discharge of its debt, under certain limited circumstances.

You might figure that if your creditors have ANY chance to object to the discharge of their debts, it would jump at the chance to do so. Or at least enough of them would object to cause you trouble. But that is NOT what happens. Most Chapter 7 cases go through with NO creditor objections at all. Well, why not?

1. The legal grounds for creditors’ objections are quite narrow. They need to have evidence that the debt was incurred through your fraud or misrepresentation, arose out of a theft or embezzlement, as a result of your intentional injury to a person’s body or property, or was related to other similar bad acts. So creditors don’t object to the discharge of their debts simply because most of the time no such facts exist.

2. Even within such narrow grounds, relatively common situations such as bounced checks or the use of credit not long before filing bankruptcy can be seen as fraudulent, so creditors can object to these kinds of debts. But even in these situations, creditors often do not bother to object because they decide it’s not worth “throwing good money after bad”—spending more money for their staff time and attorney fees in the hopes of first getting a bankruptcy judge to agree with them, AND then still needing to get you to repay the debt.

3. One of the reasons why sensible creditors decide not to object even when they think they might have the legal grounds to do so is that they risk being ordered to pay your attorney’s fees to defend against their objection. That can happen if the judge thinks that “the position of the creditor was not substantially justified.” So creditors risk not only paying for their own costs to object, but also paying for your costs in fighting the objection.

So that’s why most creditors just write off the debt and move on.

But there ARE two exceptions.

1. Leverage: If a creditor thinks it has a decent case against you—such as with a string of bounced checks or a debt incurred shortly before the bankruptcy was filed—it may well object to the discharge of the debt knowing that YOU can’t or don’t want to pay attorney fees in fighting it, EVEN if you have a decent defense. So they’ll raise the issue in the hopes of forcing you to enter into a settlement quickly.

2. Axe to grind: If you have someone you owe money to who is simply very mad at you, so that your bankruptcy filing really aggravated him or her, then this creditor might be looking for an excuse to hurt you back. Ex-spouses and ex-business partners are the most common. Irrational anger by those types, not reined in by the financial realities, probably causes the messiest objections.

To reduce any anxiety you have about any of this, talk it over thoroughly with your attorney. If you have any concern about how you incurred any of your debts, or if someone has threatened you with any trouble if file bankruptcy, lay it all out. Often, your fear will not be justified. And if there are potential problems, being up-front about it may enable your attorney help reduce the risks.

A final bit of good news: creditors have a very limited time to raise objections: generally 60 days after the Meeting of Creditors. So, if whatever assurances given by your attorney still doesn’t stop you from worrying in the meantime, you’ll at least know that you can stop worrying after that date.

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When Chapter 7s Are Not So Simple

The goal of most Chapter 7 cases is to get in and get out—file the petition, go to a simple 10-minute hearing with your attorney a month later, and two months later get your debts written off. Mission accomplished, end of story. And usually that’s how it goes. So when it doesn’t go that way, why not?

Four main kinds of problems can happen:

1. Income:  Under the “means test,” If you made or received too much money in the 6 full calendar months before your Chapter 7 case is filed, you can be disqualified from Chapter 7. As a result you can be forced instead into a 3-to-5 year Chapter 13 case, or have your case be dismissed altogether—thrown out of court. These results can sometimes be avoided by careful timing of your case filing, or by making changed to your income beforehand, or if necessary by a proactive filing under Chapter 13. Or sometimes it’s worth fighting to stay in Chapter 7 by showing that it is not an “abuse” to do so.

2. Assets:  In Chapter 7, if you have an asset which is not “exempt” (protected), the Chapter 7 trustee will be entitled to take and sell that asset, and pay the proceeds to the creditors. You might be happy to surrender a particular asset you don’t need in return for the discharge of your debts, in particular if the trustee is going use the proceeds in part to pay a debt that you want paid, such as a child support arrearage or an income tax obligation. But instead you may not want to surrender that asset, either because you think it is worth less than the trustee thinks or you believe it fits within an exemption. Or you may simply want to pay off the trustee for the privilege of keeping that asset. In all these “asset” scenarios, there are complications not present in an undisputed “no asset” case.

