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Close Your Business But Protect Yourself

Chapter 7 “straight bankruptcy” and Chapter 13 “adjustment of debts” can prevent you from harm when you decide to close down your business.


My blog post last week explained how to save your sole proprietorship business through a Chapter 13 case. But now let’s assume that you’ve instead made up your mind to close down that business. And let’s also assume that you need bankruptcy relief because of the unmanageable amount of debts you are personally liable for.

Many, many considerations come into play in deciding on your best course of action, but let’s focus here today on two main ones—assets and debts—as we consider three options: 1) a “no asset” Chapter 7 case, 2) an “asset” Chapter 7 one, and 3) a Chapter 13 case.

“No Asset” Chapter 7 Gets You a Fast Fresh Start

Once you decide that your business is not worth keeping alive, you may just want to clean up after it as quickly as possible. For that a “straight bankruptcy” may well be the best way to go.

If everything that you own—from both your business and you individually—falls within the allowed asset exemptions, then your case will more likely be relatively simple and quick. You will have a “no asset” case—one in which you keep everything you own and nothing goes to the Chapter 7 trustee to liquidate and distribute among your creditors.

A “no asset” Chapter 7 case is usually completed from start to finish in three or four months. And if none of your assets are within the reach of the trustee, there is nothing to liquidate and then distribute among your creditors. Because the liquidation and distribution process can take many additional months, avoiding that usually shortens and simplifies a Chapter 7 case greatly.

However, this assumes that all your debts can be handled appropriately in a Chapter 7 case. Specifically, the debts that you want to discharge (write off) would in fact be discharged. And those that would not be discharged are ones that you are able and willing to pay. The debts you want to pay may include secured debts like vehicle loans and mortgages; debts you are able and willing to pay—after discharging the rest of your debts—may include certain taxes, support payments, and maybe student loans.

Asset Chapter 7 Case as a Convenient Liquidation Procedure

If you do have some assets that are not exempt—not protected from the trustee—Chapter 7 may still be a good option. Assume that those unprotected assets are ones that you can do without—and maybe even are happy to be rid of, like assets from your former business that you no longer need. Letting the bankruptcy trustee collect and sell them and distribute the proceeds among the creditors instead of you going through that hassle may be a sensible, convenient, and fair way of putting your business behind you.

That may especially be true if you have some “priority” debts that the trustee would likely pay out of the proceeds of sale of your unprotected assets. For example, if you owed child or spousal support arrearage, or recent income taxes, those would likely be paid ahead of your other creditors. Your Chapter 7 trustee would be paying debts that you would have had to pay anyway, and is doing so out of the proceeds of sale of assets that you don’t need. Not a bad deal.

Chapter 13 for Flexibly Addressing Special Types of Debts

Chapter 7 does not deal well with certain important kinds of debts. However, Chapter 13 gives you a 3-to-5-year program to pay all or part of those debts while you are protected from your creditors.  

An example of an important kind of debt for owners of recently closed businesses is income taxes. Chapter 13 provides a way to potentially discharge (write-off) older taxes, pay off more recent taxes while being protected from the IRS and/or state taxing authority, and deal favorably with tax liens.

Chapter 13 can often also protect otherwise unprotected assets, for example the closed business’ assets that you now need as your tools or equipment for employment in the same field.

In the right circumstances Chapter 13 can save you thousands or even tens of thousands of dollars, while giving you protection from and a better way of dealing with important kinds of creditors. 

 

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What a Simple Chapter 13 Case Looks Like

The most common reason for a Chapter 13 “adjustment of debts” is if you have debts that can’t be written off in a “straight” Chapter 7 case.

 

When Chapter 7 Does Not Discharge Your Debts

My last blog post was about the discharge (legal write-off) of debts under Chapter 7. I concluded with the comment that if you have debts that Chapter 7 doesn’t discharge, Chapter 13 may be the way to go. It provides what is often the safest and most convenient method to deal with debts that you have to pay, while also discharging those debts that would be discharged under Chapter 7. The much longer time that Chapter 13 takes—3 to 5 years instead of as short as 3 to 4 months for most Chapter 7 cases—can be highly worthwhile under the right circumstances.

An Example

Let’s show you one example of the right circumstances. Imagine someone owing $7,000 in IRS debt for 2011 and 2012, $3,000 in back child support, $20,000 in credit cards, and $5,000 in medical bills. The person lost his or her job in late 2010 and used the situation to try to run a one-person business during 2011 and 2012. It made a little money but only barely enough to pay living expenses. There was absolutely no money available to set aside for income taxes. During that period the person also fell behind on child support payments. Then this person found a new job a few months ago that pays less than the one lost in 2010, but at least enough to pay ongoing taxes and support, in addition to living expenses. But the person’s budget leaves only about $400 to pay ALL debts, not nearly enough to pay the minimum amounts on the credit cards, much less anything towards the rest of the debts including the taxes and back support.

