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Protecting Yourself When Your Business Has to Throw in the Towel

If you’re seriously considering closing down a struggling business, you are likely very concerned about personal damage control: how do you end the business without being pulled down with it?

My last blog was about saving your business through a Chapter 13 case. I can explore that option with you when you come in to see me, but let’s assume here today that either before or after talking with me you’ve made up your mind to close the business. And let’s keep it simpler by assuming that your business is or was a sole proprietorship, as I did in the last blog, and that you truly need bankruptcy relief because of the totally unmanageable size of the debts.

Lots of considerations come into play, but let’s focus on two main ones—assets and debts—in looking at 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 for a Fast Fresh Start

After putting so much effort and hope into your business, once you accept the reality that you have to give up on it, you understandably may just want to clean up after it as fast as possible. And in fact a “straight bankruptcy” may be the most consistent with both your gut feelings and with your legal realities.

IF everything that you own—both from the business and personally—fits within the allowed asset exemptions, then your case will likely be relatively simple and quick. A no-asset Chapter 7 case is usually completed from start to finish in about three months. And if none of your assets are within the reach of the trustee, there is nothing to liquidate and distribute among your creditors. The liquidation and distribution process can take many additional months—or even years, so avoiding that streamlines a Chapter 7 case greatly.

But this assumes that all your debts can be handled appropriately in a Chapter 7 case—the debts that you want to discharge (write off) would be discharged and those that would not are ones that you either want to or 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 may include certain taxes, support payments, and perhaps student loans.

Asset Chapter 7 Case As a Convenient Liquidation Procedure

If you do have some assets that are not exempt, that alone may not be a reason to avoid Chapter 7. Assuming that those are assets that you can do without—and maybe even are happy to be rid of, such as if they came from your former business—letting the bankruptcy trustee mess with them instead of you doing so may be a sensible and fair way of putting the past behind you.

That may especially be true if you have some debts that you would not mind the trustee paying out of the proceeds of selling your non-exempt assets. You can’t predict with certainly how a trustee will act and how much if any would trickle down to which creditors, but this is something to keep in mind with this option.

Chapter 13 to Deal with the Leftover Consequences

Even if you’d prefer putting your closed business behind you quickly, there may be fallout from that business that a Chapter 7 would not deal with adequately. For example, if the business left you with substantial tax debts that cannot be discharged, non-exempt assets that you need to protect, or a significant mortgage arrearage, Chapter 13 could sometimes save you thousands of dollars and provide you protection from and a better way of dealing with these kinds of creditors. Deciding between Chapter 7 and 13 when different factors point in different directions is where you truly benefit from having an highly experienced bankruptcy attorney help you make that delicate judgment call.

 

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Your Sole Proprietorship Business Rescued by Chapter 13

Do you have a small business in your own name that would be successful if it only got a break from its debts? A Chapter 13 case would likely greatly reduce both your business and personal monthly debt service while you continued to run your business.

Although Chapter 13 is sometimes called the “wage earner plan,” it is not at all restricted to wage-earning employees. In the Bankruptcy Code Chapter 13 is actually titled “Adjustment of Debts of an Individual with Regular Income.” That word “Individual” makes clear that a corporation cannot file under Chapter 13. But if you are a person who owns a business that is operated in your own name, or that of you and your spouse, then you and business are treated as a single legal entity. The business’ assets are just part of your personal assets; its debts are just part of your debts. This is true regardless if your business is operated under an assumed business name, as long as you have not gone through the formalities of creating a corporation, a limited liability company, or other separate legal entity for your business.

Here’s how Chapter 13 works to help your sole proprietorship business:

1) Chapter 13 deals with your business and personal financial problems in one package. In a sole proprietorship you are individually liable for all debts of your business, along with your personal debts. So as long as you qualify for Chapter 13 otherwise, you can simultaneously resolve both business and personal debts with that one option.

2) Stop both business and personal creditors from suing you and shutting down your business. The “automatic stay” imposed by the filing of your Chapter 13 case stops ALL your creditors from pursuing you, including both business and personal ones. Your bankruptcy case will stop personal creditors from hurting your business, and business creditors from taking your personal assets.

