TAXES: Are they dischargeable in bankruptcy?

TAXES:  Are they dischargeable in bankruptcy?

Published on July 21, 2012 by: Ian M. Falcone

Often, I am asked whether tax debts are dischargeable in bankruptcy.  The short answer, as almost always is the case, is, it depends.  In order to make a determination, we need to know whether we are talking about trust taxes or income taxes.

Trust taxes are those taxes collected on behalf of a another party.  The two most common examples are sales taxes and payroll withholding taxes.  When you pay for an item in the store, you pay sales tax at the cash register.  The business is collecting the tax from you and holding it in trust to pay the taxing authority. 

Withholding taxes are the taxes that an employer withholds from your paycheck. It is important to note that there are actually two components to ­­­payroll taxes.  There is the portion the employer withholds and an equal payment that is matched by the employer.  Only the portion withheld from the employee’s paycheck is a trust taxes.

The person responsible for paying the taxes and failing to do so is personally responsible for the debt.  In a very small business, this is typically the owners.  In a larger business, it can be the treasurer, CFO or someone with similar duties.

Trust taxes are unfortunately, never dischargeable.  Income taxes, however, can be.

Income taxes follow a very convoluted rule.  They must be taxes that became due more than three (3) years prior to the filing of the bankruptcy petition, an actual tax return must have been filed more than two years prior to the filing of the petition, and they must have been assessed more than 240 days prior to the petition date.

The 3-year rule works as follows:  first, determine which tax year is at issue.  Second determine what date those taxes were due, including extensions.  Third, look at a calendar for the current date.  So, if the taxes were due for the 2008 tax year and no extensions were filed and it is July 21, 2012, the taxes would meet the 3-year rule.  To say it another way, as you sit there on July 21, 2012, those taxes were due on April 15, 2009 (2008 taxes are due in 2009) which is more than 3 years prior to the filing date.  However, if you asked the same question on April 14, 2012, those taxes did not meet the 3 year rule.  As you can imagine, filing an extension changes the due date and the calculation become that much more difficult.

Assuming the taxes meet the first prong of the test, we next turn to whether the return was filed more than two years ago.  Under old law, the IRS could file a return for you (known as a “substitution for return’) and you could calculate time using that date.  Under recent law, the debtor must have filed an actual return at least two years prior to the date of the bankruptcy petition.  If the tax return was never filed, the two year period never starts to run.  So, returning to the above example, if the debtor never filed the return, meeting the 3-year portion of the test doesn’t help, because the second prong can never be met.  But, what if the debtor filed his return on July 10, 2010?  Here he meets both the first and second prong of the test.  The return was due more than 3 years prior to the bankruptcy filing and an actual return was filed more than 2 years ago.

Finally, if both the 3-year and 2-year prongs are met, we next turn to whether the taxes were “assessed” more than 240 days prior to filing the petition.  “Assessed” is a term at the IRS meaning the date it is entered in their system.  It is not the date the tax return was filed.  The only way to truly determine the assessment date is to contact the IRS and obtain a tax transcript with that information.  Audits, challenges, offers in compromise and other actions can extend the date of assessment.

Finally, as a general rule, if the underlying tax is not dischargeable, then the associated penalties and interest are not dischargeable either,  However, this is only a basic rule.  Further, if a tax lien has been filed, a new layer of complexity is added, but that is for another day.

As you can see, these rules are complicated and not as easy to understand as one might hope.  If you have tax debt and want to try and discharge it, you should discuss the matter with a more experienced bankruptcy attorney that has familiarity with business and tax issues.

Divorce and Personal Bankruptcy

BANKRUPTCY AND DIVORCE: 

Which comes first?

Published on June 12, 2012 by: Ian M. Falcone

Bankruptcy and divorce cases are often intermingled.  Whether it is the divorce process that leads to the bankruptcy or the bankruptcy filing that leads to divorce is irrelevant.  The fact remains, that we are contacted on a regular basis to address “Which comes first, the divorce or the bankruptcy case?”  The short answer, as almost always is the answer, is, it depends.

