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Contrary to popular belief, a taxpayer may discharge income taxes in bankruptcy as long as the bankruptcy is not filed too soon after the tax return is filed. As a general rule, you can discharge income taxes that become due more than 3 years before filing bankruptcy, as long as it has been at least 2 years since you filed the tax return and more than 240 days since the taxes were assessed.
Bankruptcy is a game of timing. File a case one day too soon and the taxes are not discharged. File a day later and all of the tax is discharged. A wise bankruptcy attorney and an educated client will want to verify the assessment date of the income taxes owed by obtaining an Account Transcript for each year taxes are owed. IRS Form 4506 provides a taxpayer with a free copy of their account transcripts.
To discharge income taxes in bankruptcy, a few rules need to be observed:
- Only income taxes and taxes on gross receipts may be discharged. Payroll taxes are not dischargeable in bankruptcy.
- No Substitute Returns: The taxpayer must actually file the return to discharge the tax. If the IRS files the return (sometimes called a SFR or “substitute for return”), the tax is not dischargeable.
- Three-Year Rule: The taxes must have been due more than three years prior to filing bankruptcy.
- Two-Year Rule: The tax return must have been filed more than two years before filing bankruptcy. So, if you filed a return a few years after it was due, the return must be on file with the IRS for at least two years before it can be discharged.
- 240-Day Rule: The taxes must have been assessed more than 240 days prior to filing bankruptcy. This rule comes into play when the IRS audits a tax return and assesses additional taxes or penalties. So, if the IRS audits your return filed 5 years ago and assesses new taxes and penalties, you must wait another 240 days to file the bankruptcy.
- Fraud & Tax Evasion: If a taxpayer may not discharge taxes when they commit tax fraud or if they willfully evade taxes.
- Offer in Compromise: If a taxpayer files an Offer in Compromise before the time rules above have expired, the above timelines are extended by the time an Offer in Compromise is pending plus 30 days.
- Tax Liens: As a general rule, bankruptcy cancels debts and not liens. So, even though a tax may be old enough to discharge, the tax lien will remain on the taxpayer’s property despite receiving a bankruptcy discharge. In Chapter 7 cases, the mixture of tax liens and assets with equity—regardless of whether an exemption law normally protects the asset—becomes lethal with the application of Bankruptcy Code Section 724(b). The IRS is not subject to state exemption laws, and Section 724(b) gives the Chapter 7 Trustee special powers to liquidate assets if a tax lien is present.
Soda Tax?
Recently, the cash-strapped city of San Bernadino decided to file for municipal bankrutpcy following the footsteps of Stockton and Mammoth Lakes. Also, the California city of Vallejo emerged from bankruptcy after filing chapter 9 for its own reasons stemming of course from financial troubles.
On the heels of these events, local southern California cities are looking for new ways to raise revenues and stay ahead of the bankruptcy curve. Just recently, the city of El Monte, in Southern California proposed a sugar tax on sodas at 1 cent per ounce. Only time will tell whether such a tax is a sound decision to assist in the generatation of revenues for the city. Of course, the Soda companies and the lobbyists don’t like the proposed measure, which will be left to local voters to decide in November of this year.
While the measure has been met with both support and consternation depending on who you ask, the city of El Monte is taking steps to keep itself financially solvent and ahead of the curve, and for that, the city demonstrates that it is thinking ahead in this economic climate.
Keep an eye out these coming months to see if the wave of municipal chapter 9 filings are on there way, or if they are already here.
Last weekend I watched the movie Larry Crowne, starring Tom Hanks and Julia Roberts. In the movie, Tom Hanks plays a character that had recently been terminated for his job due to his lack of formal education, so he decided to go back to community college to remedy the situation. He took an economics class there with an eccentric professor. One day, the two of them were outside the school having a discussion on whether there were any economic benefits to filing for bankruptcy, I believe with Tom Hanks arguing that there were not and the professor arguing that there were. Granted, this was not the focus of the film (and I haven’t known bankruptcy to be a topic discussed in economics classes – I didn’t discuss it in mine), but the professor was right.
Bankruptcy is not something that a person should strive for. We all know that. However, for the honest debtor who finds himself or herself in a truly difficult financial situation which is unanticipated, bankruptcy does operate as a “fresh start,” which is its stated goal. What I generally mean by an “honest debtor” is a debtor who is not committing fraud by doing something like running up credit card debts in anticipation of bankruptcy, but that’s for another blog entry. In this entry, I will be referring to consumer bankruptcy.