3) Keep whatever your business assets you need to keep operating. If you do not file a bankruptcy, and one of either your business or personal creditors gets a judgment against you, it could try to seize your business assets. Also, if you filed a Chapter 7 “straight bankruptcy,” under most circumstances you could not continue operating your business. However, Chapter 13 is designed to allow you to keep what you need and continue operating your business.

4) Keep critical business and personal collateral. If you are behind either on business or personal loans secured by either business or personal collateral, Chapter 13 will at least temporarily stop the repossession of the collateral, and often give you an opportunity to either lower the payments or at least have some time to catch up on your late payments. In certain limited situations—such as some judgment liens and some 2nd/3rd mortgages—the liens can be gotten rid of altogether. Overall, through Chapter 13 you are provided ways to keep collateral that you would otherwise lose, and often do so under much better payment terms.

5) Solve both business and personal tax problems. Business owners in financial trouble are often in tax trouble, which Chapter 13 addresses well. The program is designed so that at the end of a successful Chapter 13 case, you will have either written off or paid off all your tax debts and will be tax free.

 

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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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Income Tax Refunds in a Chapter 13 Case

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

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

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

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

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

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

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

The truth is that this is not necessarily bad:

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

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

 

Here are the bullet points:

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

 

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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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THE Goal of Bankruptcy: Discharge of Your Debts

Most—but not all—debts are written off, or “discharged,” in a bankruptcy case. Is there a simple way to know what will and what will not be discharged?


As part of getting a fresh start for the new year, I’m covering the most basic concepts about bankruptcy in the first few blogs of the year. And there is nothing more basic than bankruptcy’s main purpose, getting a fresh financial start through the legal discharge of your debts.

Both kinds of consumer bankruptcy can discharge debts. But most Chapter 13s tend to have other purposes as well, and the discharge usually occurs only 3 to 5 years after the case is filed. In contrast, most Chapter 7 “straight bankruptcy” cases are filed for the sole purpose of discharging debts. And in most Chapter 7 cases, all debts that the debtors want to discharge are discharged, and it happens within just three months or so after your case is filed. So I’m focusing in this blog on Chapter 7 discharge of debts.

So is there a simple way of knowing what debts will and will not be discharged in a Chapter 7 case?

Sorry. Not really.

I can give you a list of the categories of debts that can’t, or might not, be discharged (and will give you that list in a couple paragraphs), but some of those categories don’t have clear boundaries, and some depend on whether a creditor is going to challenge the discharge and how a judge might rule.

But why can’t it be simple? Because in the political tug of war between creditors and debtors over the last few centuries, there have been lots of compromises, leaving us today with a bunch of hair-splitting rules about what debts can and can’t be discharged.  Believe it or not, the original bankruptcy laws in England did not even include ANY discharge of debt, since bankruptcy was originally designed as a procedure to help creditors collect from debtors.

But I’m making it sound a lot worse than it is in practice. Here’s what you need to know:

#1:  All debts are discharged, EXCEPT for those that fit within an exception.

#2:  There ARE a lot of exceptions, BUT if you are thorough and candid with your attorney you will almost always know whether you have any debts that may not be discharged. Surprises are rare.

#3:  Some debts are never discharged, NO MATTER WHAT: for example, child or spousal support, criminal fines and fees, and withholding taxes.

#4:  Some debts are never discharged, but THAT’S ONLY IF the particular debt fits certain conditions: for example, income taxes, depending on conditions like how long ago the taxes were due and the tax return was filed; and student loans, as long as conditions of “undue hardship” are not met.

#5:  Some debts are discharged, UNLESS timely challenged by the creditor and resulting in a ruling by the judge that the debt meets certain conditions involving fraud, misrepresentation, larceny, embezzlement, or intentional injury to person or property.

#6:  A few debts (used to be many more) can’t be discharged in Chapter 7, BUT can be in Chapter 13: for example, divorce debts other than support.

The bad news: as simple as I would like to make it, determining what debts aren’t dischargeable is simply not simple. But there’s more good news than bad. First, for many people all the debts they want to discharge WILL be discharged. Second, an experienced bankruptcy attorney will be able to predict quite reliably whether all of your debts will be discharged. And third, if you have troublesome nondischargeable debts, Chapter 13 is often a decent way to keep those under control. More about that in my next blog about simple Chapter 13.

 

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