3. Creditor Challenges to Discharge if a Debt:  Creditors have the limited right to raise objections to the discharge of their individual debts, on grounds such as fraud, misrepresentation, theft, intentional injury to person or property, and similar bad acts. In most circumstances the creditor must raise such objections within about three months of the filing of your Chapter 7 case. So once that deadline passes you no longer need to worry about this, as long as that creditor got appropriate notice of your case.

4. Trustee Challenges to Discharge of Any Debts:  If you do not disclose all your assets or fail to answer other questions accurately, either in writing or orally at the hearing with the trustee, or if you fail to cooperate with the trustee’s investigation of your financial circumstances, you could possibly lose the ability to discharge any of your debts. The bankruptcy system is still largely, believe it or not, an honor system—it relies on the honesty and accuracy of debtors (and, perhaps to a lesser extent, of creditors). So the system is quite harsh towards those who abuse the system by trying to hide the ball.

To repeat: most of the time, Chapter 7s are straightforward. No surprises. That’s especially true if you have been completely honest and thorough with your attorney during your meetings and through the information and documents you’ve provided. In Chapter 7 cases for my clients, my job is to have those cases run smoothly. I do that by carefully reviewing my clients’ circumstances to make sure that there is nothing troublesome, and if there is, to address it in advance in the best way possible. That way we will have a smooth case, or at least my clients will know in advance the risks involved. So, be honest and thorough with your attorney, to greatly up the odds of having a simple Chapter 7 case.

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A Simple Chapter 13 Case

If you have debts that can’t be written off (“discharged”) in a Chapter 7 “straight bankruptcy,” such as back child support or recent income taxes, Chapter 13 can be a much better alternative.

 In my last blog I wrote about the discharge of debts under Chapter 7. I ended by saying that if you have debts that can’t be discharged in Chapter 7, “Chapter 13 is often a decent way to keep those under control.” Here’s how.

The best way to show this is with an example. So let’s say you owe $6,000 in IRS debt for 2009 and 2010, $4,000 in back child support, $15,000 in credit cards, and $3,000 in medical bills. You had lost your job in 2009, tried to run a business during 2009 and 2010 that made a little money but not enough to pay its taxes and to make all your support payments. Then you got a new job a few months ago that pays less than the one you’d lost in 2009, but at least you now make enough to pay your ongoing taxes and support, and your living expenses. However, you’re left with only about $400 left over to pay ALL of your debts. That would not be enough to pay the minimums on just the credit cards, much less anything on the rest of the debts.

A Chapter 7 case would discharge the $12,000 in credit cards and the $3,000 in medical bills, but would leave you with $6,000 owed to the IRS and $4,000 in back support—so you’d still be $10,000 in debt. Although the IRS would likely be willing to accept payments of $400 per month, the problem is that the state support enforcement agency is about to garnish your wages for the back support, trashing any possible arrangement with the IRS. Also, you’re still in the probationary period at your new job and the last thing you want is for the payroll office to get a garnishment order for back child support. Filing Chapter 7 would not stop that kind of garnishment.

But Chapter 13 would. So you file a Chapter 13 case, keep up your ongoing regular child support payments, and put together a plan to pay to the Chapter 13 trustee $400 per month for 36 months. During that period of time neither the IRS, nor the support agency, nor your ex-spouse—nor any of your other creditors—would be able to take any action against you or any of your assets. That is they couldn’t as long as you consistently made your $400 payments, and kept current on your ongoing tax and support obligations. Over those three years you’d pay to the trustee $14,400 ($400 X 36 months), which would pay all the $4,000 of back support and the $6,000 in taxes—usually without any additional interest or penalties from the date of the filing of your Chapter 13 case. The Chapter 13 trustee would also get paid, usually about 5-to-10% of what you’re paying into the plan, as would any attorney fees you did not pay to your attorney at the beginning of your case.  If there is still any money left over (not likely very much in this example), that gets divided pro rata among the credit card and medical debts. After the 36 months of payments, any remaining balances on those debts are discharged, leaving you owing nothing to any of your creditors, and current on your taxes and support payments.

So that’s how a simple Chapter 13 case works.

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What Stops a Creditor from Chasing You After Its Debt Has Been Written Off in Bankruptcy?

Even though it’s illegal for creditors to try to collect on a debt that’s been discharged (legally written off) in bankruptcy, once in a while they may try. What makes chasing a discharged debt illegal? And what penalties can get awarded to you if a creditor breaks the law?

