While I often extol the virtues of Chapter 13 bankruptcy, there is one issue in them that can be most vexing to a Debtor in need of help. Nearly every Chapter 13 Debtor owns a car with a secured debt attached to it when they file. Previously I have talked about the benefit of being able to reduce the interest rate on high interest car loans through the Chapter 13 and even, when the debt is old enough, cram down the principal owed to the actual value of the car. These all remain true. However, there is a hidden danger to having a car loan in Chapter 13.
The danger lies in 11 USC Sect. 1235(a). This provision lists a number of things that must be true about a Chapter 13 plan for it to be confirmed. Conversely, if all the requirements of 1325 are met, the court must confirm the plan. Shaw v. Aurgroup Financial Credit Union, 552 F.3d 447 (6th Cir., 2009). The Sixth Circuit Court of Appeals has issued case law based on this code provision that severely restricts the flexibility of a Chapter 13 bankruptcy in this one area of car loans. Those decisions are In re Adkins, 425 F.3d 296, 300 (6th Cir.2005) and In re Nolan, 232 F.3d 528 (6th Cir.2000).
Essentially, these two court opinions determine that once a plan is confirmed and the car lender’s claim is allowed, then it shall always be a secured claim. This may not sound formidable, but here is how the scenario plays out: Debtor has a car worth $7,000.00 which is working okay at the start of the plan. The plan gets approved and the secured claim is filed by the lender for $7,000.00. Perhaps there is another claim for excess debt on the car that is treated unsecured, but that does not matter in this situation. A couple of years into the plan, the car starts messing up and it becomes more costly to fix than the car is now worth. The Debtor, who is paying all their disposable income into their Chapter 13 cannot get the car fixed. So, they seek to modify the plan, surrender the car, and purchase a more roadworthy vehicle. They can only manage this if they can reduce their plan payment. They can only reduce their plan payment if the deficiency of the car loan, what’s left after the car is surrendered and auctioned, is unsecured debt. However, In re Adkins and In re Nolan preclude this.
That $7,000.00 cannot be re-characterized as unsecured. Let’s say the loan after two years of payments through the Chapter 13 plan is now $6,000.00 but the car auctions only for $1,000.00. That leaves a $5,000.00 deficiency. That $5,000.00 remains a secured debt that MUST be paid in full during the remainder of the Chapter 13 plan. The Debtor still must pay the exact same amount in plan payments and thus cannot afford to buy another vehicle. Now they have no car but they still must pay for their surrendered car in full.
The Sixth Circuit used solid statutory construction and policy considerations in coming to this result. They wanted to keep a Debtor from being able to enjoy a car for a while and then shift the depreciation value to the creditor. However, because the creditor knows they will be paid in full regardless of what they do, they have no incentive to realize the actual fair mark value of the car that was surrendered. The Debtor cannot sell the car due to the lien in place and the because of the Chapter 13 bankruptcy so they are stuck. They might as well keep the car and make do for the life of the Chapter 13.
The main point in all of this is to do a careful assessment of one’s vehicles and car loans prior to filing. Going into a Chapter 13 with high value cars that also have a high debt load can leave one with almost no wiggle room for the life of the Chapter 13. It would be best surrender such vehicles prior to confirmation of the plan and obtain an inexpensive used car prior to filing. And, if they have cars with debt, the Debtor needs to have some comfort that the car will actually last the life of the bankruptcy.
This post is geared more towards attorneys practicing bankruptcy law, but it is useful to anyone trying to resolve income tax debt. I am following up on my last post about how to determine if income tax debt can be discharged in bankruptcy. First, as an attorney, you have to complete and have your client sign a Power of Attorney, Form 2848. Well, actually you have to back up a step further and obtain a CAF number from the IRS. You will need that CAF number in order to get anywhere with them.