There are times when, after full disclosure and waiver of potential conflicts of interest, it makes sense for the parties to file Chapter 7 together before the divorce is completed (a joint Chapter 13 case which obligates the parties to make payments over a 3 or 5-year period is not practical if the parties plan to divorce).  These are typically the cases where the debt is preventing the divorce (i.e. neither party can afford to pay the debts but if they could both walk away from their obligations, the divorce could be fairly easily resolved).  In these cases, the parties and the attorneys must be sure that no conflict exists.  The bankruptcy attorney cannot address what is best for either individual.  In fact, if these concerns arise, the individuals need to seek independent counsel. 

Chapter 7 (liquidation) debtors are “means test” limited by income and family size (these limitations are adjusted by state and county).  If the parties are married, or sometimes just living together, their combined incomes may be used in the eligibility calculations.  This can prevent a married couple from qualifying for chapter 7.

However, after the divorce, certain obligations incurred during the divorce can be helpful.  Assume that the husband is obligated, after the divorce case is completed, to pay child support and alimony.  These obligations are legitimate deductions from income when examining Chapter 7 eligibility under the means test.  Thus, oddly, an individual with a higher income that would not qualify for Chapter 7 bankruptcy when he was married, could become eligible for Chapter 7 after the divorce because of his child support and alimony obligations.  Incurring these debts solely for the purpose of passing the means test is improper.  However, if these debts are likely to be incurred and are helpful in the long run, an individual might benefit from agreeing to these obligations.

Another issue that often arises in our office is the “joint debt” problem.  Let’s assume that the husband and wife are jointly indebted on the mortgage.  In the divorce decree, the Court could determine that the Husband is responsible for the mortgage payments.  While the Husband could file bankruptcy and eliminate his obligation to the bank, he would still be obligated to his ex-wife for the same debt (divorce related debts are no longer dischargeable in Chapter 7 cases).  Let me say that another way, if there is joint debt and you are obligated to pay it in the divorce decree, filing a bankruptcy case may not get rid of the debt.  Anytime there is joint debt, the situation becomes more complicated and an experienced bankruptcy attorney, familiar with divorce issues, should be consulted.

Finally, the filing of a bankruptcy petition creates an automatic stay.  Although the stay does not prevent the parties from obtaining a divorce, it does prevent the division of assets.  Thus, as a practical matter, the bankruptcy stops the divorce and it may be necessary to obtain an order from the bankruptcy court before continuing with the divorce.

Divorce and personal bankruptcy can each be complicated, however the combination is almost certain to create a very complex matter. Because every situation is unique, the only way to accurately determine your options, opportunities and risks is to consult with an attorney who is experienced in complicated divorce and bankruptcy cases. The legal team at the Falcone Law Firm has extensive experience in divorce, bankruptcy and small business law. If you need answers, call 770-426-9359 to arrange for a consultation with an attorney.

Using Tax Debt To Pass The Means Test

Tax Debt May Help You To Pass The Bankruptcy Means Test

Published on June 16, 2012 by: Ian M. Falcone

One of the most challenging aspects of the revised Bankruptcy Code (BAPCPA) was the addition of the Means Test (11 USC §707(b)). When it first came out, practitioners were extremely concerned. No one likes a mechanical test that can determine a client’s fate under the Bankruptcy Code. To this day, more than six (6) years after BAPCPA’s implementation, we still get calls from potential clients claiming they are not eligible for to file for protection under Chapter 7 because they "have too much income." Most of these prospects, and very likely many attorneys with whom they have consulted, have looked only at the median income test to determine eligibility. Instead, they should be looking to see whether the test applies at all.

The Means Test applies only to debtors whose debts are "primarily consumer debts." The term "consumer debt" is defined at 11 USC §101(8) as a debt "incurred by an individual primarily for a personal, family or household purpose." This definition is crucial in determining whether the Means Test applies. Most debtor’s lawyers know to look for obvious business debts, some even inquire into the purpose of the credit card debt, but income taxes seem to be overlooked on a regular basis.

Although, at first glance, income taxes would seem to be "personal" and therefore "consumer debt", it is clear that they are not. The Sixth Circuit has examined this issued and concluded that income taxes are not consumer debt (at least for the purposes of determining whether the co-debtor stay applies to these types of debts). In re: Westberry, 215 F. 3d 589 (6th Cir, 2000).