What Chapter 7 Would and Would NOT Accomplish

A regular Chapter 7 case would likely discharge the $20,000 in credit cards and the $5,000 in medical bills, but would leave owing the $7,000 to the IRS and the $3,000 in back support. Although discharging $25,000, the person would come out of bankruptcy still $10,000 in debt, owed to two creditors who can be extremely aggressive—the IRS and your ex-spouse or the local support enforcement agency.

Although the IRS might be willing to accept payments of $400 per month, there’s a good chance that your ex-spouse or the support enforcement agency would be able to garnish your wages for the back support, and that would negate any possible arrangement with the IRS. Plus the last thing this person would want at his or her new job is for the payroll office to get a garnishment order for back child support. A previously filed Chapter 7 case would have no power to stop that kind of garnishment.

What Chapter 13 Would Accomplish

In contrast Chapter 13 would be able to stop your ex-spouse or support agency from garnishing for back support—as well as from any action the IRS or any state taxing entity, or virtually any other creditor, could take.

So the person in our example would file a Chapter 13 case, start or continue paying any ongoing monthly child support payments, and would also be sure to have withheld an adequate amount for ongoing income taxes. Then his or her attorney would put together a plan to pay the Chapter 13 trustee $400 per month (based on what is available in his or her budget) for 36 months.

During that period of time neither the IRS, nor the support agency or ex-spouse, nor any other creditors would be able to take any action against the person or any of his or her assets as long as he or she complied with the Chapter 13 plan. That means that he or she kept up the $400 plan payments, and kept current on ongoing tax and support obligations (as provided for in the budget).

Over those three years the trustee would be paid $14,400 ($400 X 36 months), which would pay all the $3,000 in back support and the $7,000 in taxes—usually without any additional interest or penalties from the date of the filing of the Chapter 13 case. The Chapter 13 trustee would also get paid, usually about 5-to-10% of what is being paid into the plan, as would any attorney fees that weren’t paid to the attorney at the beginning of your case.  If there would be any money left over (little or none in this example), that would be divided pro rata among the credit card and medical debts. After the 36 months of payments, any remaining balances on those debts would be discharged. That would leave the person at the end of the Chapter 13 case owing nothing to anyone. The back taxes and support would have been paid off, and he or she would be current on any ongoing income taxes and child support.

So that’s what a simple Chapter 13 case would accomplish and would look like. 

 

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More Good Examples of How Bankruptcy Really Helps Even When You Can’t Write Off Every Debt

Three more very practical ways that bankruptcy works to let you take control of your debts, even those that can’t be written off.


Two blogs ago I gave six reasons why it’s worth looking into bankruptcy even when you can’t discharge (write off) one or more of your debts. Today here are the final three of those reasons, each one paired with a concrete example illustrating it.

Reason #4: Taking control over the amount of the monthly payments.

The taxing authorities, support enforcement agencies, and student loan creditors have extraordinary power to take your money and your assets if you fall behind in paying them. Because of that tremendous leverage, you normally have no choice but to play by their rules about how much to pay them each month. Chapter 13 largely throws their rules out the window.

Let’s say you owe $15,000 to the IRS—including interest and penalties—from the 2010 and 2011 tax years, resulting from a business that failed. You’ve now got a steady job but one that gives you very little to pay the IRS after taking care of your very basic living expenses. The IRS is requiring you to pay that debt, plus ongoing interest and penalties, within 3 years. And it calculates the amount you must pay it monthly without any regard for your other debts, or for your actual living expenses. Even if you did not have unexpected expenses during those 3 years, paying the required amount would be extremely difficult. But if your vehicle needed a major repair or you had a medical problem, keeping up those payments would become absolutely impossible.  But the IRS gives you no choice.

In a Chapter 13 case, on the other hand, the repayment period would stretch out to as long as five years, which lowers the monthly payment amount. And instead of a rigid mandatory monthly payment going to the IRS, how it is paid in Chapter 13 is much more flexible. For example, if in your situation money was very tight now but you could more each month later—for example, after paying off a vehicle loan—you would likely be allowed to make very low or even no payments to the IRS at the beginning, as long as its debt was paid in full by the end. Also, you would be allowed to budget for vehicle maintenance and repairs, and medical costs, and other reasonable expenses, usually much more than the IRS would allow. And if you had unexpected vehicle, medical, or other necessary expenses beyond their budgeted amounts, Chapter 13 has a mechanism for adjusting the original payment schedule. Throughout all this, you’d be protected from the IRS.

 Reason #5: Stopping the addition of interest, penalties, and other costs.

Under the above facts, if you were not in a Chapter 13 case, the IRS would be continuously adding interest and penalties. So that much less of your monthly payment goes to reduce the $15,000 owed, significantly increasing the amount you need to pay each month to take care of the whole debt in the required 3 years.

In Chapter 13, in contrast, unless the IRS has imposed a tax lien, no additional interest is added from the minute the case is filed. No additional penalties get added. So not only do you have more time to pay off the tax debt, and much more flexibility, you have also have significantly less to pay before you finish off that debt.

Reason #6: Focusing on paying off the debt that you can’t discharge by discharging those you can.

This may be obvious but can’t be overemphasized: often the most important and direct benefit of bankruptcy is its ability to clear away most of your debt burden so that you can put your financial energies into the one that remain.

