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Resolve Your Income and Business Taxes through Bankruptcy While Continuing to Operate Your Business

Do you believe that your small business could survive, and even thrive, if you could just get better payment terms on your overdue taxes?

 

The Near-Universal Debt Challenge

If you are the owner of a struggling business, you likely have income tax problems.

When you are barely scraping by, needing every dollar to pay the absolutely necessary expenses to operate your business, it’s not surprising that there just isn’t enough money to pay the estimated personal income tax payments when they come due every calendar quarter. And so it’s also not surprising if those quarters of unpaid or underpaid taxes start piling up, and before you know it you are behind a year or two or more of income taxes.

The situation can be even worse if you have an employee or two. When you have some absolutely crucial business or personal expense to pay, it’s sometimes just too tempting to use the employee payroll tax withholding money to pay that expense instead of turning the money over to the IRS or the state.

Then your business improves so that you can begin to pay your ongoing estimated and withholding taxes. But you still don’t have the money to simultaneously pay both your current and past tax obligations. Plus penalties and interest keep accruing.

Catching up once you fall behind on your taxes is simply very hard to do when you’re trying to run a business.

The Fear Factor

 You likely already know that the IRS and the state taxing agencies have extraordinary collection powers that they can bring to bear against you, and against your business and personal assets. Besides the usual tools that they can use against individuals, they can do worse to you and your business. They can garnish your receivables—so that your customers find out that you are having serious tax problems. They can levy on—seize—your business equipment and inventory. They can “tap your till”—come onto your premises and seize whatever cash you have on hand.

It’s not that the feds and/or the state will take always such aggressive collection actions against every business or business owner who owes taxes. But they DO tend to be pushier with business-related tax debts, especially if they include tax withholdings.

The larger point is that if you own a business and are behind on taxes, the power of the taxing authorities to cripple your business legitimately makes resolving your back taxes your most urgent problem.

The Chapter 13 Solution

A Chapter 13 “adjustment of debts” helps resolve your tax debts, and so enables your business to survive. It does that by significantly reducing both your business and personal monthly debt obligations, and by sometimes reducing the tax debts themselves and/or giving you much more flexible payment terms.

Specifically as to the past due taxes:

  • some of the taxes and/or penalties may be permanently written off (“discharged”) altogether;
  • payments on the remaining tax debts may be stretched out over a longer period than the taxing authorities would otherwise allow, thereby 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 more quickly.

Conclusion

Filing a Chapter 13 case almost always gives you immediate month-to-month relief, easing your business and personal cash flow. That’s because the IRS and state are immediately prohibited from collecting against you, including using the strong-arm powers that they have to force payment.

And Chapter 13 gives you long-term relief by almost always reducing the total you have to pay, and giving you time and flexibility in paying it.

So, Chapter 13 is often the best way to get you and your business tax-debt free.

 

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Five Tremendous Tools to Save Your Home through Chapter 13

Powerful Chapter 13 gives you tools to solve your mortgage and other home lien problems from a number of different angles. 

 

The Limits of Chapter 7 “Straight Bankruptcy”

In my last blog I described how a Chapter 7 case can under certain circumstances help you enough to save your home. Or in other situations it can at least help you delay a foreclosure for as long as you need.  But Chapter 7 can only give limited help, maybe enough if you aren’t too far behind on your mortgage circumstances, or you don’t have other kinds of lienholders causing problems.

The Extraordinary Tools of Chapter 13

Chapter 13, on the other hand, provides you a range of much more powerful and flexible tools for solving many, many debt issues so that you can keep your home.

Here are the first five of ten significant ways that Chapter 13 can save your home (with the other five to come in my next blog).

Under Chapter 13 case you can:

1.  stretch out the amount of time for catching up on back mortgage payments for as long as 5 years. This is in contrast to the one year or so that most mortgage lenders will give you to catch up if you do a Chapter 7 case instead. This longer period can greatly lower your monthly catch-up payments, making more likely that you would succeed in actually catching up and keeping your home. Very importantly, throughout this catch-up period your home is protected from foreclosure as long as you stay with the payment plan, one that you propose. Within limits you can later modify that plan if your circumstances change.