 

In my last blog I wrote about Capital One Bank illegally filing documents in 15,500 bankruptcy cases demanding payment on debts which had already been written off in prior bankruptcies. This extensive pattern of bad behavior was discovered when the U.S. Trustee in Massachusetts learned about one case in which the Bank was trying to get payment from a couple whose $5,500 debt had been discharged in a bankruptcy 14 years earlier. The U. S. Trustee (an office of the U.S. Department of Justice which acts to protect “the integrity of the bankruptcy system”) came to realize that this was not an isolated event for Capital One, and sued the bank because of all of its illegal filings. Nobody—including Capital One–knew how many cases all over the country it had filed claims for money it was not owed. So as part of the settlement of that lawsuit, the bankruptcy court required Capital One “to hire an independent auditor, chosen by the court and paid for by Capital One” to do an audit of about 2.2 million claims that it had filed in bankruptcy cases from the beginning of 2005 through 2010. It is from this audit that Capital One’s 15,500 illegal filings were uncovered.

While the Bankruptcy Code makes it perfectly clear that trying to collect on discharged debt is illegal, it does not clearly say what, if anything, the penalties are for a creditor caught doing so. Section 524(a)(2) of the Code says a discharge of debts in a bankruptcy “operates as an injunction against” any acts to collect debts included in that bankruptcy case. But that section of the Code says nothing about what happens if a creditor violates that injunction. Feel free to read the whole section through the link above. Have fun—Section 524 goes on for pages!

Well, even though no penalties are specified in Section 524, there is a strong consensus among courts all over the country that bankruptcy courts can penalize creditors for violating the discharge injunction through another section of the Bankruptcy Code, Section 105, titled appropriately enough “Power of Court.” The basic idea is that the injunction against pursuing a discharged debt is a court order, and so a creditor violating it is in contempt of court. So the standard penalties for being in civil contempt of court apply.

Depending on the circumstances, the penalties for civil contempt can include “compensatory” damages and “punitive” damages. Compensatory damages are to compensate you for harm you suffered because of the creditor’s violation of the injunction. These potentially include actual damages such as time lost from work or other financial losses, emotional distress caused by the illegal collection, and attorney fees and costs you’ve incurred as a result. Punitive damages are to punish the creditor for its illegal behavior, and so the judge looks at how bad the creditor’s behavior was in determining whether it punitive damages are appropriate and how much to award.

The vast majority of the time creditors in a bankruptcy case write the debts off their books and you never hear about those debts again. But, as the Capital One story illustrates, some creditors don’t keep good records or simply aren’t all that vigorous about following the law. So if, after you receive your bankruptcy discharge, you hear from one of your old creditors trying to collect its discharged debt, contact your attorney right away.  It’s something that you want to nip in the bud. And if the creditor’s behavior is particularly egregious, you and your attorney may want to discuss whether to strike back at the creditor for violating the law. There might possibly even be some money in it for you.

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Audit Shows Capital One Bank Illegally Filed $24.7 Million in Claims for Debts Previously Discharged in Bankruptcy

One can understand if a major U.S. credit card company forgets that one of its customers had earlier written off that company’s debt in bankruptcy. But forgetting this very important fact for 15,500 of its customers?!?

It is bad enough that Capital One lost track that its old debts had been legally written off (“discharged”). But in each one of these 15,500 cases it didn’t bother to check if the debts were discharged, and so it actually filed documents in subsequent bankruptcy cases asserting that the debts were still legally owed. Each of these “proofs of claim” were dated and signed by a Capital One representative, with the signature right next to this statement: “Penalty for presenting fraudulent claim: Fine of up to $500,000 or imprisonment for up to 5 years, or both.” Now, I don’t think anyone is alleging that Capital One is purposely and fraudulently chasing stale debt, but they sure are being awfully negligent in their internal recordkeeping, or maybe even reckless in blindly chasing debts without bothering to find out if they are still legally owed.

This whole ugly mess was uncovered by the “U.S. Trustee.” People filing bankruptcy may hear that the U.S. Trustee is somebody who is not on your side, mostly someone who can turn your Chapter 7 case into a Chapter 13 one if you don’t follow the rules. But its watchdog role is much broader–it “protects the integrity of the bankruptcy system by overseeing case administration and litigating to enforce the bankruptcy laws.“ Obviously, a creditor filing a document in a bankruptcy case saying that it is owed money when it not is in violation of the bankruptcy laws. Doing this in 15,500 cases is majorly bashing the integrity of the bankruptcy system, and causing havoc to “case administration.”