Back to our example of the $15,000 IRS debt, let’s say the person also owes $20,000 in credit cards, $5,000 in medical bills, and a $6,000 deficiency balance on a repossessed vehicle. Discharging these other debts would both free up some of your money for the IRS and avoid the risk that those other creditors could jeopardize your payments to the IRS.   Entering into a mandatory monthly payment arrangement with the IRS when at any moment you could be hit with another creditor’s lawsuit and garnishment is a recipe for failure.

Instead, a Chapter 7 case would very likely discharge all of the credit card, medical and old vehicle loan debts. With then gone you would have a more sensible chance getting through an IRS payment arrangement.

In a Chapter 13 case, you may be required to pay a portion of the credit card, medical and vehicle debts, but in return you get the benefits of getting long-term protection from the IRS, a freeze on interest and penalties, and more flexible payments.

So whether Chapter 7 or Chapter 13 is better for you depends on the facts of your case. Either way, you would pay less or nothing to your other creditors so that you could take care of the IRS. Either way, you would much more likely succeed in becoming tax free and debt free, and would get there much quicker.

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Dramatic Examples of How Bankruptcy Can Be a Good Idea Even if It Can’t Write Off Every Debt

Here’s how bankruptcy actually works, and works well, even when a significant debt or two can’t be written off.

The last blog gave six reasons why it’s worth looking into bankruptcy even if you know that you can’t discharge (write off) one or more of your most important debts. Today here are concrete examples how the first three of those could work for you.

The first two reasons we’ll cover together. First, sometime debts which you might think can’t be discharged actually can be, and second, some debts that can’t be discharged now may be able to be in the near future.

Let’s say you currently owe $10,000 in federal income tax for the 2008 tax year. You filed that tax return on October 15, 2009 after getting an extension. You’ve been making monthly payments to the IRS on a payment plan, but because of that you did not make adequate tax withholdings or quarterly estimated payments for 2011. You know that once you file your 2011 tax returns (by October 15, 2012, because you got an extension) you’re going to be in trouble because you will owe a lot for that year as well. You know the IRS will cancel the payment plan for 2008 because of your failure to keep current on your ongoing tax obligations. You’re pedaling as fast as you can, but October 15 is less than two months away and you don’t know what to do. You are quite certain that the $10,000 tax debt cannot be discharged in bankruptcy.

You’d be right about that… but only for the moment. Because under these facts that 2008 tax debt could very likely be discharged through either a Chapter 7 or 13 bankruptcy case filed AFTER October 15, 2012. (Whether you’d file a Chapter 7 or 13 would depend on other factors, including how big your 2011 and anticipated 2012 tax debts will be.) Instead of being in a seemingly impossible situation, you would avoid paying all or most of that $10,000—plus lots of additional interest and penalties that you would have been required to pay. Instead you would be more than $10,000 ahead on paying off the 2011 and 2012 taxes!

Now here’s an example to go with the third reason to consider bankruptcy: even if you can’t discharge a debt, bankruptcy can permanently solve an aggressive collection problem.  

Change the facts above to make that $10,000 debt one owed for the 2009 tax year instead of 2008. Since that tax return was also filed with an extension to October 15, 2010, that $10,000 would not be dischargeable until after October 15, 2013. But in this example you’ve already defaulted on your monthly payment agreement. So you are appropriately expecting the IRS to file a tax lien on all of your personal property and on your home, and to start levying on (garnishing) your financial accounts, and on your paycheck if you’re employed or on your customers/clients if you’re self-employed.

With all that the IRS can do to you, you can’t wait until October of next year to discharge that $10,000. But if you filed a Chapter 13 case now the IRS would not be able to take any of the above aggressive collection actions against you. You would have to pay the $10,000 (and any taxes owed for 2010 and 2011) but you would have as long as 5 years to do so. And most importantly, throughout that time you’d be protected from any future IRS collection action on any of those taxes, as long as you complied with the Chapter 13 rules.

As for the 2012 tax year, you would likely be given the opportunity to pay extra withholdings or estimated payments during the rest of this year, which you would be able to afford because of temporarily paying that much less  into your Chapter 13 plan.

So instead of being hopelessly behind and deathly scared about everything the IRS is about to do to you, within a few days you could be on a financially sensible path to being caught up with the IRS. And then within three to five years you’d be tax debt free, AND debt free.

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Bankruptcy Can Solve Your Debt Problems Even If You Can’t Write Off Every Debt

Don’t disregard bankruptcy as an option just because it does not write off the debt which is your immediate big headache. There’s likely some good medicine for that headache after all.

Let’s say you owe a dreadfully large income tax debt from a couple of years ago. The IRS is getting aggressive about collecting it. You know for a fact that bankruptcy doesn’t discharge (legally write off) income tax debts, so you’re not seriously considering that option and have not seen a bankruptcy attorney.

You may or may not be right about whether or not that tax debt can be discharged. That’s almost always a matter of timing. So if indeed you could not discharge your debt a few months ago, that might not be true today, or might not be true a few months from now.)But whether or not the debt can be discharged,  either way, you would probably be wrong about not getting legal advice about it.