The most pervasive aspect of the fresh start is through the discharge under section 523. A bankruptcy discharge simply relieves the debtor from any further personal liability for the debts covered by the discharge. A bankruptcy discharge does not, however, eliminate the debts: the ability of creditors to look to other parties such as guarantors and insurers is unaffected. And, a bankruptcy discharge does not eliminate liens: the ability of secured creditors to look to their collateral is unaffected.
There is also the automatic stay under section 362. This means that from the moment you file for bankruptcy, your creditors cannot attempt to collect the debts that you owe them. They cannot send you letters or call your phone (by the way, even if you don’t file for bankruptcy, creditors are required by law to obey you if you tell them to stop calling your cell phone at any time, though you can’t make them stop calling your home phone without the automatic stay). They also cannot do things like terminate your utilities with the automatic stay protection. A creditor can be held in contempt for violating the automatic stay.
In certain situations, bankruptcy can also help a debtor’s credit score. This is because individuals who file for bankruptcy in the first place typically have low credit scores in the first place, often with things like late payments and charged-off accounts. When consumers receive the bankruptcy discharge, the items will be marked as included in a bankruptcy, rather than showing a high account balance, or otherwise being a bad debt. To be certain, this is not always the case; in a generic sense, the bankruptcy filing, in and of itself, will lower a consumer’s credit score. It is only the effect on the consumer’s other accounts that can sometimes improve a credit score. I should also mention that bankruptcy discharge can only stay on a credit report for ten years.
There is also plenty of free assistance for those who need it. I spent my summer in 2011 working only on pro bono bankruptcy cases. They were referred to us by Legal Services of Northern Virginia. The individuals who received the pro bono assistance did not get the bankruptcy representation for absolutely nothing – they still had to pay small fees to, among other things, pull their credit reports. They did not, however, have to pay several thousand dollars in fees, which is typical of a bankruptcy filing.
Bankruptcy is not always a bad thing. For the honest debtor who finds herself in a difficult economic situation, it can provide a fresh start, free of phone calls from creditors and personal liability for debts. Though it is often expensive to hire a bankruptcy attorney, there are often programs (such as those in Northern Virginia) to provide assistance to those who cannot afford the attorney’s fees. Based on the complexities of the bankruptcy code, though, it is probably not a good idea for most debtors to file bankruptcy pro se(without legal representation).
Thanks for reading. I’ll be back with a new post within the next few weeks.
J.P. Morgan
IRA, individual retirement accounts, are they protected in bankruptcy? I am willing to bet you expected the answer to be yes, individual retirement accounts are protected in bankruptcy. Most bankruptcy lawyers would automatically say yes, IRA accounts are protected in bankruptcy. It is common knowledge that IRA accounts are
protected in bankruptcy. Do an internet search for–is an IRA protected in bankruptcy– you will see for yourself.
The correct answer is “I don’t know.”
How can that be?
Even the bankruptcy code says that IRA accounts are protected in bankruptcy. Most lawyers would automatically point to Section 522 of the bankruptcy code and argue it is right there in black and white.
However, the bankruptcy code really says that IRA accounts are protected “…to the extent that those funds are in a fund or account that is exempt from taxation…” Although this statute lists Internal Revenue Code Section 408, which governs IRA accounts, as eligible, the account must still be exempt from taxation.
Is Your IRA Tax Exempt?
That exemption from taxation can be lost when the account is not setup properly or managed properly.
The Internal Revenue Code has rules that restrict what can be done with a retirement account. These rules apply to individual retirement accounts. They are called “prohibited transactions.” Examples of prohibited transactions are in the IRS’s Publication 590.
Prohibited transactions include:
- Using the money to benefit a “disqualified person”;
- Selling, leasing, or exchanging the property in the account with a disqualied person;
- Lending money or extending credit from the IRA to a disqualified person.
A disqualified person is you, your family, your business and your employees. The basic rule is you are prohibited from receiving any benefit from the money in your IRA, unless it is authorized by the plan and governing law, for the account to stay tax exempt.
Most of these problems are easy to avoid because the custodian of the account will not let them happen. Serious problems can come up is when an independent custodian is not in the picture. There are two common situations where these prohibited transactions come up.
