Category Archives: Taxes

US Trustee Audits — They’re BACK!

Leave a reply

One of the things lobbyists convinced Congress absolutely had to be added to the Bankruptcy system in 2005 were Debtor audits.  Well, this concept has come and gone a few times since then, generally due to budget fluctuations.  However, it is being reported that the US Trustee has found more money; and random audits are once again a fact of life.

Now, before you get too excited, I have not seen figures for the frequency of audits at this point.  One in every 250 cases being selected is pretty much the historical standard, but I have no idea how much funding the US Trustee has available at this point in time.

The purpose of the audits is to find “material” misstatements in the Debtors’ petition and schedules.  Now, you would think that material would mean material for purposes of the Bankruptcy process and to people who understand how the system works.  No, material at this point seems to mean material to the independent CPA’s from large CPA firms that the U.S. Trustee’s office contracts with to do these audits.  These guys aren’t accustomed to preferential transfers and median income calculations.  These are the same people who audit corporate financial statements.  (If you aren’t rolling your eyes by now, you haven’t been reading my blog long enough.)

Anyway, if your case is selected for an audit, you will have to begin by producing certain documents to the auditors.  The last list of documents I have seen for an audit is from 2008, but I don’t think it has changed much.  Here it is:

  • Payment advices or other evidence of payment from an employer for the six full calendar months preceding the date of the bankruptcy petition, plus those received in the calendar month in which the bankruptcy was filed, from the debtor(s), or from an individual debtor and the individual debtor’s non-filing spouse unless the debtor has checked Box 2.b on Form B22A (Chapter 7 cases only).
  • Federal income tax returns, including all schedules and all W-2, 1099, and K-1 forms, for the two most recent taxable periods prior to the date of the bankruptcy petition.  If either of the returns has not been filed, provide copies of the two most recently filed federal income tax returns.  (If joint case and debtors filed separate returns, provide both returns.)
  • Account statements for the six months preceding the date of the bankruptcy petition for all depository and investment accounts in which the debtor(s) had an interest in any of the six months, including statements (even if received post petition) that reflect activity in the month in which the petition was filed; along with sufficient documentation to explain the source of every deposit or credit over $500.  (Include information for checking, savings, money market, mutual fund, and brokerage accounts.  Examples of documentation for deposit transactions include check registers and annotations on or attached to the account statements.)  Audit firms may request that you provide additional documentation to sufficiently explain the source or purpose of an account statement entry or entries.
  • If the debtor(s) is divorced, (a) the divorce decree, (b) any orders regarding property settlements entered within the last three years, and (c) any alimony or child support orders currently in effect and amendments thereto.
  • If the debtor(s) is self-employed, then for each business owned by debtor or from which debtor derives self-employment income, (a) business tax returns for the two most recent taxable periods prior to the date of the bankruptcy petition, (b) most recent accounts receivable ledger and aging schedule/report, (c) most recent balance sheet prior to the date of bankruptcy petition, (d) income statement for the most recent period ended prior to the date of the bankruptcy petition, (e) quarterly sales tax return for the most recent period ended prior to the date of the bankruptcy  petition, if any, (f) account statements for business depository account(s) for the six months preceding the date of the bankruptcy petition, and the month in which the petition was filed, along with sufficient documentation to explain the source of every deposit or credit, and the purpose of every check, withdrawal, or debit, and (g) most recent business asset listing and depreciation schedule, if any.

My favorite requirement is that last one.  Accounts receivable ledgers, balance sheets, income statements, depreciation schedules — from a self-employed debtor?  Who are they kidding?  Anyone who has that sophisticated an accounting system isn’t self-employed.  They may operate a wholly owned professional corporation, but they aren’t self-employed.  Your self-employed debtors are lawncare people, electricians, oil field contractors, remodeling contractors, plumbers, oh and the next-door neighbor’s cousin who cleans your house. All of whom are, of course, famous for their detailed, double-entry accounting systems.

Yet another example of the 2005 Bankruptcy reform act and its ongoing quest for an abuse in need of a remedy.

Elaine

The Government is Shut Down, Can I Still File for Bankruptcy?

Leave a reply

Yes, for now.  Probably.