Why? Whether that special debt that you know can’t be discharged is a tax debt, back child support, student loans, or some other troublesome debt, here are six reasons you should STILL get legal advice about the bankruptcy  option:

1. Some debts which look like they can’t be discharged actually can. Certain income taxes can be discharged in either a Chapter 7 or Chapter 13 case, depending on how old they are and a series of other factors. Sometime a portion of an otherwise not dischargeable tax debt—such as the penalties—can be discharged, sometimes significantly reducing the amount you need to pay. Student loans are difficult to discharge, but in some unusual situations can be. And even though true child support obligations are not dischargeable, in rare situations a debt which you thought was a support obligation might not fit the legal definition for bankruptcy purposes. It’s certainly worth finding out whether the debt you assume can’t be discharged actually might be able to be.

2. Some debts that can’t be discharged now may be able to be in the future. Almost all income taxes can be discharged after a series of conditions have been met. So your attorney can put together for you a game plan coordinating these tax timing rules with all the rest of what is going on in your financial life. Timing issues can sometimes also be important with student loans, especially if you have a worsening medical condition or are simply getting close to retirement age

3. Even if you can’t discharge a debt, bankruptcy can permanently solve an aggressive collection problem.  In many situations your primary problem is the devastating way a debt is being collected. For example, you may want to pay an obligation for back child support but the state support enforcement agency is about to suspend your driver’s and/or occupational license. A Chapter 13 case will stop these threats to your livelihood, and protect you from them while you catch up on the back support.

4. You have more control over the amount of the monthly payments on debts that cannot be discharged. Debts which the law does not allow to be discharged in bankruptcy also tend to be ones that give the creditors a lot of leverage against you. Chapter 13 takes most of this leverage away from them and puts their power on hold while you pay what your budget allows, not what these creditors would otherwise be gouging out of you.

5. Bankruptcy can stop the adding of interest, penalties, and other costs, allowing you to pay off a debt much faster. Unpaid income taxes and certain other kinds of debts are so much more difficult to pay off because a part of each payment goes to the ongoing interest and penalties. Some tax penalties in particular can be huge. Most of these ongoing add-ons are stopped by a Chapter 13 filing, allowing you to become debt-free sooner.

6. Bankruptcy allows you to focus on paying off the debt(s) that you can’t discharge by discharging those you can. You may have both a debt or two that can’t be discharged and a bunch of debts that can be. Even if bankruptcy can’t solve your entire debt problem directly, discharging most of your debts would likely make that problem much more manageable. Under Chapter 7, you would be able to pay off those surviving debts much faster, which is especially important if they are accruing interest or other fees. And under Chapter 13 you would have the benefit of a predictable payment program, one that focuses your financial energies on those nondischargeable debts while protecting your assets and income from them.

So don’t let the fact that you have a debt or debts that can’t be discharged in bankruptcy stop you from getting legal advice about how your overall financial life could still be much improved through one of the bankruptcy options.  

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The U.S. Supreme Court’s Health Care Decision

Even without mentioning the word “bankruptcy,” the most important court decision in years may still have a huge effect on future bankruptcies. How? Possibly by greatly reducing the need to file bankruptcies resulting from medical debts.  

First, a short summary.

Last week’s Supreme Court decision upheld the “individual mandate,” the most contentious part of the Affordable Care Act. That’s the obligation for certain people who don’t get health insurance to pay a penalty for not doing so. The Court held that the mandate is not constitutional under the Commerce Clause because NOT buying insurance is NOT engaging in commerce. So not buying insurance is not behavior that Congress has the power to regulate on that basis.

However, the Court still determined that the mandate is constitutional, under a different part of the Constitution, Congress’ taxing power. Even though Congress did not call the penalty a tax, it functions as a tax because, among other reasons, payment and collection of the penalty are done only through the IRS.

The Court also upheld the “Medicaid expansion” part of the Act. But while doing so the Court significantly limited a penalty for any states which decide not to participate in that expansion.

Second, if you want to read all or part of the full opinion, it’s here on the Supreme Court’s website. And for a good all-around news summary of the decision, here is an article from the Washington Post on the day it was released. For a more thorough summary, see this blog in “plain English” from the highly respected SCOTUSblog.

Third, to make it even easier for you, the rest of this blog consists of key quotations from the Court’s opinion. So you get the actual language of the court without wading through what are actually four different opinions totaling 193 pages. Thes following excerpts come only from the “opinion of the Court,” the parts which got the necessary five-out-of-nine votes to carry the day, totaling only about 36 pages out of the 193. Also to keep it manageable, these excerpts focus only on the “individual mandate” issue, not the Medicaid issue or any of the other procedural ones. (If you want to find any of the excerpts within the full opinion, the page number from Chief Justice Roberts’ opinion is in parentheses at the end of each one.)