How so? Think about it. A creditor’s proof of claim is generally considered accurate unless somebody challenges it. The creditor usually attaches some documentation, which makes the debt look authentic. The debtor usually has little incentive to spend time or money on the issue because usually that proof of claim does not change how much the debtor has to pay, instead only how the creditors will divide up the money. When Capital One gets paid on a false claim in an asset Chapter 7 case or a Chapter 13 case, that inappropriate payment reduces the trustee’s payouts to all the other creditors, the amount of reduction depending on the size of each one of the other creditors’ claims. So now in 15,500 individual cases Capital One has to give back whatever money it actually received—amounting to $2.35 million—and the trustee in each case has to precisely recalculate how much each one of the other creditors was short-changed, and then cut checks for all those other creditors in those amounts. What a huge waste of time.

What does this mean for you? As to Capital One, if it is or was one of your creditors and you are (or will be) in either a Chapter 13 case or asset Chapter 7 case, have your attorney keep a close eye on any proofs of claim this creditor files. As to creditors in general, this is good reminder that creditors sometimes file inaccurate documents—purposely or not—in bankruptcy court. Proof of claims specifically, and other documents as well (such as motions for relief from stay) need to be scrutinized carefully, not just accepted as face value. Much of the time most creditors keep decent records and file accurate documents in court. Just don’t assume all of them do all the time. Especially Capital One.

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Keeping Everything You Own in Bankruptcy

You want to know: “Can I really keep everything I own if I file bankruptcy?”

A two-part answer:

1) Yes, you can, usually, keep those possessions that are all yours (you don’t owe any money on them).  

2) Yes, you can, usually, keep those particular possessions on which you are making payments to a creditor (like your home or vehicle), IF you want to keep it them, AND are willing and able to meet certain conditions. (Hint: those conditions are usually lots better in bankruptcy than without one.)

In today’s blog I’ll get into the first part of that answer. I’ll get to the second part later.

Most people who file bankruptcy can keep what they own for two reasons: 1) exemptions and 2) Chapter 13 protections. I’m covering exemptions today.

Make no mistake: at the heart of bankruptcy is the basic principle that your debts are discharged—legally written off forever—in return for you giving all your assets to your creditors. Except you can keep any of your assets which fit within an exemption. As the saying goes, this exception swallows the rule. Most of the time, all assets are exempt and so debtors get a Chapter 7 discharge without giving anything to the trustee.

Exemptions are simply a list of the types and amounts of assets that are protected from your creditors, and thus from the Chapter 7 trustee acting for those creditors. But exemptions are anything but simple.

First, the Bankruptcy Code contains its set of federal exemptions, and each state also has its own exemptions. If you file a bankruptcy in certain states, you have a choice between using the federal exemptions and the state ones, while in other states you can only use the state exemptions. In states where you have a choice, picking which of the two exemption schemes is better for you is often not at all obvious and you need an experienced attorney to advise you.

Second, if you have moved relatively recently from another state, you may have to use the exemption rules of your prior state. Because different state’s rules can differ wildly, thousands of dollars can be at stake depending on what day your bankruptcy is filed.

Third, once you know which set of exemptions apply to you, whether any of your particular assets is covered by an exemption, and thus protected from your creditors, is often not clear. The exemption statues were often written many decades ago, use archaic language, and have a whole history of court ruling to interpret what they include. Plus the local trustees often have unwritten rules about how they interpret the exemption categories in practice. So, determining whether an asset is exempt or not is often much, much more than checking down a list of exemptions. By way of example, if you and your spouse each have one vehicle that you use for getting to work, and a third one used by your 18-year-old to get back and forth to school, will your vehicle exemption cover all three vehicles? Under what circumstances?

So navigating through exemptions can be much more complicated than it looks, and is one of the most important services provided by a bankruptcy attorney.

The fact remains that among most people who do end up filing a Chapter 7 bankruptcy case, everything they own DOES fit within the exemptions. So the bankruptcy trustee takes nothing from them.

But what if you DO own one or more assets which do not fit any of the available exemptions? How can those still be protected through a Chapter 13 case?  I cover that in my next blog.