Once the 2848 is completed, you send it in to the IRS so that they can either lose it or take weeks to process it. Oh, but do not worry, you can still proceed. You next want to get a Form 4506-T completed. You really should do this at the same time as the 2848 to save time. There are fax numbers of the back of the 4506 to send it to and you only have to try that fax number a dozen or so times. More recent years can be obtained by calling the automated number for the IRS, but the transcripts can only be sent directly to the taxpayer’s address if you go that route.
Once the Account Transcripts come in, you need to look for those “520″ codes I mentioned in the last post. If there are any on the transcripts, you will want to spend a leisurely afternoon on the phone listening to the Internal Revenue Services music interrupted by occasional transfers to different departments. Once you get to the right place, you will be grilled about who your are. They will look in the system and fail to find the 2848 that you had dutifully sent in per the instructions. Just go ahead and have a copy of the 2848 at hand because the person helping you will ask you to fax it directly to them.
Once that 2848 is in front of them, they will ask you to repeat information that is clearly spelled out on the form itself to “verify” things. It seems this only verifies that you faxed them the very same document they are looking at, but no matter. Now you are cooking with GAS – well, perhaps kerosene. It will just take a few seconds to get the closing code. If you want to forgo this whole experience, then look for a code “971″ and see it there is one whose dates corresponds to the “520″. If so, you are safest to assume that the closing code is 77.
PS: By the by, attorneys, this is a time intensive and liability laden analysis, so be sure to charge separately from the bankruptcy for this procedure.
PPS: Be sure to get your client’s dates of birth – the IRS sometimes asks for this to verify that you are whom you say you are.
I just finished an analysis of whether over $90,000.00 in income tax debt from 2003 to 2005 could be discharged for a client through bankruptcy. The surprise answer for them was that it would be discharged completely in a Chapter 7 or a Chapter 13. Many have the mistaken belief that income tax debt never goes away; even many attorneys assume you must pay it no matter how far behind you find yourself. The truth is, there is a series of time-based limits set on income tax debts and once those limits are reached, the tax is treated like any other unsecured debt in bankruptcy.
To know whether a tax debt can be discharged in bankruptcy, one must obtain an “Account Transcript” for each year in which tax debts are owed. This transcript has a series of three digit codes along with dates for those codes and sometimes dollar amounts listed. Certain codes matter more than other. For example, one must make sure there are no “320′s” because that indicates an assertion that there was fraud involved in the tax return filed. Then, one needs to ascertain the dates of any penalties assessed by scrutinizing codes 290, 294, 298, 300 and 304. These penalties are also subject to the time limits but have to be addressed separately due to different stating dates.
Another code that makes a huge difference is the “520″ code. A 520 event is one that may or may not cause a stand still (a “tolling”) of those time limits from running. Just finding the 520 code is not enough because one must CALL the Internal Revenue Service to find out what the “closing code” is. The closing code will be a “77″ or a “90″. The 77 closing code means the time between the 520 date and the following 521 or 522 closing date did toll the time making it take longer to be able to discharge the debt. There is also code “480″ that happens when there is an “offer in compromise” proposed. A 480 event also tolls the time until the tax debt can be discharged.
If you have done your best to pay your income tax debt and it is just too big a burden, go a an attorney who can analyze a Tax Account Transcript. Find out if you can get a fresh start even from income tax debt.
I am often asked by Chapter 13 debtors if they can pay their Chapter 13 off early. This is a problematic question with no one clear answer. It is problematic because certain property of the debtor continues to come into the Chapter 13 estate while the bankruptcy is pending. This is different from a Chapter 7 where the property of the estate is established and remains static at the moment the bankruptcy is filed. The clearest example of this ongoing inclusion in a Chapter 13 are wages and other earned income of the debtor.
Since ongoing wages and earned income of the debtor comes into the estate of the Chapter 13 so long as the case is pending, then one cannot use those wages to pay your plan off early IF you were not below the median income on the means test OR you are paying 100% of unsecured debts in the Chapter 13. This makes sense because the idea with a Chapter 13 is that you repay creditors to the extent that you reasonably can. So, if you end up getting promotions or a better paying job during the bankruptcy, then you could reasonably pay a higher percentage of your unsecured debts.
