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The Simplest Save-Your-Business Chapter 13 Case

Here’s how to focus on running your business, by stopping your creditors from taking the wind out of your sails.

In the last few blogs I’ve been talking about some of the extra considerations that come into play when you own a business, are having financial troubles, and wonder if bankruptcy can help. No question—most of the time, having a business adds an extra layer of issues for me to help you work through in deciding whether bankruptcy is the best option, and then putting your case together if it is. But a business Chapter 13 case does not have to be complicated. Let’s take a very simple business situation, and walk it through a Chapter 13 case, to get a practical feel for how it works.

So let’s say Mark, a single 30-year old, started a handyman business when he lost his job three years ago. Before that he’d done about ten years of all kinds of construction and maintenance work, already owned all the tools he needed, and had even taken a few courses at the local community college in small business management because he’d always wanted to run his own business. He had good credit at the time, owed nothing but about $3,000 on some credit cards, plus had never been late on his modest mortgage. Mark had lived all his life in the same city, was the kind of guy who knew tons of people, and had well-earned reputation that he could fix anything. He put a lot of time into putting together a detailed and realistic business plan. He knew he should have some money saved up to get him past the start-up phase, but then the recession hit, he was out of work, and decided it was now or never. Besides, he had $7,000 of credit available on his credit cards if he got desperate.

His business started off slowly, partly because he didn’t have any money for advertizing. But he was creative and worked very hard building a customer base and a good business reputation. His income was creeping steadily upwards, but way too slowly. Over the course of the first year Mark maxed out his credit cards, and simply didn’t have enough money to pay income taxes to the IRS, falling behind $7,000 to them. Then during the second year he managed to service the credit card debt but couldn’t pay it down any, and fell behind another $7,000 to Uncle Sam. Then this last year, the IRS forced him to start making $500 monthly payments on his $14,000 debt, plus the estimated payments for the current year so that he didn’t continue falling further behind with them. As a result he’d gotten spotty on his credit card payments, which jacked up the interest rates and pushed him over the credit limits, piling on all kinds of fees. And now he’s missed a total of 4 payments on his mortgage, putting him $6,000 in arrears.

In the midst of all this his business now has steady—and still slowly increasing—income, Mark enjoys his work in spite of all the financial pressures, and believes he can keep growing it, especially if/when the economy improves. But the IRS has him in a vice, the credit cards creditors are sending their accounts to collection agencies, and his home is heading sooner or later to foreclosure.

A Chapter 13 case filed now for Mark would:

  • Stop the pressure by the IRS on the $14,000 debt, by cancelling the $500 payments, and giving him much longer—3-to-5 years—to pay that debt, usually with NO additional ongoing interest or “failure to pay” penalties, thus reducing the total amount to be paid to the IRS.
  • Stop collection efforts by the credit card creditors and collection agencies, who would only receive money AFTER he caught up on the house arrearage AND paid off all the taxes, with the amount received depending on what Mark could afford and how much in assets he needed to protect.
  • Immediately and consistently protect all his business and personal assets—tools and supplies, his business truck and/or personal vehicle, receivables owed by customers for prior work, and his business and personal bank and/or credit union accounts.
  • Allow him to focus on his business instead of his creditors, giving that business much more of a chance at success.
  • Get him debt-free–at the end of the 3-to-5 years Chapter 13 Plan, his mortgage would be current, he would owe nothing more to Uncle Sam, and he would have paid as much as he could afford on the credit cards, with the rest written off.

And the business that he loves, and in which he invested so much hope and dedication, would be alive and well.

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Chapter 13 Conquers Both Older and Newer Income Taxes

If you owe a number of years of income tax debt, Chapter 13 allows you to favor those taxes that have to be favored, while dumping the taxes that can be dumped.

In my last blog I gave an example showing how Chapter 13 can be an extremely good way to handle income tax debts particularly when you owe multiple years of taxes. In that hypothetical case, without a bankruptcy a couple would have had to pay about $30,000 to the IRS for back taxes, plus about another $45,000 in medical bills and credit cards, a total of $75,000. And paying this huge sum of money on their income would have taken them many, many years of pressure and uncertainty. In huge contrast, in a Chapter 13 case this same couple would only need to pay about $17,500, less than 1/4th the amount. And they would be allowed to do so through pre-arranged affordable monthly payments, for three years, all the while not having to worry about aggressive actions by any of their creditors, including the IRS.