Real Estate Individual Retirement Accounts (IRA)
The rules against “prohibited transactions” do not allow you to sell a house you own to the IRA. You may not lend money to the IRA to purchase property. The IRA cannot be collateral for a loan used to purchase real estate. You cannot provide services to the IRA. This includes maintaining, repairing, or renting the property. These services cannot be provided by you, a business you control, or a family member. Although it is possible to have an IRA invest in real estate, the only safe way to do so is completely hands off. Otherwise, the IRA will lose its tax exempt status.
IRA Roll Overs
The tax code, section 408, allows you to switch your IRA account from one company to another. This can be done two ways. One is called a custodian to custodian rollover. This is extremely easy and safe. The new company will have a form for you to sign directing the old company to transfer the account.
Another way to rollover an IRA from one account to another is to withdraw the funds from the old account and then deposit them into the new account. The tax code allows us 60 days to complete the rollover. This 60 day window is often used as a tool to borrow from the IRA. This is a very risky strategy because the IRS does not allow you to use the money for any other purpose during the 60 day period.
IRS Rules Against Taxpayer
The IRS’s position is outlined in Private Letter Ruling 20054402 a case where the taxpayer requested as extension or waiver of the 60 day rule. The taxpayer withdrew money from his IRA to help with the purchase of a new home. Hurricane Frances hit and damaged the home. The permanent financing on the home was delayed. The permanent financing would replace the funds withdrawn from the IRA.
The IRS turned down the taxpayers request because using the IRA money to help purchase a home is a prohibited transaction.
The consequence of a prohibited transaction is the entire IRA is no longer tax exempt under Section 408(e)(2) of the tax code. Had the taxpayer not sought a Private Letter Ruling and just redeposited the money he would have risked losing the tax exempt status of the entire IRA account.
But, the tax code allows a partial rollover of an account. Section 408(3)(D) allows a taxpayer to take funds out of an IRA and deposit part of the money into a new IRA. The part put into the new IRA will continue to be tax exempt, provided it was not used for a prohibited transaction. The part not deposited is treated as taxable income.
The Bankruptcy Problem
The reason self-directed real estate individual retirement accounts and borrowing from an IRA work without widespread problems is the IRS is too busy to audit these accounts.
In a bankruptcy case it is different. It is not the IRS you need to worry about. It is the Bankruptcy Trustee.
If the trustee’s investigation shows you have entered into a prohibited transaction using the IRA funds or assets the trustee will object to your claim it is protected in the bankruptcy. A successful objection will mean the entire account is not protected in your bankruptcy. The 11th Circuit Court of Appeals agreed with this argument in a 2011 case. The Trustee has an incentive to investigate since he or she is paid a percentage of the property collected for creditors.
What to Do
If you are considering filing bankruptcy and have significant savings in an individual retirement account make sure that you meet with a lawyer that knows and understands the tax code and its rules on IRA accounts. The simple answer that IRA accounts are protected in bankruptcy is often wrong. A Chapter 7 filing is risky when you own a large IRA unless you are confident that you have not engaged in a prohibit transaction. A Chapter 13 case may be a better idea to minimize the risk of losing the IRA account.
Original article: Is My IRA Protected in Bankruptcy?©2013 Arizona Bankruptcy Lawyer. All Rights Reserved.The post Is My IRA Protected in Bankruptcy? appeared first on Arizona Bankruptcy Lawyer.
Many couples or individuals, prior to deployment, try to get their personal matters in order. 
During this very stressful time and period of adjustment the last thing any service member needs is to be worried about their financial status. For many, however, this issue arises as life never goes according to plan. Considering bankruptcy - either Chapter 7 or Chapter 13 is a viable option for many soldiers. Often I find prospective clients unsure if they should file for bankruptcy or not because they are preparing to deploy or their spouse is preparing to deploy. It is important for you to remember that the military provides you with a power of attorney for a reason. We have had situations in our office where one spouse was about to deploy and wanted to leave knowing their financial matters were under control for his wife/husband. Using the power of attorney we were able to file the case and the spouse was able to sign the necessary documents and appear at the required 341 Meeting of Creditors on his behalf. This is not an unusual occurrence and it is one that the United States Trustee will allow. The benefit of this is that you can continue to move forward on your bankruptcy when filing a Chapter 7 or a Chapter 13 if you are deploying and not have to be worried about the financial strain your family may be in. Bankruptcy provides you and your family with a fresh start.
