The Florida Bankruptcy Law Blog

Anticipating Bankruptcy: Plan Now To Avoid Forfeiting A Tax Refund To Your Bankruptcy Trustee

There are usually several things you can do to prepare for filing bankruptcy if you can anticipate the need to file months in advance. I consulted with a client living in Ft. Myers who he will need to file Chapter 7 bankruptcy by the end of this year.  He needs to wait until year end so that his repayment of family loans in 2009 will not be reversed as preferential payments chosen creditors. The told me he usually gets a significant tax refund and asked me if there is anything he can do to avoid losing the refund over to the bankruptcy trustee after his creditor meeting anticipated early in 2011.

I suggested that this client change his income tax withholding to zero for the balance of the year. My CPA tells me that taxpayers have the right to set their withholding amounts. If the client does not withhold taxes for the second half of the year he will probably wipe out any tax refund accrued during the first part of the year and end up owing taxes when he files in April, 2011. There will be no tax refund receivable if he files bankruptcy later in 2010. The client can spend the extra money not withheld by the IRS on necessary house or medical expenses, bankruptcy attorney fees, or on a dream vacation. This person is not obligated to give the IRS money now to  hold for the benefit of his creditors and a bankruptcy trustee after filing. Better that the client use the money for himself than forfeit a 2011 refund in his bankruptcy case.

Income Tax Season For Chapter 7 Bankruptcy Trustees

Its tax season once again. In bankruptcy, tax season means hunting season for Chapter 7 trustees. During the first four months of year the Chapter 7 trustees are especially diligent about going after IRS tax refunds owed to debtors. The general rule is that any money, including income tax refunds,  owed to you at the time you file bankruptcy is part of the bankruptcy estate and available to pay your creditors. There are certain exemptions such as joint refunds where only one spouse files bankruptcy and refunds from the earned income tax credit. Bankruptcy trustees will ask all debtors if they expect a tax refund based on their 2009 tax return, and in most cases will require the debtor to send a copy of the 2009 tax return whenever it is filed.

I read a good blog post from Ohio bankruptcy attorney Wayne Novik about how debtors can best protect tax refunds. One option, discussed in the post, is simply to delay filing bankruptcy until you have filed your tax return and received a refund. You can spend your tax return on necessary expenses such as past-due mortgage or car payments or your bankruptcy attorney fee. Of course, if you receive a large tax refund the trustee may ask you to account for the money. As a practical matter, if you expect a small tax refund the Chapter 7 trustee will decide its not worth pursuing and will let you keep the money.

Client Seeks Bankruptcy To Avoid Imputed Income After A Foreclosure On Investment Property

Some people facing mortgage foreclosure consider filing bankruptcy to preclude liability for deficiency judgments. Deficiency liability is not the only problem associated with foreclosure; another issue is income tax from imputed income when a lender foregives part of a mortgage note for a property other than a primary residence. Today, I met an elderly lady who had guaranteed a mortgage loan used by her son to buy the son’s primary residence. The mother resided in her own house even though her name was on the title and mortgage of her son’s house. The son’s house is about to go into foreclosure because the son is unemployed. The mother received an offer for a short sale. The mother wants to file Chapter 7 bankruptcy in order to avoid income tax liability from forgiveness of the debt following either foreclosure or the short sale. People who file bankruptcy do not recognize imputed income from mortgage debt forgiveness. This client had no credit card debt or other unsecured debts. She has no assets other than her exempt pension.

I advised the mother not to file bankruptcy. Most lenders who accept short sales are asking the debtor/owners to sign a note for the amount of debt forgiveness, ie, the "short amount." I advise people with assets not to sign the note even if it means killing the short sale. In this case, the mother would not be putting any assets at risk by signing a note. If the mother signs a promissory note as part of the short sale the lender would be forgiving nothing and there would be no imputed income. In the event the lender rejects the short sale, or if the lender does not accept a note for the "short amount", the mother’s best tax result would be to make sure the lender does not forgive any of the mortgage debt in the course of the foreclosure. The mother is defending the foreclosure in state court. I suggested her lawyer pursue a settlement that eliminates debt forgiveness; she wants to remain liable for the mortgage. The mother can later file bankruptcy if, for instance, it appears that the mortgage company will forgive the mortgage balance after a short sale or foreclosure, or if the mortgage lender pursues a deficiency judgment or note enforcement. In general, bankruptcy is a last resort to be used when there are no other options.

posted by Jonathan Alper, bankruptcy and asset protection attorney, Orlando, Florida

Question About Income Taxes In Chapter 7 Bankruptcy

Treatment of income tax debt in Chapter 7 bankruptcy is a complicated subject. There are many rules and exceptions to the rules applicable to determine if past due taxes can be discharged. I received the following question by email:

"I was planning on filing bankruptcy next month and just went through an IRS audit for the tax year 2005. I owe $10,000 now to the IRS for mistakes made on my 2005 tax return. This includes interest and penalties. I was told that I could include this amount owed to the IRS in bankruptcy as long as I waited 240 days from the time I was assessed the tax since the return is 3 years old. But, there seems to be conflicting opinions on this as I was also told by my tax attorney that it can't be discharged at all, or maybe it can if I wait 3 more years. "

The general rule is that income taxes are not dischargeable if they relate to a tax return due to be filed less than three years prior to the bankruptcy petition or if the taxes were assessed within 240 days of the petition. There are additional exceptions when returns were filed late or when there is tax fraud.