How does Chapter 13 pull this off?

1) Tax debts that are old enough are lumped in with the lowest priority “general unsecured” creditors—like medical bills and credit cards—and so in many cases do not need to be paid anything unless there is enough “disposable income” to do so. This means that often those taxes are paid either nothing—as in the example—or  only a few pennies on the dollar.

2) The more recent “priority” taxes DO have to be paid in full in a Chapter 13 case, along with interest accrued until the filing of the case, but a) penalties—which can be a large part of the debt—are treated like “general unsecured” debts rather than “priority” ones, and 2) usually interest or penalties stop when the Chapter 13 is filed. These can significantly reduce the amount of tax that has to be paid.

3) “Priority” taxes are paid in a Chapter 13 case before and instead of “general unsecured” debts. This often means that having these taxes to pay simply reduces the amount of money which would otherwise have gone to those “general unsecured” creditors. So sometimes, amazingly, having tax debt does not increase the amount paid in a Chapter 13 case. In our example, the couple paid about $500 per month for three years, which is the same amount they would have paid even if they did not owe a dime to the IRS! They met their obligations under Chapter 13 by paying the IRS instead of their other creditors.

4) The bankruptcy law that stops creditors from trying to collect their debts while a bankruptcy case is active—the “automatic stay”—is just as binding on the IRS as on any other creditor. The IRS can continue to do some very limited and sensible things like demand the filing of a tax return or conduct an audit, but it can’t use the aggressive collection tools that the law otherwise grants to it. Gaining relief from collection pressure from the IRS AND all the rest of the creditors is one of the biggest benefits of Chapter 13.

I confess that I put this example together in a way that would showcase the advantages of Chapter 13 in dealing with income tax debts. If the facts were different, the advantages could easily be less. If, for instance, more of the taxes were “priority” debts that had to be paid, the debtors would have to pay more, either through larger monthly payments or for a longer period of time. There are definitely situations where it is a close call choosing between Chapter 7 or Chapter 13, or possibly even not filing bankruptcy at all but doing an offer in compromise with the IRS. To decide what is best for you, you need the independent advice of an experienced bankruptcy attorney, who is ethically and legally bound to look out for your best interests. Regardless whether your tax debts and other circumstances point strongly in one direction or it’s a closer call, you need a professional qualified both to help you make an informed decision and then to execute on it.  

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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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Writing Off Income Taxes with a “Straight Bankruptcy”

You don’t always need to file a Chapter 13 case—with its 3-to-5-year payment plan–to deal with income tax debts. Thinking that you do is a myth, alongside the broader myth that “you can’t write off taxes in a bankruptcy.” Both have a kernel of truth, which is why they persist. It’s true: some taxes cannot be discharged (legally written off) in bankruptcy. But some can. And it’s true: Chapter 13 is often an excellent way to solve tax problems. But that does not necessarily mean it is the best for you. Instead Chapter 7 might be.

Chapter 13 tends to be the better tool if you owe a string of income tax debts including relatively recent ones. Why? Because in this situation Chapter 13 gives you the best of both worlds. First, if you owe recent income taxes which cannot be discharged, you get lots of advantages under Chapter 13, including paying less by avoiding most penalties and interest. That can be a huge savings, especially if you can afford only relatively small payments. Second, if you have older back taxes, these are also wrapped into the Chapter 13 plan, often without you paying any more into your plan, then they are discharged at the end of your case.

But you DON’T NEED the best of both worlds if all or most of your income tax debts are dischargeable. Then Chapter 7, the straightforward “straight” bankruptcy is enough.

So, WHAT ARE the conditions for a specific income tax debt to be discharged in Chapter 7? How are you going to know if Chapter 7 will discharge all or most of your taxes so that it is the right option for you?

Some of the conditions for discharge of taxes are quite straightforward. Some are more complicated. And as you’ll see, some are even purposely vague. So unfortunately it’s not as simple as plugging a particular tax debt into a clear formula to see if it is dischargeable. Determining whether a particular tax debt will be discharged requires the careful judgment of an experienced attorney.