Some Chapter 13 trustees require a new budget (Schedules I & J) to be submitted each year. If they see a substantial bump up in disposable income, they then require the plan to be modified to pay a higher percentage of the unsecured debts. In the Eastern District of Kentucky, the trustee does not automatically require this. However, if you begin to pay ahead on your Chapter 13 plan, they well may pay attention and decide you must be making more money. This can trigger a demand from the trustee for a new budget and probably a higher plan payment.
There are some things that clearly and unquestionably CAN be used to pay off a Chapter 13 plan early. If you use property of the estate that was exempt at the inception of the bankruptcy, such as a 401k account, then there should be no issue if you fell below the median on the means test. However, there are other things that need to be investigated and carefully considered by your attorney. Therefore, I must abstain from listing those things that are in the grey area here lest I miss some peculiarity of your situation.
Since I do not focus on a volume practice in bankruptcy and because I have become known as someone who is able and willing to tackle some unusual situations, I get to consult with debtors that have really tough circumstances. A recent case led me down a path of seeing just how creative I could be in a bankruptcy situation to forestall and ultimately pay their home loan lender. Anyone who has talked to me or read many of my posts know that I am quite fond of Chapter 13 bankruptcies. This is partly due to the flexibility afforded by them to accomplish many things, such as saving one’s house from foreclosure. So, I fully expected to find that a Chapter 13 would be the best vehicle to solving this client’s issue where they were nigh on losing their home.
In the scenario presented to me, the debtor had a sizable asset they had not been able to touch which was in trust but not much in ongoing income. The trust was not a spendthrift trust, or else we would not even venture far down this path. However, the debtor hoped that in bankruptcy, the trust assets could be obtained in order to pay their debts – likely at 100%. There are many twists and turns to this matter which I simply cannot go into here. Negotiating this one particular twist will just bring us to another turn and so the analysis is far more complicated than I am putting forth. Other issues involve the couple being unmarried and looking at who actually owns what. There are issues related to the automatic stay when a foreclosure has already been granted, but on appeal. And, just how tight the trust actually is will determine much. However, this particular issue I am focusing on may be helpful to others. In theory, the debtor’s notion of satisfying their debts with this currently unattainable asset is appealing.
We must look at 11 USC Sect. 1322(b)(8) to start the analysis. This section allows the plan proposed by the debtor to provide for payment of all or part of a claim from their property or property of the estate (let’s not worry about that distinction too much – it is often one and the same, but not always). The debtor can do this, in part, because under 11 USC Sect. 1306(b), the debtor remains in possession of all property of the estate. In other words, if you have property you cannot cover with exemption and you really want to keep that property, the way to be assured of that and file bankruptcy is in a Chapter 13. In a Chapter 7, what you cannot exempt is subject to being liquidated.
So far, so good – the debtor keeps the trust assets and keeps the house. Oh, but then we have to look at other provisions of the code. Next, we turn to 11 USC Sect. 1325 which requires that they are able to make payments. If my debtor’s only means to make payments on the plan is accessing their trust, then we run into a problem because there is no reasonable certainty that they will get into that trust in bankruptcy. After all, they were unsuccessful before considering bankruptcy. Because of this uncertainty and the absence of regular income, the plan may not get confirmed. The second barricade the debtor hits is the dreaded “adequate protection” called for in 11 USC Sect. 361. If they cannot protect the secured creditor’s interest in the Chapter 13, then they have no right to keep the asset securing the debt. In essence, this is a carve out of the Section 1306 provision.
Oh, but the secured property is land which typically increases in value; it does not decrease in value. However, in our situation, the amount owed on the property is far more than the value of the land under current market conditions. Still, we may be able to show adequate protection if we show that the value of the land is increasing faster that the debt is accruing interest and other allowed charges. Let us leave this one alone then, since it is driven by things I do not wish to get mired in.