Believe it or not, the question of how the government shutdown would impact the practice of Bankruptcy consumed most of my morning last Tuesday; and I was not alone.

The simple answer is that the Federal Courts, of which the Bankruptcy Courts are a part,  announced on Monday that they had enough money to continue operating normally for two weeks.  Most of that money comes from filing fees, and I suspect a large percentage of it comes from Bankruptcy filing fees – but I regress.  So, the simple answer is – no problem for two weeks, then the Courts reassess.

Not so fast.  The bankruptcy system is overseen by the U.S. Trustee’s office, which is a division of the Department of Justice; and almost all of them are furloughed.  Many bankruptcy cases have the IRS, the SBA or some other Federal agency as an active party.  They are all furloughed, and if they aren’t, odds are that their bankruptcy lawyers are from the Department of Justice; and they are furloughed.  So, now what.

One thing that my court did quickly, and that appears to be unique to my jurisdiction is that my Judges entered a General Order staying all matters in Chapter 7’s and 13’s to which the IRS is a party.  Well, we are taking that to mean in which the IRS is an active party.  Technically, the IRS is a party in almost all Chapter 7’s and 13’s.  So, the two objections to claim that I filed last week in the same case now have different response dates, and one hearing date has been indefinitely postponed.

Also, the case trustees are not Federal employees, they are private attorneys; but they are appointed by the U.S. Trustee’s office.  They remain on the job, but I am unsure how long they will continue to be appointed to new filings.  First Meetings of Creditors continue to be held as scheduled, except, of course, neither the IRS nor the U.S. Trustee’s office will be there asking questions I would generally rather my clients weren’t being asked.  In fact, this may be a uniquely good time to file a case with means test issues.  Actually, a month ago probably would have been better. . . . I am teasing – sort of.  It would be interesting to see how that would play out.  If the US Trustee can’t object to a bankruptcy filing because the staff is furloughed, does that toll the time in which the objection must be made?  I wouldn’t think so, and it will be really interesting to see how the Courts deal with that issue, and they almost certainly will.

In the meantime, cases are filing like normal.  The automatic stay (i.e., bankruptcy protection) is going into effect just like always.  Most cases are proceeding normally at this point.  How thing will change if this continues for long, I don’t know.  I am reasonably sure of one thing, though.  The Bankruptcy courts are not going to stop accepting new filings anytime soon.  Bankruptcy cases all include a filing fee – $281 for a Chapter 13 and $306 for a Chapter 7 filing; and the Federal Courts are far too broke to turn that down.

Elaine

Yes, Virginia, You Can Discharge Taxes in Bankruptcy — Sometimes.

Leave a reply

Taxes and bankruptcy is a complicated subject.  There are multi-volume book sets written on the issue.  Still, there are some general rules that a blog post can cover.

First of all, you have to determine what kind of taxes you owe.  Personal income taxes, business withholding taxes, sales taxes, property taxes; they are all treated differently.

The most common case is personal income taxes.   In order to determine whether or not your personal income taxes are dischargeable, your attorney will need to know four things.

  • When the returns were due, that includes lots of things, but the big one is whether or not you filed for an extension;
  • When the return was actually filed, and that means received by the IRS not just put in the mail;
  • When any taxes were officially assessed by the IRS, and this includes any assessments following audits or revisions to the return;
  • Finally, your attorney will need to know if you have filed a Bankruptcy or made an Offer in Compromise since the time the taxes were incurred.

In order to be absolutely sure about these dates your attorney will probably require a tax transcript that includes all of this information.

The general rule is that personal income taxes become dischargeable in Bankruptcy once the returns have been due for at least three years, the returns have been on file for at least two years and the taxes have been assessed for at least 240 days.  These rules make certain assumptions — the returns were not fraudulent, the taxpayer has not made any attempts at tax evasion, etc.

Then, of course, there are the exceptions; and there are way too many exceptions to go into them here.  Although one exception that is developing rapidly (and not in a good way) is the effect of a late filed return on the ability to discharge taxes.  This is an area where you just have to talk to an attorney, and again this is an area where a tax transcript is invaluable.