I’ll just list these conditions for discharging income taxes here, and then explain them in my next blog. Don’t be surprised if they sound confusing in this list. It’s true: anything having to do with taxes tends to be complicated!

To discharge an income tax debt in a Chapter 7 bankruptcy case, it must meet these conditions:

1) Three years since tax return due: The applicable tax return must have been due more than three years before you file your Chapter 7 case. And if you requested any extensions for filing the applicable tax returns, you have to add that extra time to this three-year period.

2) Two years since tax return actually filed: Regardless when the tax return was due, you must have filed at least two years before your bankruptcy is filed in court.

3) 240 days since assessment: The taxing authority must have assessed the tax more than 240 days before the bankruptcy filing.

4) Fraudulent tax returns and tax evasion: You cannot have filed a “fraudulent return” or “willfully attempted in any manner to evade or defeat such tax.”

You can see that these are begging for some clarification. For that please come back to read my next blog. Or else call to set up a consultation with me. If you have substantial tax debts, you should definitely get some thorough personal advice. Know your options so you can make an informed choice, about bankruptcy and otherwise.

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Taxes and Bankruptcy–Debunking a Hardy Myth

No wonder people think “bankruptcy can’t help me with my tax debt.” Even attorneys sometimes perpetuate the myth.

A few days ago I saw a video of a bankruptcy attorney being interviewed in what amounted to be an infomercial. He was asked by the interviewer whether there were some debts that can’t be “touched” in a bankruptcy:

Attorney: “Absolutely. Things like child support, alimony, uh, tax debts, student loans. Those generally aren’t dischargeable.”

Interviewer:  “So the government’s gonna help you eliminate some of the debt in a bankruptcy. But not the debt to them.”

Attorney: “Not theirs, of course!”

Lumping tax debts in with child support and alimony—which indeed cannot be legally written off, or discharged—is just plain wrong. For him to say that tax debts “generally aren’t dischargeable” while including it with other debts that are never dischargeable, or in the case of student loans very rarely dischargeable, is at best very confusing.

And no question, the merger of taxes and bankruptcy can be confusing, because each of these are rather complicated areas of law. Misinformation doesn’t help.

In my next few blogs, you’ll get some solid answers about what taxes can be discharged and what can’t. The fact is that bankruptcy can discharge taxes of many types and in many situations. Sometimes ALL of a taxpayer’s taxes can be discharged, or most of them. But there ARE significant limitations, which I will explain carefully.

But right now maybe the most important thing to understand is that even as to the particular taxes that may not be discharged, a bankruptcy still usually provides huge advantages in dealing with those taxes. So besides the possibility that you will be able to discharge some or all of your taxes, bankruptcy can also:

1. Keep the taxing authorities from garnishing your wages and bank accounts, and “levying on” (seizing) your personal and business assets.

2. Stop them from gaining greater leverage against you, through tax liens and piling on greater penalties and interest.

3. Avoid forcing you to pay them monthly payments based on totally unreasonable policies (such as giving no consideration to most of your other legal obligations), all the while penalties and interest continue to accrue.

Overall, bankruptcy gives you leverage against the IRS, or state or local taxing authority that you cannot get any other way. It gives you a lot more control over a very powerful class of creditors. And your tax problems are resolved as part of your whole financial package, so you don’t find yourself working hard to deal with your taxes while worrying about being blindsided by other creditors.

I’ll explain all this in my next blogs. Call me in the meantime if you can’t wait, or you know you shouldn’t wait. There is no kind of debt that needs more careful personal attention and advice than tax debts.

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Surprising Supporters of Increased Taxes on the Rich

Not only do the majority of the wealthy think that they should be taxed more, so do a majority of Republicans. These are the surprising conclusions of two recent polls.

When the second-richest American, Warren Buffett, wrote an op-ed column in the New York Times a few months ago advocating increased taxes for himself and everybody else with an annual income over $1 million, that wasn’t such a big surprise. He has been pushing similar policies for quite a while. For that matter so has the # 1 richest American, Bill Gates.