 

Introductory excerpts:

“In our federal system, the National Government pos­sesses only limited powers; the States and the people retain the remainder. Nearly two centuries ago, Chief Justice Marshall observed that ‘the question respecting the extent of the powers actually granted’ to the Federal Government ’is perpetually arising, and will probably continue to arise, as long as our system shall exist.’ McCulloch v. Maryland, 4 Wheat. 316, 405 (1819).” (p. 2)

“The Federal Government has expanded dramatically over the past two centuries, but it still must show that a consti­tutional grant of power authorizes each of its actions.” (p. 3)

“Our permissive reading of these powers is explained in part by a general reticence to invalidate the acts of the Nation’s elected leaders. ‘Proper respect for a co-ordinate branch of the government’ requires that we strike down an Act of Congress only if ‘the lack of constitutional authority to pass [the] act in question is clearly demon­strated.’ United States v. Harris, 106 U. S. 629, 635 (1883). Members of this Court are vested with the authority to interpret the law; we possess neither the expertise nor the prerogative to make policy judgments. Those decisions are entrusted to our Nation’s elected leaders, who can be thrown out of office if the people disagree with them. It is not our job to protect the people from the consequences of their political choices.  (p. 6)

“In 2010, Congress enacted the Patient Protection and Affordable Care Act, 124 Stat. 119. The Act aims to in­crease the number of Americans covered by health in­surance and decrease the cost of health care.  … .

“The individual mandate requires most Americans to maintain ‘minimum essential’ health insurance coverage. 26 U. S. C. §5000A. The mandate does not apply to some individuals, such as prisoners and undocumented aliens. §5000A(d). Many individuals will receive the required cov­erage through their employer, or from a government pro­gram such as Medicaid or Medicare. See §5000A(f). But for individuals who are not exempt and do not receive health insurance through a third party, the means of satisfying the requirement is to purchase insurance from a private company.”  (p. 7)

“The Government advances two theories for the proposi­tion that Congress had constitutional authority to enact the individual mandate. First, the Government argues that Congress had the power to enact the mandate under the Commerce Clause. Under that theory, Congress may order individuals to buy health insurance because the failure to do so affects interstate commerce, and could un­dercut the Affordable Care Act’s other reforms. Second, the Government argues that if the commerce power does not support the mandate, we should nonetheless uphold it as an exercise of Congress’s power to tax. According to the Government, even if Congress lacks the power to direct individuals to buy insurance, the only effect of the indi­vidual mandate is to raise taxes on those who do not do so, and thus the law may be upheld as a tax.” (p. 15)

The Commerce Clause

“The Constitution grants Congress the power to ’regulate Commerce.’ Art. I, §8, cl. 3 (emphasis added). The power to regulate commerce presupposes the existence of com­mercial activity to be regulated.” (p. 19)

“The individual mandate, however, does not regulate existing commercial activity. It instead compels individ­uals to become active in commerce by purchasing a product, on the ground that their failure to do so affects interstate commerce.”  (p. 20)

“Congress already enjoys vast power to regulate much of what we do. Accepting the Government’s theory would give Congress the same license to regulate what we do not do, fundamentally changing the relation between the citizen and the Federal government.”  (pp. 23-24)

“The Framers gave Congress the power to regulate com­merce, not to compel it, and for over 200 years both our decisions and Congress’s actions have reflected this un­derstanding.” (p. 24)

“The Government argues that the individual mandate can be sustained as a sort of exception to this rule, because health insurance is a unique product. According to the Government, upholding the individual mandate would not justify mandatory purchases of items such as cars or broccoli because, as the Government puts it, ‘[h]ealth in­surance is not purchased for its own sake like a car or broccoli; it is a means of financing health-care consump­tion and covering universal risks.’ Reply Brief for United States 19. But cars and broccoli are no more purchased for their ‘own sake’ than health insurance. They are purchased to cover the need for transportation and food.” (p. 27)

“No matter how “inherently integrated” health insurance and health care consumption may be, they are not the same thing: They involve different transactions, entered into at different times, with different providers. And for most of those targeted by the mandate, significant health care needs will be years, or even decades, away. The proximity and degree of connection between the mandate and the subsequent commercial activity is too lack­ing to justify an exception of the sort urged by the Gov­ernment. The individual mandate forces individuals into commerce precisely because they elected to refrain from commercial activity. Such a law cannot be sustained under a clause authorizing Congress to ‘regulate Commerce.’ ” (p. 27)

Congressional Taxing Power

“The Government’s tax power argument asks us to view the statute differently than we did in considering its com­merce power theory. In making its Commerce Clause argument, the Government defended the mandate as a regulation requiring individuals to purchase health in­surance. The Government does not claim that the taxing power allows Congress to issue such a command. Instead, the Government asks us to read the mandate not as order­ing individuals to buy insurance, but rather as imposing a tax on those who do not buy that product.” (p. 31)

“Under the mandate, if an individual does not maintain health insurance, the only consequence is that he must make an additional payment to the IRS when he pays his taxes. See §5000A(b). That, according to the Government, means the mandate can be regarded as establishing a condition—not owning health insurance—that triggers a tax—the required payment to the IRS. Under that theory, the mandate is not a legal command to buy insurance. Rather, it makes going without insurance just another thing the Government taxes, like buying gasoline or earn­ing income. And if the mandate is in effect just a tax hike on certain taxpayers who do not have health insurance, it may be within Congress’s constitutional power to tax.” (p. 32)