The real problem I find myself up against is caused by the very provision that usually helps people out so much in a Chapter 13: Section 1306. When we combine the fact that the debtor keeps possession of their assets with the other nicety of Chapter 13s: the debtor has an absolute right to convert to a Chapter 7 or dismiss their Chapter 13 case, that is where get to the rub. My debtor cannot show that she can and will make payments to unsecured creditors as required by Section 1325 when she could dismiss the case as soon as she gets hold of the trust assets. Such a plan is unlikely to get confirmed.
Only if her income could pay an amount equal to the non-exempt asset could she get confirmed because there is one other hurdle not yet mentioned. The final hurdle is back in Section 1325 which basically says that creditors have to come out at least as well as or better than if the debtor filed a Chapter 7. This is the creditor’s “best interest” test that balances out the debtor’s benefits in Chapter 13s. In our case, if the debtor filed a Chapter 7 which cannot be converted dismissed without permission and where the assets of the estate go into the trustee’s hands, my debtor cannot pass this test.
Oddly enough, given many facts that I did not go into, this case is actually one where Chapter 7 gives a better likelihood of saving the house. The trustee would be vested with the ability to crack open that trust and has more resources with which to do it than the debtor in a Chapter 7. And, if successful, the home loan would still likely be paid in full even after the commission and other expenses.
For the second time in as many days a person I was speaking to highlighted the importance of getting the whole picture when looking at a bankruptcy matter. I accepted the compliment today when the potential client said that, after over a decade of trying to resolve certain debt issues and getting help from various professionals, I was the first person to sit and listen to the whole story. Actually, this is also true of family law cases such as custody or divorce. That may be why I am involved in both of these kinds of cases – because I naturally want to look at the whole picture to find a global resolution when possible.
Yesterday the issue was being served with a foreclosure notice on a house where the person was never named of the deed to the house. After a few more inquiries, it became clear that the person had a potential dower or curtesy (yes, that is spelled correctly) interest in the property as a result of being married to the owner at the time it was purchased. However, that was not the end of the story. I explained that we needed to look closer at the underlying documents. If the foreclosure was only extinguishing a dower or curtesy interest, then the person had nothing to lose. But, if they had ever signed a promissory note, even without ownership in the house, they could be hit with a deficiency debt. It is dangerous in law to stop at the simplest or most obvious answer; you gotta look at the whole picture.
Actually, that was more of a slice of the whole picture, but today’s story was more compelling on looking at the everything. To minimize wordiness, I will not explain the whole picture. This tale involved going back to 2003 and recounting several key events, tragedies, and attempts at resolving debt. What I learned was that nearly $100k of tax debt might be discharged except that there was a time they would have been “tolled”. I knew I had to get tax account transcripts to determine this. Also, there were events and circumstances that might actually allow for the rare discharge of student loan debt. However, it was clear that if I could help with the tax debt, then there might be enough relief that the student loans would not be so onerous. If I had not taken the hour plus to hear all the ins and outs of this families circumstances, I may have missed a key piece of the puzzle and blundered ahead making things worse rather than better.
The end result was that by looking at the whole picture, rather than just the immediate concern of the student loan debt, the potential client left with a sense of hope. I could not promise that the student loans could be discharged, but by coming at it from a different angle, relief was still at hand.
I have said it many times – nearly everyone who I help with bankruptcy has already gone beyond reason in trying to pay off their debts by the time they reach my door. This post is about one of those very common steps people take in being as responsible as they can for their financial obligations: emptying retirement accounts.
I am not going to say it is a mistake to empty retirement accounts to pay off debt, nor am I going to say it is a good idea. It is simply a choice. However, it is a choice that you need to make armed with knowledge. Under the Federal bankruptcy code, retirement account funds are exempt pursuant to 11 USC 522. If you have over a million dollars in an Individual Retirement Account, though, you need to make sure your attorney is aware of this so their can maximize exemption amounts.