2. slash your other debt obligations so that you can afford your mortgage payments. The mortgage debt—especially your first mortgage—can’t be significantly changed under Chapter 13. So you are usually required to pay your full monthly mortgage payment, and to catch up any arrearage, but to accomplish this you are allowed to pay to most of your other debts.

3.  permanently prevent income tax liens, and child and spousal support liens, and such from attaching to your home. The “automatic stay” preventing such liens under Chapter 7 last usually only about 3 months, and there’s no mechanism for dealing with these kinds of debts. Instead under Chapter 13, these liens are prevented throughout the three-to-five-year length of the case.

4.  have the time to pay debts that can’t be discharged (legally written off) in bankruptcy, all the while being protected from those creditors attacking your home. So even if a tax or support lien is already in place before you file, you are given the opportunity to pay the debt while under the protection of the bankruptcy laws. That undercuts the leverage of those liens against your home. Then by the end of your case, the debts are paid and those liens are released.

5.  discharge (write off) debts owed to creditors which could otherwise attack your home. For example, certain (generally older) income taxes can be discharged, leaving you owing nothing. But had you not filed the Chapter 13 case, or delayed doing so, a tax lien could have been recorded, which would have required you to pay some or all of the balance to free your home from that lien. Even most standard debts can turn into judgment liens against your house once you are sued and a judgment is entered. Depending on the facts, a judgment liens may or may not be able to be gotten rid of in bankruptcy.  If instead you file a Chapter 13 case to prevent these liens from happening, at the end of your case the debt is gone, and no such liens attach to your home.

See my next blog post for the other five house-saving tools of Chapter 13.

 

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When a Chapter 7 “Straight Bankruptcy” Helps You Enough on Your Home

A 3-to-5-year Chapter 13 case is often the right tool if you are behind on mortgage payments. But sometimes the simpler Chapter 7 is enough.

 

Chapter 13 Is a Powerful Package

If you want to keep your home but are behind on your mortgage payments, a Chapter 13 “adjustment of debts” is often what you need. It comes with an impressive set of tools to address many home debt problems. It gives you more time to catch up on the mortgage, may enable you to “strip” a second or third mortgage off your title, and gives you very helpful ways for dealing with property taxes, income tax liens, judgment liens, and such.

When Chapter 7 is Enough  

But what if you have managed to fall only a few months behind on your mortgage, and could afford the payments if you just got relief from your other debts?

Or what if you aren’t even keeping the house, but do need a little more time to find another place to live?

Then you may not need a Chapter 13 case, and could save the extra time and cost that it would take compared to Chapter 7. In the right situations Chapter 13 is highly worthwhile because of what it can do. But if you don’t need those advantages, Chapter 7 may be adequate and appropriate.

Buying Just Enough Time for What You Need

The “automatic stay”—the bankruptcy provision that stops virtually all actions by creditors against you or your property—applies to Chapter 7 just as it does to Chapter 13.  So the filing of a Chapter 7 case stops a foreclosure just as quickly as a Chapter 13 filing.

But Chapter 7 usually buys you much less time than a Chapter 13 could.

If you are not very far behind on your mortgage payment(s) and want to keep your home, when you file a Chapter 7 case your mortgage lenders will usually give you several months to catch up on your back payments. You must immediately start making your regular monthly payments, if you had not been making them, and must enter a strict schedule for catching up on the arrearage. In return the lender agrees to hold off foreclosing, as long as you make the payments as agreed.

If instead you are not keeping the house but just need to have more time to save money for moving into a rental home, a well-timed Chapter 7 case will buy you more time in your house. During that time you don’t pay mortgage payments, enabling you to get together first and last month’s rent payment, any necessary security deposit and other moving costs.