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The Amazing but True Evolution of Bankruptcy Law

You’ve heard of debtors’ prisons. But that’s only one hideous part of the very colorful history of bankruptcy law.

American bankruptcy law was of course based on the law of England at the time of the colonies. Today’s blog tells how incredibly different pre-Revolutionary War bankruptcy laws were from current law.

  • The first bankruptcy law in England was enacted more than 450 years ago during the reign of Henry the Eighth, the one who had a habit of decapitating his former wives. Debtors were called “offenders” under this first law, essentially as perpetrators of a property crime.  The purpose of this law, and as if was expanded during the following hundred and fifty years, was not to give relief to debtors but rather to give creditors a more effective way to collect on the debts owed by their debtors.
  • Consistent with that, the law included no discharge of debts. After a bankruptcy was finished—with the assets of the “offender” seized and sold and distributed to creditors—separate creditors could still continue chasing the individual for any remaining balance.
  • Only creditors could start a bankruptcy proceeding. Creditors had to allege an “act of bankruptcy” by the debtor. Physically hiding from creditors was “an act of bankruptcy,” as was hiding assets by conveying them to others. Today’s very seldom used “involuntary bankruptcy” is a throwback to this.
  • Since credit was seen as immoral, only merchants were allowed to use credit, for whom it was seen as a necessary evil. So only merchants could become bankrupt.
  • For the following century and a half, Parliament made the law even stronger for creditors, allowing bankruptcy “commissioners” to break into the homes of “offenders” for their assets, put them into pillories (those wooden structures with holes for head and hands used for public shaming), and even cut off their ears.
  • The discharge of debts was finally introduced in the early 1700s for cooperative debtors, but was given only upon consent of the creditors. Furthermore, to induce cooperation, fraudulent debtors were subject to the death penalty (although it was very seldom used).
  • Cooperative debtors received an allowance from their own assets, a bit of a foreshadowing of Chapter 13 payment plans.

This was the English bankruptcy law in effect that the U.S. Constitution was adopted, with its Bankruptcy Clause giving Congress power to “pass uniform laws on the subject of bankruptcies.” More on that and the very rocky history of U.S. bankruptcy laws in my next blog.

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Chapter 13 Tames Your Income Tax Monster

A “straight” Chapter 7 can write off some income taxes. But if you owe recent taxes, or multiple years of taxes, Chapter 13 is usually a much better way to go. It often provides tremendous advantages over both Chapter 7 and dealing with the IRS on your own.

I’ll illustrate this with an example, and then explain it in my next blog.

Let’s say a husband and wife owe $35,000 in a combination of medical bills and credit cards, requiring monthly payments of $800. After the husband lost his long-time job back in 2006, he followed his dream of starting a business, which was starting to make progress when it got hammered in the Great Recession. He closed it in 2010 and found a reliable job a number of months later, although one where he earns 30% less than he did at the one lost years earlier. His business had generated some income, but barely enough for the couple to meet their bare essentials. So there was no money to pay the quarterly estimated taxes, and they had no money to pay the amount due when they filed their joint tax returns for 2006, 2007, 2008, 2009 and 2010. They expect to come out even for the 2011 tax year because of tax withholdings from their wages. To try to simplify the facts, assume they owe the IRS $4,000 in taxes, $750 in penalties, and $250 in interest for each of those five years. So their total IRS debt for those years is $25,000—including $20,000 in the original taxes, $3,750 in penalties, and $1,250 in interest. The wife has had consistent employment throughout this time, with pay raises only enough to keep up with inflation. They filed each of the tax returns in mid-April when they were due, and have been making modest payments when they have been able to, but those have not even been keeping up with the penalties and interest. Assume they have no secured debts—no mortgage or vehicle loans. They can realistically afford to pay about $500 a month to all of their creditors, not enough to pay their regular creditors much less the IRS.

Outside of bankruptcy, the IRS would likely require payment in full of the entire tax obligation, with interest and sometimes penalties continuing to accrue until everything was paid in full. Their payments would be imposed without regard to the other debts they owe. And if the couple failed to make their payments, the IRS would likely try to collect through garnishments and tax liens. Depending how long repayment would take, the couple could easily end up paying $30,000 or more with additional interest and penalties. This would be in addition to their $35,000 medical and credit card debts, which could easily increase to $45,000 or more, especially if these other debts went to collections or lawsuits. That’s likely because the couple would be paying all available money to the IRS. So likely the couple would eventually end up paying at least $75,000 to their creditors.  