You should never assume that taxes will (or won’t) be dischargeable until you have actually talked to an attorney and probably gotten transcripts for the appropriate years.  Still, in most cases where these three rules are met, the taxpayer may file for bankruptcy and discharge his personal liability for the taxes.  That filing will not avoid any tax liens that have attached to property prior to the filing, but it will stop liens from attaching to after-acquired property and it will stop the IRS from attempting to collect from you personally.

It is not uncommon for people to come see me who have many years of past-due taxes owed.  In some cases those taxes add up to hundreds of thousands of dollars.  In many cases they have been making payments for years and have done so without realizing that unless otherwise indicated the IRS will apply payments to the oldest outstanding tax year.  In many cases a Bankruptcy filing will not discharge all of their taxes, but it can convert an unmanageable debt into a manageable one.

So, if you have more tax debt than you can pay, don’t discount the possibility of contacting a bankruptcy attorney.  Do mention when making the appointment the amount of taxes in play.  Not all attorneys are comfortable filing cases with large amounts of tax debt.  So, don’t be surprised if the first attorney you contact refers you to someone else.  Also, don’t expect to get completely out of trouble; but you may be very surprised at what a bankruptcy can do for you.

Oh, and if you remember one thing from all of this, file your tax returns ON TIME.  If you can’t pay, you can’t pay; but file your returns ON TIME.  Extensions are fine, just file before the end of the extension period.  Returns not filed timely can create a problem you can’t change.

Elaine

Old Debt, Foreclosed Home, 1099 in the Mail — Oh NO!

Leave a reply

Once upon a time the start of tax season was heralded by would-be clients who had been to see me sometimes months earlier calling very excited, because they finally have the money to file.  Then, there are the Trustees wanting a share of tax refunds that accrued to debtors prior to the filing of their bankruptcies — those calls are less fun.

Recently, though, tax season has started a bit earlier — in January and early February.  Former clients are calling scared, because they have just gotten a 1099 in the mail for some HUGE amount of money that they thought they had discharged in their Bankruptcy — and they are right.

Any time a creditor “forgives” debt, which is a very broad term and doesn’t necessarily have anything to do with whether or not they still intend to collect it or the Debtor still owes it, the creditor is required to send a 1099 for the amount of the forgiven debt to the Debtor and the IRS.  The IRS is then going to assume (unless told to the contrary) that this amount is to be included in the debtor’s gross income for that taxable year.

Breathe.  I promise, it isn’t nearly this bad.  Go back and read that “unless told to the contrary” part again.  If you have filed for Bankruptcy and discharged your personal liability for debt, it does not have to be included in your taxable income.  There is an IRS form 982 that will solve this problem for you.  Form 982 deals with 1099’s if the debt has been discharged in Bankruptcy or if the Debtor was insolvent at the time the debt was forgiven.  The insolvency exception is considerably more difficult and more treacherous.  The Bankruptcy (Title 11) provision is much more straight forward.

There are different rules if the forgiveness of debt involved your homestead, and the property was foreclosed or the subject of a short sale; but the 1099 may still qualify to be excepted from your taxable income.  In that event, I suggest you talk to a competent CPA.   Likewise, if you have any questions regarding the application or use of Form 982, a CPA is the person to call.

Where those 1099’s can be a real issue is if you did some type of debt management plan where you paid less than 100% of your debt.  If it was a Chapter 13 Bankruptcy, Form 982 may still apply.  Otherwise, you might have a real problem; and you cannot call a CPA for help too soon.  I hate getting calls from people who tried to do the right thing, tried to pay their debt; and then after years of scrimping and suffering find out after the fact that they now owe tax on the total amount (including interest) that they didn’t pay.  A Chapter 13 Bankruptcy would likely have been cheaper, more effective and actually gotten them out of debt instead of into tax debt.

So happy tax refunds, and do not pay tax on discharged debt unnecessarily!

Elaine

Short Answers to Complicated Questions

Leave a reply

Frequently when I get a call from someone considering a bankruptcy filing, the first question I’m asked is — complicated.  Here are a few examples.

Are taxes dischargeable in Bankruptcy?