In reaching its conclusion, the Court stated the following: "First, a tax debt is incurred differently from a consumer debt. . . .[Its] incurrence is not voluntary on the part of the taxpayer." The Court went on to note that a "consumer debt is incurred for personal or household purposes, as stated in the statute, while taxes are incurred for a public purpose." It would be hard to argue with this logic since, "The Supreme Court has long noted, in other contexts, the public purpose of the imposition of taxes. See, e.g. Loan Assoc. v. Topeka, 87 U.S. 655, 664, 22 L. Ed. 455 (1874) ("We have established . . . beyond civil that there can be no lawful tax which is not laid for a public purpose.")" Finally, the Court noted that "taxes arise from the earning of money, while consumer debt results from its consumption. See Greene, 157 B.R. at 497, Harrison, 82 B.R. at 558, Pressimone, 39 B.R. at 244."

Thus, if a prospective client comes to your office, depressed that they have plenty of tax debt, explain that this may be a blessing in disguise and could help them pass the Means Test and qualify for Chapter 7 treatment.

Chapter 7 - Removing An Unsecured Lien

Chapter 7 Debtors Can Now Strip Off A Wholly Unsecured Lien

Published on June 14, 2012 by: Ian M. Falcone

Last month the 11th Circuit Court of Appeals decided that a Chapter 7 debtor can strip off a wholly unsecured second lien. See In McNeal v. GMAC Mortgage, LLC, et al, No. 11-11352 (11th Cir. May 11, 2012)

In Dewsnup v. Timm, 502 U.S. 410 (1992), the Supreme Court had rejected a Chapter 7 debtor’s argument to allow for the “strip down” of an undersecured lien. “The vast majority of courts have concluded that Dewsnup’s reasoning for not permitting a “strip down” of an undersecured lien in chapter 7 applies likewise to a chapter 7 debtor’s attempt to “strip off” a wholly unsecured lien. Talbert v. City Mortgage Services 344 F.3d 555 (6th Cir. 2003); Ryan v. Homecomings Fin. Network, 253 F.3d 778 (4th Cir. 2001); Laskin v. First National Bank of Keystone (In re Laskin), 222 B.R. 872 (B.A.P. 9th Cir. 1998); In re Caliguri, 2010 WL 1027411 (Bankr. E.D.N.Y. Mar. 17, 2010); In re Grano, 422 B.R. 401 (Bankr. W.D.N.Y. 2010); In re Arrieta, 2009 WL 1789576 (Bankr. N.D. Ill. 2009). Contra, In re Lavelle, 2009 WL 4043089 (Bankr. E.D.N.Y. Nov. 25, 2009); Howard v. National Westminster Bank, U.S.A. (In re Howard), 184 B.R. 644 (Bankr. E.D.N.Y. 1995).”

In the McNeal case, the Chapter 7 debtor alleged that her home was worth less than the amount of the first mortgage. Debtor argued that § §506(a) and (d) required that the second mortgage, being wholly unsecured, should be determined to be void and the lien stripped off completely. Judge Bonapfel of the Bankruptcy Court of the Northern District of Georgia, Atlanta Division, disagreed, and ruled that the reasoning of Dewsnup applied and that a wholly unsecured lien could not be “stripped off” in a Chapter 7 case. The district court then affirmed. The National Association of Consumer Bankruptcy Attorneys (NACBA) filed an amicus brief with the Court. The Eleventh Circuit then reversed the decison.

To determine whether such an allowed -- but wholly unsecured -- claim is voidable, we must then look to section 506(d), which provides that “[t]o the extent that a lien secures a claim against a debtor that is not an allowed secured claim, such lien is void.” See 11 U.S.C. § 506(d). Several courts have determined that the United States Supreme Court’s decision in Dewsnup v. Timm, 112 S. Ct. 773 (1992) -- which concluded that a Chapter 7 debtor could not “strip down” a partially secured lien under section 506(d) -- also precludes a Chapter 7 debtor from “stripping off” a wholly unsecured junior lien such as the lien at issue in this appeal. See, e.g., Ryan v. Homecomings Fin. Network, 253 F.3d 778 (4th Cir. 2001); Talbert v. City Mortgage Services., 344 F.3d 555 (6th Cir. 2003); Laskin v. First National Bank of Keystone, 222 B.R. 872 (B.A.P. 9th Cir. 1998). But the present controlling precedent in the Eleventh Circuit remains our decision in Folendore v. United States Small Business Administration, 862 F.2d 1537 (11th Cir. 1989). In Folendore, we concluded that an allowed claim that was wholly unsecured -- just as GMAC’s claim is here -- was voidable under the plain language of section 506(d). 862 F.2d at 1538-39.