In a Chapter 13 case, the 2006 and 2007 taxes, interest and penalties would very likely be paid nothing and discharged at the end of the case. So would the penalties for 2008, 2009, and 2010. That takes care of $11,500 of the $25,000 present tax debt. The remaining $13,500 of taxes and interest for 2008, 2009, and 2010 would have to be paid as a “priority” debt, although without any additional interest or penalties once the Chapter 13 case is filed. Adding in some “administrative expenses” (the Chapter 13 trustee and our attorney fees), and assuming that their income qualified them for a three-year Chapter 13 plan, this couple would likely be allowed to pay about $500 per month to ALL of their creditors—credit cards and medical, AND the IRS. Then after three years, they’d be done. The “priority” portion of the IRS debt would have been paid in full, but the older IRS debt and all the penalties would be discharged likely without any payment. So would the credit card and medical debts. After the three years, the couple would have paid a total of around $17,500 (including the “administrative expenses”), instead of about $75,000 without the Chapter 13. They’d be done instead of barely starting to pay their mountain of debt. And they would have not spent the last three years worrying about IRS garnishments and tax liens, lawsuits and harassing phone calls, and the constant lack of money for necessities.

As I said, in my next blog I’ll explain how all this works.

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Four Hoops to Jump Through to Write Off Income Taxes in Bankruptcy

The conditions you have to meet to write off an income tax debt actually make sense. And understanding those conditions is a lot easier if you understand the sense behind them.

In my last blog I introduced the four conditions for discharging taxes in a Chapter 7 “straight bankruptcy,” and said I’d explain them in this blog today.

This is made easier by the fact that there is a single principle behind all four of these conditions: bankruptcy law believes that taxpayers who pretty much follow the tax laws should be able to write off their tax debts just like the rest of their other debts, after first giving the IRS (or other tax authority) a sensible amount of time to collect the taxes.

How long is this sensible amount of time? How much of an opportunity do the tax authorities have to collect before you can discharge the tax debt? Each of the four conditions measures this amount of time differently, based on 1) when the tax return for the particular income tax was due, 2) when the tax return was actually filed, 3) when the tax was “assessed,” and 4) whether the tax return that was filed was honest and therefore reflected the right amount of tax debt when it was filed. You must meet all four of these conditions, all four of these measures of time.

Taking them one at a time:

1) Three years since tax return due: Every income tax debt has a fixed point in time when its return had to be filed. That date is extended by a certain number of months if you asked for an extension, but it’s still a fixed point in time, one that can be easily ascertained. So this first condition gives the tax authorities three years to collect, three years from a fixed point not affected by your actions (the timing of filing the return) or their actions (audits, legal disputes).

2) Two years since tax return actually filed: In contrast, this is a time period triggered by your own action. Notice above when I stated the overall principle at work here, I said you must “pretty much” follow the tax law. Thus you can file a tax return late and still be able to discharge the debt if at least two years has passed since you filed the return.

3) 240 days since assessment: Assessment is the tax authority’s formal determination of your tax liability, usually by its review and acceptance of your tax return. Normally an income tax is assessed within a few weeks that it is received, so the 240 days since assessment usually passes way before the above three-year or two-year time periods. But the law has to account for the less common situations when assessment is delayed. So, when a tax is subject to a lengthy audit or litigation, or an “offer-in-compromise” (a taxpayer’s formal offer to settle), and the three-year and two-year periods have passed, the tax authority still has 240 days after assessment to chase that tax debt.

4) Fraudulent tax returns and tax evasion: This last condition essentially says that none of the above time periods are triggered at all if you are intentionally dishonest on your tax return or try to avoid paying the tax in some other way. If you are cheating on your taxes then the tax authority has no opportunity to collect the debt, so you cannot discharge the debt, no matter how old the tax is.

If your tax debt can jump through these four hoops, you should be able to discharge that tax in a Chapter 7 bankruptcy.

But what if you owe taxes which do not meet these four conditions? What if some of your taxes do but others do not? Or what if the IRS has recorded a tax lien? Or if a lot of the taxes came from operating a business, or are not income taxes but some other kind? I’ll tell you about these situations in my next blogs.

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