The tough-to-answer question is how much extra time would a Chapter 7 filing give you. It mostly depends on how aggressive your mortgage company is about trying to start or restart the foreclosure efforts.  A pushy lender could, soon after you file your case, ask the bankruptcy court for “relief from the stay”—permission to start or restart the foreclosure process. If so, then your bankruptcy filing would buy you only an extra month or so.

Or on the other extreme, a mortgage lender could potentially take no action during the 3 months or so until your Chapter 7 case is finished. At that point the “automatic stay” protection expires, and the lender can start or restart the foreclosure. Or it may sit on its hands even longer. During the height of the mortgage crisis a few years ago, mortgage lenders were so backed up and so reluctant to foreclose, that many homeowners were living in their homes without making payments for a year or two! That is mostly a thing of the past but it goes to show how open-ended this situation can be at times.

Your bankruptcy attorney will likely have some experience in how aggressive your particular mortgage lender is under facts similar to yours.

Stopping Dangerous Liens Against Your Home

Chapter 7 prevents potential liens from being placed against your home, especially important when the lack of a lien makes all the difference. This can occur with IRS and state tax liens and judgment liens. A timely filing of a Chapter 7 case could result in paying nothing on a debt vs. paying it in part or in full.

Consider the example of an older IRS debt that meets the conditions for discharge (legal write-off in bankruptcy), in a situation in which you have equity in your home but no more than would be protected under the homestead exemption. If you did not file a bankruptcy until after the IRS recorded a tax lien for that debt against your house, that lien would continue being attached to your house in spite of your bankruptcy. You would have to pay the tax debt in order to get the lien released when you sold or refinanced the house.

However, if your Chapter 7 case was instead filed before the IRS recorded a tax lien, the “automatic stay” would prevent that tax lien from being recorded, the tax debt would be discharged and never have to be paid.

Discharge Other Debts So You Can Afford to Pay Your Mortgage Payments

Chapter 7 allows you to focus your financial resources on your house payments by getting rid of your other debts.

If you’ve managed to keep current on those mortgage payments, but fear you can’t continue to do so because of financial pressure from other debts, the relief you get from discharging those other debts can allow you to stay in your home long term.

Or you may have missed only a few mortgage payments, AND, after discharging your other debts, can reliably make future monthly payments plus enough extra to catch up on your arrearage within year or less. If so, then Chapter 7 would like likely do enough for you. Most mortgage creditors will make arrangements with you –called a “forbearance agreement”—to catch up the missed payments by paying a sufficient specific amount extra each month until you’re caught up, as long as that catch-up time is relatively short.

However, if after discharging your other debts you could not catch up on your arrearage within about a year, you may well need the extra firepower of Chapter 13 to buy you more time.

 

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Saving Your Home Through Chapter 7 and Chapter 13 in Three Scenarios

Here are 3 common scenarios. When is Chapter 7 “straight bankruptcy” enough, and when do you need Chapter 13 “adjustment of debts”? 

 

Assuming that your most important goal is saving your home, here’s how each kind of bankruptcy helps with that goal.

Scenario #1: Current on Your Home Mortgage(s), Behind on Other Debts

Chapter 7:  Would likely discharge (legally write off) most if not all of your other debts, freeing up cash flow so that you can make your house payments. Stops those other debts from turning into judgments and liens against your home. May also allow you not to fall behind on other obligations—income taxes, support payment, utility bills—which could also otherwise turn into liens against your home.

Chapter 13:  Same benefits as Chapter 7, plus often a better way to deal with many other special debts, such as income taxes, back support payments, and vehicle loans. May be able to “strip” (permanently get rid of) a 2nd or 3rd mortgage, so that you would not have to make that monthly payment, and paying little or nothing on the balance during the case and then discharging any remaining balance at the successful completion of your case.  Is better at protecting assets than Chapter 7, if you either have more equity in your home than your homestead exemption allows or have any other asset(s) not protected by other property exemptions.