“The exaction the Affordable Care Act imposes on those without health insurance looks like a tax in many re­spects. The ‘[s]hared responsibility payment,’ as the statute entitles it, is paid into the Treasury by ‘tax­payer[s]’ when they file their tax returns. 26 U. S. C. §5000A(b). It does not apply to individuals who do not pay federal income taxes because their household income is less than the filing threshold in the Internal Revenue Code. §5000A(e)(2). For taxpayers who do owe the pay­ment, its amount is determined by such familiar factors as taxable income, number of dependents, and joint filing status. §§5000A(b)(3), (c)(2), (c)(4). The requirement to pay is found in the Internal Revenue Code and enforced by the IRS, which—as we previously explained—must assess and collect it “in the same manner as taxes.” Supra, at 13–14. This process yields the essential feature of any tax: it produces at least some revenue for the Government.” (p. 33)

“Congress’s authority under the taxing power is limited to requiring an individual to pay money into the Federal Treasury, no more. If a tax is properly paid, the Government has no power to compel or punish individuals subject to it. We do not make light of the se­vere burden that taxation—especially taxation motivated by a regulatory purpose—can impose. But imposition of a tax nonetheless leaves an individual with a lawful choice to do or not do a certain act, so long as he is willing to pay a tax levied on that choice.” (pp. 43-44)

“The Affordable Care Act’s requirement that certain in­dividuals pay a financial penalty for not obtaining health insurance may reasonably be characterized as a tax. Be­cause the Constitution permits such a tax, it is not our role to forbid it, or to pass upon its wisdom or fairness.” (p. 44)

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Debts You Really Care About, and WANT to Pay

In bankruptcy, are you allowed to favor: 1) creditors with collateral, so that you can keep the collateral; 2) creditors toward whom you have special loyalty; and 3) creditors who have extraordinary leverage against you?

When clients first talk with me about filing bankruptcy, they are often very concerned about what will happen to debts that they want to keep paying. In fact sometimes people believe that bankruptcy is not a serious option for them because they are afraid of what will happen with these debts that are so important to them. As their legal counselor, my job is to respect and understand these fears.  Then I can make recommendations about how to best deal with these debts.

These special debts fall into three categories.

1. Debts You Care About Because of Crucial Collateral

Before getting to the point of seriously considering bankruptcy, you may have been doing everything possible to keep current on your home or vehicle. You may have made the decision that holding on to your home for the sake of your family is your absolutely highest priority. Or you may feel the same way toward your vehicle, because you need to be able to get to work and/or to keep your family or personal life sane.

Chapter 7 and Chapter 13 both have ways that you can help keep your home and vehicles. Sometimes these involve not paying other creditors so that you can pay the mortgage or vehicle loan. In other situations you may be able to keep your home and vehicle while paying significantly less to do so. Overall, bankruptcy usually allows you to focus your limited financial resources on these kinds of debts if they are your highest priority.

2. Debts You Care About Because of Moral Obligation

Many of my clients feel different levels of loyalty to different creditors. Some even feel guilty about feeling that way. But it is perfectly human to feel differently about a personal loan owed to a family member than about a credit card balance owed to a national bank. Or how you feel towards a medical debt owed directly to your long-time family doctor compared to how you feel towards a debt that is now at a second or third collection agency and you don’t even know which medical provider they are collecting for. 

If you feel an absolute moral obligation to pay a debt regardless whether or not you file bankruptcy, there are safe ways to do so and very dangerous ones. I’ll tell you about this in an upcoming blog. In any event, be sure you tell your attorney about this because it can effect whether you file a Chapter 7 or a Chapter 13 case, and sometimes also the timing of your filing.

3. Debts You Care About Because of Extra Creditor Powers

Although one of the most basic principles of bankruptcy law is that your creditors must be treated equally, the more accurate version of that principle is that legally equal creditors must be treated equally. And because the law is filled with legal distinctions among creditors, some debts are more dangerous than others, both inside and outside of bankruptcy. You may well have heard about or directly experienced the extraordinary collection powers of the taxing authorities, support enforcement agencies, or student loan creditors, for example. You may also be aware that some debts cannot or might not be written off in bankruptcy. Understandably you’re concerned what will happen with these debts if a bankruptcy won’t help you with them.

The reality is that usually a bankruptcy will help you with even the most aggressive creditors, even those whose debts will not be discharged. Almost always there are sensible ways to deal with these special creditors. Sometimes it involves using the bankruptcy system’s own substantial powers to gain important advantages over these creditors. Sometimes it involves reasonable payment arrangements after completing a Chapter 7 case, when you have no other debts. Sometimes it involves directly favoring these creditors by paying them before or instead of other creditors in a Chapter 13 case, while under continuous protection from the bankruptcy court. Overall, usually bankruptcy provides you a manageable way to handle these legally favored creditors.

The next few blogs will give you specific information on how bankruptcy can help you keep valuable collateral, satisfy your moral obligations, and deal with your most aggressive creditors.