The Court then explained although several Courts had treated Folendore as having been abrogated by Dewsnup, departure from a prior panel’s ruling was only appropriate only when an intervening Supreme Court decision is “clearly on point.”

Although the Supreme Court’s reasoning in Dewsnup seems to reject the plain language analysis that we used in Folendore, “‘[t]here is, of course, an important difference between the holding in a case and the reasoning that supports that holding.’” Atlanta Sounding Co., Inc., 496 F.3d at 1284 (citing Crawford-El v. Britton, 118 S. Ct. 1584, 1590 (1998)). “[T]hat the reasoning of an intervening high court decision is at odds with that of our prior decision is no basis for a panel to depart from our prior decision.” Id. “As we have stated, ‘[o]bedience to a Supreme Court decision is one thing, extrapolating from its implications a holding on an issue that was not before that Court in order to upend settled circuit law is another thing.” Id. In fact, the Supreme Court -- noting the ambiguities in the bankruptcy code and the “the difficulty of interpreting the statute in a single opinion that would apply to all possible fact situations” -- limited its Dewsnup decision expressly to the precise issue raised by the facts of the case. 112 S. Ct. at 778.

The Court reversed the District Court's opinion. Thus, at least in the 11th Circuit, a wholly unsecured lien may now be stripped in a Chapter 7 case.

New Georgia Homestead Exemption 2012

Published on June 9, 2012 by: Ian M. Falcone
In May 2012, Governor Deal signed legislation that increased the homestead exemption from $10,000 to $21,500 per person ($43,000 per married couple). While this is a welcome change, unfortunately the new legislation did not amend the amount of the wildcard exemption (which remains at a maximum of $5600).
Previously, debtors with more than $10,000 of equity in their homes ($20,000 per married couple) were often forced to file a Chapter 13 case simply to save their residence. The new law will allow Chapter 7 debtors an opportunity to protect more equity in their homes, and will improve the chances for meeting the (Means Test) qualifications for filing Chapter 7 bankruptcy.
While this change will probably not have any major impact during the current economic recession, it will likely have a substantial impact as home prices recover down the road.

About Homestead Exemptions in Georgia

Generally, a homeowner is entitled to a homestead exemption on their home and land underneath provided the home was owned by the homeowner and was their legal residence as of January 1 of the taxable year. (O.C.G.A. § 48-5-40)

Application for Homestead Exemption

To be granted a homestead exemption, a person must actually occupy the home, and the home is considered their legal residence for all purposes. Persons that are away from their home because of health reasons will not be denied homestead exemption. A family member or friend can notify the tax receiver or tax commissioner and the homestead exemption will be granted. (O.C.G.A. § 48-5-40)
Application for homestead exemption must be filed with the tax commissioner's office, or in some counties the tax assessor's office has been delegated to receive applications for homestead exemption.
A homeowner can file an application for homestead exemption for their home and land any time during the calendar year. To receive the homestead exemption for the current tax year, the homeowner must have owned the property on January 1 and filed the homestead application by the same date property tax returns are due in the county. Property tax returns are required to be filed by April 1. Homestead applications that are filed after this date will not be granted until the next calendar year. (O.C.G.A. § 48-5-45)

Failure to apply by the deadline will result in loss of the exemption for that year. (O.C.G.A. § 48-5-45) Click this link for more information on when homestead applications should be filed in the county.

Will I lose my business if I file personal Chapter 7 bankruptcy?

Published on November 21, 2011 by: Ian M. Falcone

I am often asked whether a client will lose their business if they file for personal Chapter 7 bankruptcy. The short answer, of course, is, it depends. A business is an asset. And, like any asset, it must be listed in your schedules and is subject to liquidation by the Trustee.