Scenario #2. Not Current on Home Mortgage(s) But Only a Few Payments Behind & No Pending Foreclosure

Chapter 7:  May buy you enough time to get current on your mortgage, if you’ve slipped only two or three payments behind. Most mortgage companies and their servicers (the people you actually interact with) will agree to give you several months—generally up to a year—to catch up on your mortgage arrearage. Generally called a “forbearance agreement”—lender agrees to “forbear” from foreclosing as long as you make the agreed payments. Works only if you have an unusual source of money (a generous relative or a pending legal settlement that’s exempt from the other creditors), or if filing Chapter 7 will stop enough money going to other creditors so you will have enough monthly cash flow to pay off the mortgage arrearage quickly.

Chapter 13:  Even if only a few thousand dollars behind on your mortgage, you may not have enough extra money each month after filing a Chapter 7 case to catch up quickly on that mortgage arrearage.  Lenders seldom voluntarily give you more than about a year to catch up, but if you file a Chapter 13 case that forces them to accept a much longer period to do so—three to five years. That greatly reduces what you need to pay towards the arrears every month, often making it affordable.  

Scenario #3. Many Payments Behind on Your Mortgage(s):

Chapter 7:  Not helpful here unless you have some extraordinary means for paying off the large mortgage arrears. Buys only a few weeks of time, or at most three months or so (if the mortgage lender chooses to do nothing while your bankruptcy case is pending). Also, no possibility of “stripping”a 2nd or 3rd mortgage.

Chapter 13:  As stated above, gives you up to five years to pay off the mortgage arrearage, all of which time your home is protected from foreclosure as long as you maintain the agreed Chapter 13 Plan payments. Assumes that you can at least make the regular mortgage payment consistently, along with the arrearage catch-up payment. Does not enable you to reduce the first mortgage payment amount, although in some situations you may be able to “strip” your 2nd or 3rd mortgage.

 

CAUTION: these are just the very basic advantages and disadvantages. There are lots of other twists and turns which will likely apply to your unique scenario. Be sure to meet with an attorney for the best game plan for you to meet your goals. 

 

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Chapter 13 Handles Both Older and Newer Income Tax Debts

If you owe a few years of income taxes, Chapter 13 lets you write off those that can be, while giving you time to pay those that must be.

 

Our Example

The last blog post introduced an example of how Chapter 13 can be a particularly good way to handle income tax debts when you owe multiple years of taxes. In that example:

  • Without a bankruptcy, a couple would have 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 about $75,000. Given their modest income and resulting ability to pay these obligations only very slowly, this couple would almost certainly be subject to many years of collection efforts, lawsuits and garnishments until the obligations were paid off.
  • Under Chapter 13, this same couple would pay only about $18,000—36 months of $500 payments. That’s less than 1/4th of the above $75,000 amount—and substantially less than the taxes alone!. Furthermore, the couple’s monthly payments would be based on their ability to pay. During this payment period their creditors—including the IRS—would be prevented from taking any collection action against them.

How Does Chapter 13 Work to Save So Much on Taxes and Other Debts?

  • Tax debts that are old enough are grouped with the “general unsecured” debts—such as medical bills and credit cards. These are paid usually based on how much money there is left over after paying other more important debts. This means that often these older taxes are paid either nothing or only a few pennies on the dollar.
  • 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. However: 1) penalties—which can be a significant portion of the debt—are treated like “general unsecured” debts and thus paid little or nothing, and 2) usually interest or penalties stop when the Chapter 13 is filed. These can significantly reduce the total amount that has to be paid.
  • “Priority” taxes—those more recent ones that do have to be paid in full—are all paid before anything is paid to the “general unsecured” debts—the medical bills, credit cards, older income taxes and such. In many cases this means that having these “priority” taxes to pay simply reduces the amount of money which would otherwise have been paid to those “general unsecured” creditors. As a result, in these situations having tax debt does not increase the amount that would have to be paid in a Chapter 13 case, which is after all based on what the debtors can afford. In our example, the couple pays $500 per month because that is what their budget allows. That’s the same amount they would have to pay even if they owed nothing to the IRS! The couple meets their obligations under Chapter 13 by having most of their plan payments go to the IRS recent tax debts, and likely nothing to their other creditors or older IRS debts.
  • The bankruptcy law that stops creditors from trying to collect their debts while a bankruptcy case is active—the “automatic stay”—is as effective stopping the IRS as 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.