Unfiled Tax Returns: Chapter 13 Bankruptcy

I received an interesting email about Chapter 13 and income taxes from attorney Larry Heinkel from St. Petersburg. Mr. Heinkel specializes in the area of income taxation and bankruptcy and represents debtors in bankruptcy courts throughout Florida. (taxproblemlaw.com). Here’s what he said. "Over the last several month I have had several clients see me about owin taxes after filing chapter 13 bankruptcy. The usual fact pattern is that (the client files Chapter 13) even though there are unfiled tax returns. The client then has the returns prepared to file with the IRS and the trustee only to discover that the tax debts (all being priority...) are too large for the client to repay throu th chapter 13 plan. As a result, the case is either dismissed or converted which does not do the client/debtor any good at all."

Getting Banks To Pay Your Taxes: Some Debtors Are Discharging Credit Card Debt Used For Income Taxes

I have met three or four prospective Chapter 7 bankruptcy clients over the past few months who told me they paid their 2007 taxes with a credit card and that they now want to file bankruptcy to include the same credit card debt. The effect is that the credit card lender  will have paid the clients’ income taxes, and that the clients would have discharged their income tax bill. Income taxes are not dischargeable in bankruptcy.

Bankruptcy Discharge of Credit Card Debt Used to Pay Taxes

A caller asked me if he could discharge in bankruptcy a credit card charge of $10,000 used to pay property taxes on commercial real estate. The general rule is that all credit card debt and other unsecured debts are dischargeable in Chapter 7 bankruptcy. However, Section 523 of the Bankruptcy Code provides for exceptions. One the exceptions is certain income tax and property tax which are "priority" debts. The Bankruptcy Code does not permit a debtor to discharge credit card debt incurred to pay non-dischargeable taxes. In other words, the Code does not allow people to convert non-dischargeable property tax or income tax into unsecured credit card debt to be wiped out as part of general unsecured debts.

Income Tax Effect Of Deed In Lieu Or Short Sales

Many real estate investors have serious financial problems due to declining real estate values and credit problems. During the past few months a large portion of my banrkuptcy and asset protection inquiries are from people who find themselves unable to pay mortgages they used to buy investment real estate near the end of the housing bubble. Several of my callers, and people who have become clients, have asked me about the consequences of giving a bank a deed in lieu of foreclosure or selling the property for less than full mortgage balance as part of an agreed "short sale." (A "short sale" is where the bank agrees to accept less than the mortgage balance to release the mortgage in order to facilitate a sale and partial recovery of the loan). One issue that frequently is discussed is the income tax consequences for the borrower from a short sale of deed in lieu as opposed to letting the bank foreclose. Income tax may be imposed for a cancellation of a debt. ("COD") I am not an income tax professional. Recently, I posed the question to my personal CPA, Mr. Lonnie Young of Lake Mary, Florida, and asked him to explain the income tax consequences of giving property back to a mortgage lender.

Does High Income Prevent Chapter 7 To Discharge Income Taxes?

A prospective bankruptcy client contacted me about filing Chapter 7 to eliminate substantial income tax debtor for years 1995 through 2001. The debtor filed all his returns in a timely manner, and it appears he qualifies to discharge the income tax liability. He had relatively small amounts of unsecured credit card debt. The client said he had visited two other bankruptcy attorneys who had told him he could not file for Chapter 7 bankruptcy because he makes too much money, approximately $110,000 per year family income. The attorneys told the client his Chapter 7 would be rejected as substantial abuse. I disagreed, and think this person will qualify for Chapter 7 regardless of his income.

Penalties and Interest on Employment Taxes

Employment tax liability cannot be discharged in Chapter 7 bankruptcy. If you are liable to the IRS for payment of employment taxes collected by your company you cannot wipe out your IRS debt by filing bankruptcy. A caller asked whether interest and penalties on past due employment taxes can be discharged even though the base tax liability must still be paid.

I believe the answer is that interest and penalties cannot be discharged for employment taxation. The general rule is that if any tax liability to the IRS is nondischargeable in bankruptcy, the interest and penalties on such debt is also not dischargeable.