That depends.  Some taxes, like sales taxes and some withholding taxes are never dischargeable.  More commonly I am asked about income taxes, and not surprisingly the rules are complicated.   The most important thing I can tell you in brief is that when you see tax problems developing (and they usually snowball on you), file your returns on time.  Extensions are fine, as long as you file before theyexpire.  If you can’t pay, well, you can’t pay; but file the return.  There are three time frames that must be met before income taxes can become dischargeable, and one of them runs from the time that the tax return was filed.  There is also some troubling case law developing in other parts of the Country limiting dischargeability for late-filed returns.  Of course, if the IRS has filed a substitute for return, that is a whole different ball game.  Yes, I know, this doesn’t make a lot of sense.  It is a short answer to a very complicated question.  Just remember to file your returns timely, and if you wind up way over your head with tax debt, contact a qualified Bankruptcy attorney in your jurisdiction for a consultation.

If I file for Bankruptcy, can I keep my car?

Well, that depends on a lot of things — is it paid for, are you current on it, how much equity do you have in it, have you maintained insurance, can you afford to make the payments?

Think about this one for a minute.  There were over 6300 people who filed for Bankruptcy in the Western half of Oklahoma last year.  If they were all hitchhiking to work, don’t you think you would have noticed? Generally, the impetus for this question is a deep seated sense of shame and a fear that you have been bad and are going to be punished.  I don’t mean to belittle this, it is very real; and most of us have a voice in the back of our heads that says things like this to us, but bankruptcy isn’t about punishment; and most people who file for Bankruptcy keep their cars.   Are there exceptions?   Yes, but that is a whole different blog post.

I’m married, does my spouse have to file with me?

Probably not.  Now, are there reasons why you may want to file jointly?  Yes.  Are there times when you both need to file in order to get a particular result that you want?  Yes.  If your spouse doesn’t file with you, will your filing affect your spouse?  That really depends, and that is one of many reasons why I require that non-filing spouses attend the initial appointment with the filing spouse.

Is the Trustee going to come to my house?

Well, I don’t know.  Are you inviting him for dinner?  Seriously, now, the Chapter 7 panel trustees are highly compensated professionals who get paid a very small amount of money to administer cases.  They make their money administering non-exempt assets.  No one is paying them to go through your sock drawer.  Now, if a Trustee has reason to believe that you are concealing valuable assets, can a Trustee get a search warrant for your home or office?  Well, yes; and in 22-years of practice, I have seen that happen once.  The Debtor went to prison for a number of years for all kinds of fraudulent behavior.  So, don’t hide uncashed royalty checks; and the Trustee will not be paying you a visit.

Elaine

Bankruptcy, the Fiscal Cliff and Tax Refunds

Leave a reply

Evidently, we have a deal on the fiscal cliff — well, sort of.  We have a deal for two months, and then all bets are off.  So, I’m not completely sure that what I have read so far accurately describes the contents of this deal (so double-check my facts before relying on them, please); but even better, anything that does (or doesn’t) change today might in 60 days or so.  I’m sorry, but Congress needs to grow up.

What does this have to do with Bankruptcy and Tax Refunds?  Well, first of all, it appears that the tax exemption for forgiveness of debt income on a principal residence has been extended for a year — or at least until March.  So, if your primary reason for filing for bankruptcy was to avoid tax consequences from a foreclosure or short sale; now, you may not need to.  The emphasis there is on MAY.  Do pay the relatively trivial amount of money to check this with a qualified tax expert — which I am not, and this tax exemption is deceptively complicated.

Now, for the bad news, your pay check will get smaller.  Tax withholding rates are going up 2%.  Most people who file for Bankruptcy have been living pay check to pay check  for many months.  A 2% withholding hit can make all the difference in the world between keeping the heat on and not.  Of course, the problem is that filing for bankruptcy isn’t cheap; and if you are living close to the edge, you probably don’t have the cash laid by for attorneys fees and filing fees.  So, before you spend your 2012 tax refund getting current on bills (like credit cards) and then realizing that you’ve blown your refund and still owe more than you can pay; consider whether you will be better served using that money to pay for a bankruptcy filing.