Bankruptcy debtors use their $4,000 wildcard exemptions most often to protect cars. The debtor can apply the wildcard only to cars in the debtor's name. For example, if a married couple is considering Chapter 7 bankruptcy and both of the...
This blog entry includes material originally prepared by the author for the 2012 FBA Bankruptcy Seminar.
The U.S. Supreme Court’s decision in Stern v. Marshall, 131 S. Ct. 2594 (2011), immediately cast a shadow of uncertainty on bankruptcy courts’ constitutional authority to enter final orders. But Stern leaves many questions unanswered, and the bankruptcy judges within the Western District of Michigan have differed as to whether the case should be interpreted narrowly or broadly. As a result, depending on the presiding judge in a particular case, Stern may be critically important or unworthy of mentioning. The following is a brief review of cases in this district that address the scope of Stern. Read More ›
Tags: Chapter 7, U.S. Supreme Court, Western District of Michigan
Chapter 13 bankruptcy offers debtors the opportunity to strip off a wholly unsecured second mortgage on their primary residence. Most courts have held that debtor’s mortgage is stripped from his house when he completes the Chapter 13 plan and gets...
Common Misconceptions about Credit After Bankruptcy
Rebuilding credit after bankruptcy is one of the biggest fears that my clients have. There is so much misinformation about bankruptcy
and credit that most of these fears are not realistic. Some people believe that filing bankruptcy will mean that they will never be able to get credit again. Others are convinced that they will not be able to get credit for at least 7 years–how long they think the bankruptcy will be on their credit report. Many don’t care. They know their credit has already “hit bottom” and the bankruptcy won’t make any difference.
Facts About Credit After Bankruptcy
How long a bankruptcy stays on the credit report depends on the type of bankruptcy filed. The law allows the credit bureaus to report the bankruptcy for 10 years from the date the bankruptcy is filed. The credit bureaus don’t have to report the bankruptcy that long–they just cannot report it any longer. Their current policy is to report a Chapter 7 bankruptcy for the full ten years. Chapter 13 is different. The credit bureaus report a Chapter 13 bankruptcy on their reports for 7 years. However, one of the major credit bureaus will report a dismissed Chapter 13 for ten years.
How Long Will it Take to Get Credit After Bankruptcy?
There is really no fair answer to this question. Some people are able to reestablish credit immediately after their bankruptcy. Others struggle for several years. The opinion of most of the credit professionals I have spoken to about this say the average is about two years for a person to reestablish their credit to the point that they can get credit with fair terms. A mortgage lender suggested that the Federal Housing Administration (FHA) is a good guideline. Their current rules require that a Chapter 7 bankruptcy discharge be at least two years old in order to qualify for a home mortgage. The rules for a Chapter 13 allow you to qualify for an FHA mortgage one year after the case is filed. The FHA rules are summarized on their website here: FHA rules for mortgages and bankruptcy.
How to Rebuild Credit After Bankruptcy
You will notice that the FHA rules require that you have reestablished some credit prior to meeting the rules for their program. This does not require that your credit be back to normal. It just means that you have one or two new accounts that are showing positively after your bankruptcy and that you not have new credit problems after your bankruptcy. There are four steps to making this happen.
Step One: Get your credit reports
After you receive your bankruptcy discharge you need to make sure that the discharged debt is not holding you back. Do this by ordering a copy of your credit report from all three of the major credit bureaus. All of the information you need about how to contact them is available from the FDIC’s website here: Credit Bureau Information. We help all of our clients complete this first step.
Step Two: Challenge any discharged account that shows a balance
The bankruptcy is not going to erase your discharged accounts. They can still be reported. What they cannot do is report that you still owe any money. When they are reported with a zero balance and a notation that the account was included in bankruptcy it is being reported correctly. Too often people will find that an account is still being reported with a delinquent balance owed. These need to be challenged by filing a dispute with the credit bureau. If the creditor will not correct the inaccurate information it would be a good idea to see an attorney. This step is critical and explains why we ask our clients to send us copies of their credit reports.