So, if you take money out of retirement to pay off debts, you are converting exempt assets. This is all well and good if, by doing so, you avoid bankruptcy altogether. However, if it only buys time and you end up filing bankruptcy regardless of the valiant effort, then you simply have lost those funds down the black hole of debt. Additionally, you will have incurred extra taxes if you withdraw the funds or borrow them but are unable to repay timely.
These are funds that would have ridden through the bankruptcy and remained available to for starting over after all debts were discharged. It is very difficult to gauge whether the strategy of raiding retirement accounts will pay off or not. Therefore, I strongly recommend getting a third-party, preferably and attorney familiar with the bankruptcy code, to review your situation before you withdraw those funds. As my dad would say, “There’s no use throwing good money after bad!”
I write about this every year because it is a recurring issue for people facing bankruptcy. Taxes have a bearing on bankruptcy whether you are owed a refund or whether you owe the IRS. Therefore, they must always be taken into account, but it is especially important during this first handful of months each year.
The first thing to remember is that if you are owed a refund at the time of filing, that refund is an asset of the estate and must be reported in Schedule B and hopefully exempted in Schedule C. If you owe taxes, they are reported on either Schedule F or E depending on whether they are priority debts or not. Your attorney can help sort that out. Tax debt and tax refunds arise on December 31st each year. So, if you file a bankruptcy on January 1st, then you must account for the tax situation that arose from just the day before. So, even if you do not file your tax return until April 15th (or October if you file an extension) you either owe taxes for the year that just ended or you are getting a refund (rare indeed is the person who lands right at zero, but I suppose it happens).
If you owe taxes for the preceding year, they will be considered a “priority” debt and a debt that cannot be discharged. In a Chapter 7, the IRS and any state agency you owe taxes to will begin collection activity after your Chapter 7 is closed. In a Chapter 13, you will have to make sure you pay enough into the plan for those taxes to be paid in full over the life of the Chapter 13 along with 4% interest for federal income taxes and 5% interest on Kentucky income taxes.
If you are owed a refund, you need to report the refund as accurately as possible in your schedules of assets. This means you will likely have to run at least a rough draft of your tax return to get a good faith estimate of what is due back to you. Then, you will attempt to cover the entire amount in “wild card” exemptions. If you cannot exempt the entire amount, you will need to make a determination with help from your attorney as to whether you should wait until you receive the refund or press on.
If you decide to wait until you receive the refund, then the smart thing to do would be to pay for the bankruptcy and spend the money on necessities, such as food or needed repairs to you car. Do NOT use it to pay unsecured debt, especially not to relatives. Your attorney can help you know how much you can hold onto and exempt.
Your attorney can also help you determine if older income tax debts, such as those that arose a few years prior to the bankruptcy, will be discharged in your Chapter 7 or 13. All of this is acceptable pre-petition planning to make the most of the fresh start bankruptcy allows.
Everything in our culture drives towards giving bigger and better gifts for Christmas. Even when our budget is tight, we do not want to let our families down. So, we are tempted to buy gifts on credit. The risk is that this will put us over the top of our threshold for handling debt leading to a new year’s bankruptcy.
This raises the specter of challenges to discharge of debt for luxury items and having assets that cannot be exempted. That is because the laptop you bought for your child who lives with you is still an asset of yours to report and exempt. Gift items worth several hundred dollars are likely luxuries.
Take a deep breath and remember, the best gift is actually you being present.
- Car Cares and the Chapter 13 Dilemma
- Phone Adventures or “How does one get an “Account Transcript” from the IRS?”
- Surprising Facts About Income Tax Debt and Bankruptcy
- The Ramifications of Paying Off a Chapter 13 Early
- Fast, free and sometimes fun info on Instagram (of all places!)
- How Creative Can One Get?
- Getting the Whole Picture
- Things to be aware of when facing bankrutpcy #10
- Taxes & Bankruptcy
- The Christmas Excess Trap
- When a violation of the Consumer Protection Act lands you in debt
- The Scoop on the $71.00 Bankruptcy
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