Tag Archives: tax returns

Afraid to File Your Taxes?

Trust me. I get it. Lots of us are afraid to file our tax returns – well, ok, afraid to prepare them may be closer to the truth; but, trust me, I get it.

– and it just got worse.

Not filing your taxes has always been bad. Filing late has always had some consequences, but most of them were manageable. Now, there is a new one.

In the last week of 2014 the 10th Circuit Court of Appeals handed down an opinion agreeing with an earlier decision from the 5th Circuit. So far, they are the only two circuits to hear this particular issue; and they agree. This is not good.

Here is the problem. Generally, speaking income taxes are dischargeable in a bankruptcy proceeding provided that they meet certain requirements. Like with anything involving either the Bankruptcy Code or the Tax Code (let alone both), there are more rules, limitations and exceptions to the basic rules than holes in Swiss cheese. Still, generally speaking, if the taxes meet certain age tests they are dischargeable in a bankruptcy filing – any chapter. Well, the 10th Circuit, following the 5th, has added a new wrinkle.

According to these Courts if the returns were filed so much as a day after they are due, the taxes on those returns are never dischargeable in a Bankrutpcy. Of course, if they are filed before the expiration of a properly granted extension, they are not late. If they are filed after the extension expires, however, or if no extension is granted; then, we have a whole new problem.

I have a case right now where a client has filed a bankruptcy, and taxes are a major part of the debt. I just went through every one of her tax transcripts. One of those returns was filed late. Anywhere inside the 5th or 10th Circuits the taxes on that return are not only not dischargeable in this Bankruptcy – they will never be eligible for a discharge. Oh, and the date on that return? Filed less than two weeks after April 15, and no request for extension was filed.

This seriously sucks.


Your Bankruptcy Trustee Can Pay Your Taxes For You

Occasionally, I run into a situation where a client needs to file for bankruptcy, maybe even needs to file NOW; but – they have non-exempt assets. Now, in Oklahoma we have pretty generous exemptions, and most people who file for Bankruptcy lose nothing but a bunch of debt. Occasionally, though, I run into someone with mineral interests, a significant amount of jewelry (our wearing apparel exemption is generous, but a $35,000 ring that isn’t your wedding or engagement ring is going to be a problem); and they still need to file. This is a problem.

Usually, given a little time we can find a solution that the client is happy with. This is what is called pre-bankruptcy planning, and it is tricky. There are plenty of things that you can do with an asset right before a bankruptcy filing that your Trustee can just undo. There are other things you can do that will get you into real trouble – losing your discharge, going to jail. This is not an area to mess around with if you don’t know what you are doing. Still, generally, given time, there are things that can be done to protect a non-exempt asset.

So, what happens when you don’t have time? Sometimes you need to file NOW. In those cases you file the case knowing that the Trustee is going to administer whatever the asset is. Several years ago, I filed a Chapter 7, and first thing the next morning was emailing the freshly appointed Trustee (who didn’t even know she was the trustee yet) wanting to know when would be convenient for my client to deliver approximately $50,000 in jewelry to her office. She was a little taken aback. In this particular case the client didn’t want the jewelry and had made some efforts to sell it but had not been successful.

Consequently, he was thrilled when I asked him if he would like to have the Trustee pay his taxes with the proceeds from the jewelry he didn’t want and hadn’t been able to sell.

Here is the scoop. We filed for what is called a short tax year. It is perfectly legitimate, although it is very rarely done. Basically, my client filed two tax returns for the year in which he filed for Bankruptcy. He filed one return for the calendar year up to the day he filed for bankruptcy, and he filed a second return for the remainder of the calendar year. We did this, because he had made no estimated quarterly payments prior to filing for bankruptcy; and his income for that period had been substantial.

By doing this we converted his tax liability for that first, short-year, return into a liability of his Bankruptcy estate that was entitled to priority – meaning it got paid first. He still had to pay the tax liability for the rest of the year, but that was only about a quarter of the year’s total tax liability. So, he got his Bankruptcy Trustee to liquidate stuff he didn’t want and use the proceeds to pay three quarters of his taxes for the year. Now, that is pretty sweet.


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.


US Trustee Audits — They’re BACK!

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.


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!