Every year people call me in late April or May who got back several thousand dollars in March or early April.  They spent that getting current on a bunch of debt and then realize a month later, that their balances aren’t going down and their income isn’t going up.  If your tax refund is enough to get you out of trouble, enough that you won’t need to file, enough that you will then be in a position to take care of yourself and your kids instead of Chase and Discover; then, by all means, use it to pay the bills — but do the math first.  Then, take a look at your retirement accounts and your kids’ college funds.  J.P. Morgan Chase made record profits in the 3rd quarter of 2012.  Did you?

Elaine

How Lawyers Get Educated

Leave a reply

I am writing this on the plane coming home from a Bankruptcy law continuing education conference.  I taught a class on Friday and attended the rest of the conference.  It was held at a  Ritz Carlton on the beach.  I recognize that this is a terribly rough gig, but somebody’s got to do it.

There is actually more truth to that last sentence, then most people realize.  Lawyers, at least in most States, are required by their State bar associations to take a minimum number of continuing education hours a year.  In other words, like any good education, law school is the beginning not the end.  However, even if my State didn’t require continuing education, it just isn’t feasible to stay current on all areas of my practice without help.  That is where continuing education conferences come in.

I figured out years ago that the best education to help me be better what I do every day is offered Nationally, not locally.  So, every year I try to go to at least one National seminar.  This last week I happened to be teaching and attending.

So, during the last few days I have studied the intersection of the Bankruptcy Code with the Tax Code (I really could have used a glossary), litigation tools for stay and discharge violations, the whole world of non-bankruptcy, debt settlement procedures; current developments in case law, rules changes and proposed changes to the official forms; utilizing the new proof of claims rules to more effectively serve my clients’ interests, and ideas in marketing and office management.  Oh, and in the midst of it all I taught a segment for new practitioners and legal assistants on the Statement of Financial Affairs.  It was an intense couple of days, although it calmed down a lot once I was done teaching and could just be a student for a while.

At the end of the conference, my to-do list had gotten a lot longer.  I now have procedures to revamp, forms to re-write, ideas to implement and areas that I know need a lot more study.  More importantly, I am thinking in new ways and excited again about this strange way in which I make my living.

My clients are usually very understanding when I am out of town, but with hearings tomorrow and the next day and appointments most days this week; I am going to have to hit the ground running – hard.  It was worth it, though — well, probably.

Elaine

Taxes, Mortgages and Questions

Leave a reply

I don’t usually post about questions I don’t know the answers to.  Llooking stupid in public is just not something I go out of my way to do.  Today, however, is an exception.

Here is the question.  What are the tax consequences for someone who is in a Chapter 13 Bankruptcy in which a 2nd mortgage is being lien stripped (treated as wholly unsecured with a lien release at the end of the plan) if the mortgage company as part of the National mortgage settlement forgives the 2nd mortgage?

Answer?  I have absolutely no idea.  The general rule is that forgiveness of debt is taxable income.  There are three exceptions to that:  1.  if the debt is discharged in bankruptcy;  2.  if the Debtor is insolvent at the time of the transfer; or 3.  if the property was bought as the debtor’ homestead and the forgiveness qualifies for the Mortgage Forgiveness Debt Relief Act.

Problems — the Mortgage Forgiveness Debt Relief Act is set to expire the end of this year.  As far as I can tell extending it is not a partisan issue, it just is a not important enough to get it done when you could be out campaigning issue.  So, if the debt forgiveness isn’t done in time, that act sunsets December 31, 2012.  So, that might help you; and it might not.

Insolvency seems like a no-brainer, this question assumes a bankruptcy filing.  Except the IRS definition of insolvency includes exempt assets like retirement accounts.  That can be a problem.

Bankruptcy discharge should be the safe and easy one — except it’s not.   Here’s the problem.   Mortgage company issues its 1099 after the first of the year.  (Taking the forgiveness outside of the statutory relief, although, that would not apply to a rental property.)  Tax liability will be assessed on the 2013 tax return.  Debtor is in year two of a five year Chapter 13 plan.  Debtor doesn’t get his discharge until 2015.  Taxes have already been assessed.   Discharge exception might not work, but then again, it might.

Oh, and this is the simple reading of this issue.  I’ve been reading discussion between tax geeks that I don’t even understand about this issue.  Now, if you will excuse me, I’m going to go bang my head slowly against hard objects until I feel better.

Elaine