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The Power of Chapter 13 to Save Your Home, Brought to Life

A mere list of the many ways that Chapter 13 can help save a home can start sounding dry. So here’s a powerful example that shows off some of its extraordinary advantages.

 

Let’s start by setting the scene. Say you lost your job in early 2010 and, except for temporary, part-time work, you did not find new full-time employment until 3 months ago. It pays less than your old job.

  • While you weren’t working full-time, you used up your savings and then borrowed on your credit cards to try to pay the house payments. That seemed to make sense at the time because you kept getting promising job leads, none of which panned out until you finally got hired for your present job. So you owe $18,000 on the credit cards, with minimum payments totaling $550 per month.
  • After your savings and available credit ran out, you still fell $5,000 behind on your first mortgage and $3,000 behind on your second. They are both starting to send papers sounding like they are going to start foreclosing.
  • Because there wasn’t enough money in your property tax escrow account with your first mortgage lender to pay the recently due annual $2,000 property tax bill, the lender is demanding that you pay that right away. It is threatening to foreclose for this separate reason if you don’t.
  • You had some medical problems soon after losing your earlier job, while you had no medical insurance, resulting in a $7,500 medical bill. That went to a collection agency, turned into a lawsuit, and then recently into an $8,000 judgment lien against your home.
  • Money had been tight even back before you’d lost your job because of cutbacks in hours, so you cut your tax withholding way back, so that you owed $2,000 to the IRS for 2009 income taxes. You couldn’t make the agreed monthly installment payments, and have just found out that that a tax lien has been recorded against your home in the amount of $3,000, after adding in all the accrued penalties and interest.
  • While you were working temporary jobs during 2010 and 2011, you were desperate for every dollar you could bring home, and so didn’t have any taxes withheld. As a result you owe the IRS another $2,500 for each year, or a total of another $5,000 that you have not even filed tax returns for yet.  You’re afraid to because you have no money to pay it and are afraid of more tax liens against your home.
  • Your home was worth $300,000 in 2008, but has lost about 25% of its value by now, so is worth $225,000. You owe $230,000 on the first mortgage, with monthly payments of $1,000, and owe $50,000 on the second mortgage, with monthly payments of $300.
  • With your current reliable income, after paying modest but reasonable living expenses, you have $1,500 available monthly for all creditors, including the two mortgages. That’s only $200 per month beyond the two mortgage payments, a drop in the bucket considering this mountain of debt:
    • credit cards: $18,000
    • first mortgage arrears: $5,000
    • second mortgage arrears: $3,000
    • property tax arrears: $2,000
    • judgment lien: $8,000
    • 2009 income tax with tax lien: $3,000
    • 2010 and 2011 income tax: $5,000

That’s a total debt of $44,000, besides the $230,000 first mortgage and $50,000 second mortgage.

  • Last fact: your two school-age kids live with you, they’ve lived in this home their whole lives, and have gone to the good local public schools for years, with their friends who live in the neighborhood. So more than anything you want to maintain this home and the stability it brings to their lives (and yours!). But it sure seems hopeless.

A Chapter 7 “straight bankruptcy” would help by discharging (writing off) tens of thousands of dollars, but NOT likely help nearly enough for you to be able to keep the home. A Chapter 7 case would likely discharge all or most of the credit card balances, as well as the medical bill that turned into the judgment, and likely even get rid of that judgment’s lien on your home title. That would save you about $26,000, and take away one threat to your home. But with only $200 to spare after paying the current first and second mortgage payments, that $200 is just way too small to even begin to satisfy the mortgage lenders or the IRS, much less both.

So after your Chapter 7 case would be completed, the IRS would attempt to collect the 2009 debt through garnishments of your bank account or wages, and sooner or later you’d have to deal with the 2010 and 2011 taxes, possibly resulting in them at some point turning into tax liens. And sooner or later your home would be foreclosed because you would have no way to catch up on the mortgage arrears.

However, if INSTEAD you filed a Chapter 13 case, under these circumstances you very likely you WOULD be able to keep your home, cure the mortgage arrears, and pay off all the taxes. And all this would happen while you and your home was protected from collection efforts by any of your creditors. How could that possibly be? I’ll show you in my very next blog. Sorry to keep you hanging, but today’s blog is way too long already.

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Save Your Home with 5 Powerful Prescriptions Found in Your Chapter 13 Medicine Cabinet

Chapter 13 is often your best option for holding onto your home. That may be simply because it solves one of your major home debt problems, or instead because it solves a bunch of them all in one package.

 

If you’ve heard that Chapter 13 bankruptcy—the three-to-five year plan for “adjustment of debts”—is a good way to save your home, you’re probably thinking of a particular problem that you heard it solves. But the true beauty of Chapter 13 is in how many different kinds of problems it can handle all at the same time. So even if your home is being attacked from multiple directions, this bankruptcy option can often successfully defend against all those attacks.

But don’t get the false impression that if you are in danger of losing your house, Chapter 13 can necessarily save it. Even with all of the different ways it can help, this type of bankruptcy has its limits. Your situation has to fit for it to work.