Deciding Between Chapter 7 and 13 for Income Taxes

If, unlike the example, all of the taxes were old enough to meet the conditions for discharging them under Chapter 7, there would be no need for a Chapter 13 case. On the other hand if more “priority” tax debts had to be paid than in the example, the debtors would have to pay more into their Chapter 13 plan, 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. And sometimes preparing an offer in compromise with the IRS—either instead of or together with a bankruptcy filing—is the best route. To decide which of these is best for you, you need the advice of an experienced bankruptcy attorney to help you make an informed decision and then to execute on it.  

 

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The Four Conditions for Writing Off Income Taxes in Bankruptcy

The conditions for writing off income tax debts actually make sense.

 

The last blog introduced the four conditions for discharging (legally writing off) taxes in bankruptcy. Here’s a fuller explanation of them.

The Core Principle Behind the Four Conditions

There is a simple principle behind all four of these conditions: under bankruptcy law taxpayers should be able to write off their tax debts just like the rest of their debts, AFTER the IRS (or other tax authority) has a reasonable length of time to try to collect those taxes.

What’s a reasonable length of time in the eyes of the law? How much of an opportunity do the tax authorities have to collect before you can discharge the tax debt?

The four conditions each measure this amount of time differently, based on the following:

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.

To discharge an income tax debt, it must meet all four of these conditions.

Here they are in order:

1) Three Years Since Tax Return Due:

All income taxes have a fixed due date for its return to be filed. That date may be delayed by a certain number of months if you asked for an extension, but it’s still a specific point in time. This first condition gives the tax authorities three years from the tax return filing date, or from the extended filing date if you asked for an extension. Note that this is fixed date, not affected by when you actually filed the return nor by what the tax authority did once it received the tax return.

2) Two Years Since Tax Return Actually Filed:

This second condition is different than the first because it is a time period triggered by your own action, your filing of the tax return.

Note that you can file a tax return late and still be able to discharge the debt if at least two years have passed since you filed the return. (Caution: there are some parts of the country where some court opinions have questioned this—be sure to talk with your attorney about the law in your jurisdiction.)

3) 240 Days Since Assessment:

This third condition can be a bit confusing. It very seldom comes into play—most tax debts meet this condition without any problem.

Assessment is the tax authority’s formal determination of your tax liability. It usually happens in a straightforward way, when it receives, processes, and accepts your tax return.

Most of the time an income tax is assessed within a few days or weeks that it is received. So the period of time of 240 days after assessment usually passes long before the above three-years-since-the-return-is-due or two-year-since-tax-return-filed time periods. But the law has to account for the less common situations when the assessment is delayed. These situations can involve a lengthy audit, or litigation, or an “offer-in-compromise” (a taxpayer’s formal offer to settle). In these kinds of situations the three-year and two-year periods may have passed before the official assessment of the tax, and so the tax authority still has 240 days once assessment is made to pursue that tax debt.

4) Fraudulent tax returns and tax evasion:

This last condition effectively means that the above time periods are not triggered at all if you are intentionally dishonest on your tax return or try to avoid paying the tax in some other way. In those situations the tax authority has no opportunity even to begin collecting the tax. So, if you don’t meet this condition, you cannot discharge the tax no matter how old it is.

If your tax debt meets these four hoops, you should be able to discharge that tax in either a Chapter 7 or Chapter 13 bankruptcy.

If You Don’t Meet These Conditions

But what if you owe taxes which do not meet these four conditions, and so can’t be discharged? What if some of your taxes can be discharged by meeting these conditions but some of them don’t? Or what if the IRS or the state tax authority has recorded a tax lien? What if your tax debt arises from your operation of a business? What if you owe not income taxes but some other type of tax? The next few blog posts will get into these questions. 

 

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