Step Three: Apply for a Secured Credit Card Account
These accounts are easy to get after bankruptcy. A secured account requires that you deposit into a savings account money to act as collateral for the credit card. Do some research on the bank that you are considering opening an account with. Also, make sure that the bank reports their accounts to at least one of the major credit bureaus. Not all do. Also, beware of scams when looking for an account.
Step Four: Use the Account to reestablish your credit after bankruptcy
Just having the account is not enough. I recommend that you use the account every month and pay it off every month. This positive activity will do far more for your credit score than having several inactive accounts.
Once you follow these four steps you will see a significant increase in your credit score and discover that getting credit after bankruptcy is not nearly as difficult as you feared. Repeat step one and two every six months for a couple of years to make sure that nothing negative is being reported illegally. Before you know it you won’t have any trouble being approved for credit that you can reasonably afford.
Mesa Bankruptcy Lawyer: Free Appointment
Please let us know what you think of this information or have other ideas that we can pass along. We have spent a lot of time researching and investigating how bankruptcy affects credit because we want to be able to help our clients reestablish their credit and put the bankruptcy behind them. When you are seriously considering bankruptcy call us to schedule a free appointment. The number is 480-820-0800. We will continue to help even after the bankruptcy is over.
Original article: Credit After Bankruptcy: Four Important Steps to Rebuilding Your Credit©2013 Arizona Bankruptcy Lawyer. All Rights Reserved.The post Credit After Bankruptcy: Four Important Steps to Rebuilding Your Credit appeared first on Arizona Bankruptcy Lawyer.
Bankruptcy & Credit: Confusion
Bankruptcy and Credit create more confused advice than any other area of bankruptcy law. Many people believe that so long as a 
bankruptcy is being reported on their credit report they will have no hope of buying a house or car. It’s not true.
Plenty of Conflicting Advice about Bankruptcy and Credit Reports
Many of my clients have told me that they know bankruptcy stays on credit reports for 7 years. Not necessarily true. Google the phrase: How long does Chapter 13 stay on my credit report. You might be surprised by how many different answers you get. Most of the articles will say 7 years. Not always true. Others will say 7 years from the date of discharge. Also not true. A few will say 10 years. That is sometimes true, but often wrong.
What are the rules about how long Chapter 13 Stays on your Credit Report
Some of the different answers about how long Chapter 13 stays on a credit report are caused by the questions. There is a difference between how long it can be reported and how long it is usually reported.
Fair Credit Reporting Act controls how long it can be reported
The Fair Credit Reporting Act is a Federal law that controls what credit bureau’s can report. It does not have much to say about bankruptcy. In fact, the word bankruptcy only appears one time in the entire Act. What it says is:
Cases under title 11 [United States Code] or under the Bankruptcy Act that, from the date of entry of the order for relief or the date of adjudication, as the case may be, antedate the report by more than 10 years.
That makes it clear that it is legal to report any bankruptcy for 10 years from the date that the bankruptcy is filed. But, this law does not require that a credit bureau report the Chapter 13 for 10 years. It just means that they cannot legally report the Chapter 13 bankruptcy filing for any longer than 10 years.
The Credit Bureau decides how long the Chapter 13 is reported on the credit report
There are 3 major credit bureaus used by the financial industry. Each of them have their own policies on how long they will report a Chapter 13 bankruptcy on your credit report. For example Experian says they will report the Chapter 13 bankruptcy filing for 7 years on your credit report. However, Equifax says they will report a dismissed Chapter 13 for ten years.
Bankruptcy and Credit: What Does it all mean?
It is very easy to get advice about bankruptcy and credit. It is not so easy to evaluate the trustworthiness of that advice. When it comes time to seriously consider filing bankruptcy in Arizona you need someone who knows the system and knows the answers in detail. Trucly Pham Swartz and Joe Volin are experienced Phoenix Bankruptcy Lawyers and can provide you with the help you need. For a free bankruptcy appointment call us at 480-820-0800.
Original article: Bankruptcy and Credit: How Long Does Chapter 13 Stay on a Credit Report?©2013 Arizona Bankruptcy Lawyer. All Rights Reserved.The post Bankruptcy and Credit: How Long Does Chapter 13 Stay on a Credit Report? appeared first on Arizona Bankruptcy Lawyer.
Updated daily, this blog will keep you informed on the latest bankruptcy news! 
Learn more about how Bankruptcy works and what you need to know.