I have a list of ten distinct ways that Chapter 13 can save your home, five covered in this blog and then five in the next one. This list of ten will give you a good sense of the multiple powers of Chapter 13, but also some sense of their limits.

1. Stretch out mortgage arrearage payments: This is the one you likely hear about most often: reduce what it costs you each month to catch up on your back mortgage payments by using up to five years to do so. This is in contrast to the much shorter time you’d have to catch up—likely a year or less—on the back payments, and the much, much higher monthly payments you’d have to pay to do so, if you had instead filed a Chapter 7 case.

2. Junior mortgage strip: Through Chapter 13—but not Chapter 7—you can “strip” a second or third mortgage lien off your home title. This often saves you hundreds of dollars monthly that you could instead pay to other more crucial obligations—or to your living expenses. And in the long run it can often save you thousands or tens of thousands of dollars. Very importantly, getting rid of some of the debt on your home can either create equity in your home where you did not have any, or at least make it less underwater than it had been.

3. Flexibility in buying more time for your home: There are all kinds of situations in which you need to buy time for your home, but not just the straightforward one for catching up on the mortgage arrearage. If you need to stop your house from being foreclosed to have time to sell it, or if you want to delay selling your home until two years from now when a child graduates from a local school, or when you qualify for retirement or expect some other definite change in your finances, Chapter 13 can often give you more control of the situation. Instead of being under the protection of the bankruptcy court for only the three months or so of a Chapter 7 case, you can potentially be protected for years under Chapter 13. Mind you we would have to formulate a plan to keep the mortgage creditor happy during this time. But the point is that there may well be creative ways to meet your goals without just being at the mercy of your lender, as you would pretty much be after, or even sometimes during, a Chapter 7 case.

4. Property taxes: When you fall behind on mortgage payments, at the same time you can also fall behind on your property taxes. Not paying a property tax payment on time is usually a separate breach of your contract with your mortgage lender, giving it another reason to foreclose on the property. Chapter 13 provides an excellent way to catch up on those taxes, while at the same time preventing the lender from using your missed tax payment as a reason to foreclose in the meantime. And because interest on property taxes is often higher than other secured debts, in your Chapter 13 Plan you may well be able to save money by paying off this tax debt earlier than other obligations.

5. Income tax liens: While I’m talking about taxes, Chapter 13 is also often the best way to satisfy an income tax lien which has attached to the title of your home. IRS and other possible state tax liens are generally not shielded by a homestead exemption, and have to be paid even if the underlying tax would otherwise have been discharged in bankruptcy. After a Chapter 7 case, you are left to fend against the tax authority on your own, facing the potential seizure of your home, with that used as intense leverage against you. In contrast, in Chapter 13 you are protected from such seizure, and as with property taxes can generally earmark payments towards the tax lien before most other creditors so that it gets paid off. It’s a much less worrisome and sensible way of taking care of this kind of scary debt.

These are the first five powerful ways that Chapter 13 can solve debt problems involving your home. Please come back in a couple days for the other five.

 

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Getting a Handle on Your Income and Business Taxes Through Bankruptcy While Your Business Forges Ahead

Could your small business survive and even thrive if you could just get better terms for payment of your back tax debts?

The owners of just about every struggling sole proprietorship have income and business tax problems. When you are barely scraping by, needing every dollar to pay the absolutely necessary keep-the-business-running expenses, you can find yourself unable to scrape together the money to make your estimated personal income tax payments each quarter. If you have an employee or two, it can be all too tempting to use the withheld payroll tax money for some critical business or personal expense instead of paying it over to the IRS. So even when business improves, once you fall behind with your taxes it’s terribly difficult to catch up, to be simultaneously paying both your current and past tax obligations. This especially true considering accruing late charges and interest, which can greatly increase the amount you must pay to catch up.

Add to the mix the IRS’ limited flexibility on payment terms for back taxes, plus its extraordinary collection powers against you and against your business and personal assets, and it’s no wonder that back taxes are often the most urgent problem for a business owner trying to figure out what to do.

If your business is a sole proprietorship in your name, or in your name and that of your spouse, a Chapter 13 case would very likely give you a series of advantages in dealing with your past due tax liabilities, while allowing your business to continue to operate. (If your business is instead in the form of a corporation, or if your debt amount is larger than a certain threshold, you may not qualify for Chapter 13 but instead need to consider Chapter 11 or other options, a discussion which is beyond the scope of this blog.)

A Chapter 13 bankruptcy could help your business survive by significantly reducing both your business and personal monthly debt obligations, and the tax debts themselves as well as the rest of your debts. As for the back taxes:

• some of the taxes or penalties may be written off (“discharged”) altogether;

• payments on the remaining tax debts would usually be stretched out over a much longer period than the taxing authorities would otherwise allow, thereby greatly reducing the amount you would need to pay each month; and

• ongoing interest and penalties usually stop accruing, so that the payments you make pay the tax debts off much more quickly.

So Chapter 13 almost always gives you both immediate month-to-month relief easing your business and personal cash flow, and long-term relief reducing what you must pay before you are tax debt free, and completely debt free.

 

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