Tag Archives: tax refunds

Christmas Bills, a New Year and Bankruptcy

There are a number of reasons why Bankruptcy filings surge after the first of the year. The New Year brings introspection and the desire to finally find a way out of the hole you have been trying to climb out of for years. Christmas bills can be the last straw. Then, of course, there is the impending tax refund, which can be a helpful way to pay for the bankruptcy filing.

There are a few things to consider, though.

First, let’s talk about Christmas bills. The general rule is that you want to wait at least 70 days and preferably 90 days after you have last used your credit cards before filing a bankruptcy. There are exceptions to this, but those are sufficiently fact specific, that you will want to talk to a lawyer about your particular facts. What you should remember is, if you haven’t already stopped using your cards – do it now, before you call the lawyer. Then, go ahead and schedule the appointment. You will want some time to get things ready to file anyway, but have a good idea what your card usage has looked like during the last 30 – 60 days so you can discuss it with your lawyer in detail.

There are actually a couple of issues with tax refunds. First of all, you will be happier if you have your tax return for the completed year prepared before you file your Bankruptcy. In some cases, you will have to have it, but you will always want to have it in hand. One reason for that is that if you have not received your tax refund before you file your bankruptcy, your Trustee may be entitled to the refund. The solution to that, of course, is to have already received it and done something constructive with it before the case is filed. I will caution you that you will want to discuss exactly what you do with that refund with your lawyer before you do it – not after. Of course, I think that one of the best things to do with that refund is to pay your attorney for filing the bankruptcy – but I might be prejudiced.

Finally, there is that decision to start a new year finally freeing yourself from the unending cycle of debt that you have been mired in. Finally, it is time to put yourself back in a place where you can take care of yourself, your family, put something aside for retirement – yes, it is time! Not so fast. Is it time? Are you through getting into trouble? If you have lost a job, do you have a stable pay check coming in? With health insurance? If you’ve had health problems, are they behind you? If so, then, yes. It is time. Time for a New Year and a new start.


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

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!


Bankruptcy, the Fiscal Cliff and Tax Refunds

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?


Tax Refunds and the Bankruptcy Estate

Tax refunds present a couple of interesting points in a Bankruptcy filing.  This post is concerned with Chapter 7 filings.  Chapter 13 is a little bit different for a couple of reasons.  This is also rooted in Oklahoma law, and although the theory remains the same, the results can be very different in other States. 

When talking about tax refunds with my clients, the first thing I have to do is figure out exactly what we are talking about.  I long ago stopped asking my clients and just started looking at their most recent returns.  Clients tend to refer to that check they receive from the IRS (or electronic credit) as their tax refund, although in many cases, it is all kinds of other things.  A tax refund is literally the refund of money that the tax payer overpaid to the IRS during the course of the year.  Various tax credits are paid along with the refund, but they are money given, or credited, to the tax payer by the Government.  Some common tax credits are Earned Income Credit, Child Care Credit and recently the Making Work Pay Credit.  Those are not a tax refund, those are tax credits.  At this point my clients are generally rolling their eyes and muttering, “Whatever” under their breath thinking I can’t hear them.  Then, I get their attention.

You see, tax refunds are not exempt in Oklahoma.  That means that any tax refund that has accrued to a debtor at the time he files for bankruptcy becomes property of his bankruptcy estate — meaning his Bankruptcy Trustee gets the money, and the debtor doesn’t.  Earned Income Credit, however, is exempt; and the Debtor gets to keep that money.  It is about this point that eyes stop rolling and clients’ posture visibly improves. 

Let me explain.  A Chapter 7 Bankruptcy is a deal.  The Debtor agrees that if he has any non-exempt property that the Trustee wants to administer for the benefit of his creditors, the Debtor will put it on the front porch with a red bow on it for the Trustee to come get — and BE HAPPY ABOUT IT.  In exchange, the Debtor gets a discharge — meaning he gets out of the debt that brought him to my office in the first place.  If that deal isn’t worth doing, then don’t file a Chapter 7 Bankruptcy.  Now, in most cases my clients lose no property, because the list of property that you get to keep in Oklahoma (exempt property) is really very generous.  Most people who file in Oklahoma lose nothing but a whole bunch of ugly debt they didn’t want in the first place, but the most commonly lost asset in Oklahoma is a tax refund — because tax refunds are not exempt.  Earned Income Credit, however, is exempt; and so the Debtor gets to keep that.  Ah, yes, focused attention. 

Now, I am posting this in April — tax time; but this is a relevant topic all year.  Here’s why.  Any time a bankruptcy is filed, the Debtor creates what is called a Bankruptcy Estate, and he gives to that Estate everything he owns and everything he owes.  Then, the Debtor takes back all property that he is claiming as exempt.  The goal is to leave as much debt as possible trapped in the Bankruptcy Estate and as little property as possible.  The Debtor can take back his Earned Income Credit.  He cannot take back his overpaid taxes, those are trapped in his estate and belong to his Trustee to pay to his Creditors. 

Notice, that last sentence refers to overpaid taxes, not specifically to a tax refund.  That is why this is an issue that is relevant all year.  Let’s assume that a client is expecting a $4,800 tax refund.  That means he has overpaid his taxes at the rate of $400 a month ($400 x 12 = $4,800).  If he files for Bankruptcy on January 1, he will have overpaid to the IRS the whole $4,800.  Now, he probably can’t file his taxes and claim it for at least another month or two; but he is owed that money even though he doesn’t have it yet.  His right to that money passes into his estate the instant he files his Bankruptcy.  That means when he does file his tax return, that entire refund will belong to his Trustee for the benefit of his creditors — all $4,800 of it.  Ouch. 

Now, let’s assume that this same person files on July 1 rather than January 1.  At that point he will have overpaid his taxes by $2,400 (January – June = 6 months x $400 = $2,400).  Even though he can’t claim that money for another seven or eight months, he is entitled to it.  Think of this as a savings account that you could only withdraw from after the first of the year.  You still are entitled to the money you deposit, you just might have to wait a while to get it.  Well, your Trustee can wait a while too.  So, in this set of facts, if the Debtor files for Bankruptcy July 1 and gets a $4,800 tax refund the following February or March, he will be entitled to keep the excess, or refund, that he paid in after he filed his Bankruptcy on July 1.  The Trustee will be entitled to the excess paid in before July 1. However, to the extent that refund is Earned Income Credit rather than tax refund, the Debtor gets to keep it all, regardless of when he filed.

This illustrates several significant concepts central to the Bankruptcy system:  1.The nature of the Bankruptcy Estate; 2. The inclusion in the Estate of accrued interests in property; 3. The difference between exempt and non-exempt property, and how technical that distinction can appear to be; and 4. The role of the Trustee.

Of course, the moral of this story is don’t file a Bankruptcy shortly after the first of the year until your tax refund is back and spent.  Do, however, talk to an attorney in advance, however.  There are ways you can spend a tax refund right before you file that can cause bigger problems.  As this post should have pointed out, Bankruptcy is a complex and technical area of law, and there can be significant ramifications to deceptively routine transactions.