If you owned shares of stock in Coca-Cola and filed a chapter 7 case, the Trustee would have the opportunity to sell your shares, raise money and ultimately distribute funds to the creditors. The same is true in your personal case, but the situation is far more complicated.

First, there is an easy market in which to sell shares of Coca-Cola. This is most often not the case for a small business. Secondly, most small businesses simply have no real market value. Often, they have very limited assets and substantial debts. For example, if you are a plumber, you probably own a truck, some hand tools and a limited amount of parts. The real value of your business is you. What could the Trustee possibly sell? However, if you are a bookstore, the value of your business lies in its inventory and its goodwill. Basically, the more the business is service oriented, the less likely it has a value and therefore, is less likely to be sold by the Trustee.

We always ask our clients for the quick sale value of the business' assets and the debt associated with the business. If there is more debt than value, we usually list the value of the business as zero. In these cases, the Trustee typically conducts a cursory investigation and agrees with our analysis. The end result, the client gets to keep their business.

This is obviously a complicated and very fact specific area of law. If you own a business and are thinking of filing personal bankruptcy, be sure to discuss the situation in detail with your attorney. Not every attorney is prepared to handle these cases. Ask whether they handle business related cases. Be honest with your lawyer. They cannot do their job unless you tell them the truth.

Consumer Bankruptcy 101

Published on February 1, 2010 by: Ian M. Falcone

The decision to file for personal bankruptcy protection is, at best, difficult. Individuals often experience feelings of failure and sometimes wrongdoing. People make mistakes or have bad circumstances thrust upon them. Regardless, they are not required to suffer forever. The Bankruptcy Code is designed to help people restructure or eliminate their debt. The two major consumer chapters are Chapter 7 bankruptcy and Chapter 13 bankruptcy.

Chapter 7 is sometimes called a "straight bankruptcy" or "liquidation". Theoretically, an individual gives up everything he owns in exchange for getting rid of all of his debt. Neither of these statements is completely accurate. The law provides for "exemptions" or protections in differing amounts for different categories of property. These amounts vary substantially from state to state. However, in Georgia, it is fair to say that most Chapter 7 debtors have little to no equity in the items they own.

Unfortunately, not all types of debts are dischargeable. Debts for alimony, support, or maintenance, debts for certain types of taxes, and debts incurred by fraud, may not be discharged in bankruptcy.

In Georgia, the ideal Chapter 7 debtor has little to no equity in the items he owns, does not have excessive earnings and owes predominantly unsecured debt, such as credit cards. Under the right circumstances, the debtor can keep his basic property, get rid of the majority of his debt and get a fresh start.

When the circumstances are not right, a debtor should consider filing for relief under Chapter 13. Chapter 13 is properly known as a "reorganization of an individual with regular income." It is sometimes referred to as a "wage earner plan" or "reorganization". Under this Chapter, a certain amount of repayment is required. In order to qualify, a Chapter 13 debtor’s take home pay must be greater than his regular household expenses. The amount creditors receive is based on several factors, including the debtor’s income, debtor’s expenses and value of debtor’s property after exemptions. Unsecured creditors will receive anywhere from 1% to 100% of the money owed to them over a 3 to 5 year period. Chapter 13 debtors typically have more secured debts than a Chapter 7 debtor and are often delinquent in their mortgage or car payments. If successful, a Chapter 13 debtor may be eligible for a discharge of certain debts which might not have been discharged in a Chapter 7 case.

Chapter 7 bankruptcies will stay on a debtor’s credit report for 10 years and a Chapter 13 stays for 7 years. Of course, most credit information remains on a report for 7 years.

Today, the stigma of filing for bankruptcy protection has been substantially reduced. Debtors come from all walks of life. They are business owners, neighbors, teachers, police officers, firefighters, and even doctors. They are usually good people who need a second chance. Under the right circumstances, the Bankruptcy Code provides them with that chance.

If you are experiencing serious financial difficulty, you should consult with an attorney to discuss your bankruptcy and non-bankruptcy options. For more information, visit our Atlanta bankruptcy attorney website.