But that column by Buffett generated such a firestorm of opposition that it would have been easy to think that he and Gates don’t have much support among their wealthy colleagues.  Not true, according to a survey of millionaires taken during October 2011 by the Spectrem Group, “the premier research and consulting firm in the wealth and retirement industry.” More than 67 percent of those millionaires surveyed said that the U.S. economic situation would be improved by increasing taxes on those with more than $1 million in annual income, pretty much what Buffett is advocating.

Well, OK, that’s surprising. But maybe they’re so rich they can easily afford to pay taxes. Or maybe those in the top 1% being made infamous by the Occupy Wall Street folks are not as greedy as they are being made out to be. Or maybe just not that anti-government. As Mark Cuban, another of the ultra-rich, has said straight out in his own blog a couple months ago: “Pay your taxes. It’s the most Patriotic thing you can do.”

Now Gates, Buffett, and Cuban may not exactly be representative of all wealthy Americans. And who knows how reliable that Spectrem Group survey is. But if true, it’s noteworthy that a full two-thirds of millionaires think that if their taxes were higher that would help our economy instead of hurt it.

But what about everyday Republicans? I would have thought that a very strong majority of Republicans would oppose “increasing the taxes paid by people who make more than one million dollars a year.” This was the wording of the question asked in a CNN/ORC poll taken in mid-October.  But instead about 56% of Republicans favored increased taxes for these high-earners, while 43% opposed them.

I don’t pretend to know what this means. It may be as simple as an attitude—even among Republicans–of “tax the other guy to plug the deficit.” There are only about 250,000 U.S. households with incomes of more than a million dollars, so they don’t get a lot of votes in a national poll. Whatever the cause for this willingness for a selective tax-increase among the Republican electorate, it seems to reveal a disconnect between them and their single-mindedly anti-tax representatives in Washington.

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Bill Gates and Warren Buffett Want Higher Taxes for Themselves

 The two richest people in America think they are under-taxed. Do they know what they are talking about?

I noticed on the latest list of the country’s wealthiest that Bill Gates and Warren Buffett are #1 and #2. They both have been publicly arguing in favor of increased taxes for themselves and their very rich colleagues. Whether this is good policy is a matter of intense political debate. It’s a particularly important one considering what the country just went through a couple of weeks ago with the exhausting debt-ceiling battle. A central part of its last-minute compromise was to hand over responsibility for finding $1.5 trillion cuts in federal spending to a 12-person super-committee of U.S. Senators and Representatives. And to do so by the day before Thanksgiving.

With this timing clearly in mind, Warren Buffett wrote an op-ed column in last Sunday’s New York Times titled “Stop Coddling the Super-Rich.”

He makes two primary arguments:

1. The rich currently pay less in taxes as a percent of their income than the middle class:

While the poor and middle class fight for us in Afghanistan, and while most Americans struggle to make ends meet, we mega-rich continue to get our extraordinary tax breaks. Some of us are investment managers who earn billions from our daily labors but are allowed to classify our income as “carried interest,” thereby getting a bargain 15 percent tax rate. Others own stock index futures for 10 minutes and have 60 percent of their gain taxed at 15 percent, as if they’d been long-term investors.

… .  It’s nice to have friends in high places.

… .

The mega-rich pay income taxes at a rate of 15 percent on most of their earnings but pay practically nothing in payroll taxes. It’s a different story for the middle class: typically, they fall into the 15 percent and 25 percent income tax brackets, and then are hit with heavy payroll taxes to boot.

2. Refuting the “job-killing” argument of fiscal conservatives, Buffett says that he and his fellow investors aren’t affected by higher tax rates :

I have worked with investors for 60 years and I have yet to see anyone — not even when capital gains rates were 39.9 percent in 1976-77 — shy away from a sensible investment because of the tax rate on the potential gain. People invest to make money, and potential taxes have never scared them off. And to those who argue that higher rates hurt job creation, I would note that a net of nearly 40 million jobs were added between 1980 and 2000. You know what’s happened since then: lower tax rates and far lower job creation.

Buffett closes his piece by asking for an immediate higher income tax rate for those making more than $1 million, and an even higher rate for those making more than $10 million. He concludes:

My friends and I have been coddled long enough by a billionaire-friendly Congress. It’s time for our government to get serious about shared sacrifice.

 

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