The Surprising Benefits: Saving Your Vehicle through Bankruptcy

Bankruptcy can get you out of the dilemma that a vehicle loan can put you in. Chapter 7 works if you can afford the loan payments afterwards.  


Here’s the Problem

You’re paying on a car or truck. You absolutely need this vehicle for getting to work, and to keep your life going. You can’t do without it.

But you’re having trouble keeping up on the loan payments. You owe lots of other debts, so keeping current on the vehicle loan is a big challenge. It’s a big stressor every month.

On top of that there’s a good chance that you owe more on your vehicle than it is worth. You know that if you somehow found other reliable transportation and surrendered your present vehicle—or if it was repossessed—you could easily still owe thousands of dollars of “deficiency balance.” That’s the amount you would owe on the loan after the surrender or repossession.

The amount you’d owe would very likely be much more than you expect. That’s because repossessed vehicles are usually sold at auto auctions, resulting in less credit to your account than you’d expect. Plus the costs of repossession/surrender and sale, and late charges and such would all be added to the balance. So giving up the vehicle doesn’t seem to make any sense.

As a result you feel stuck. You really need the vehicle but you can’t afford pay for it. And even if you could somehow do without it, you’d likely still owe thousands of dollars from letting it go.

Chapter 7 Regular Bankruptcy Gives Limited Help

Chapter 7 bankruptcy accomplishes two things regarding your vehicle loan. First, if you want to keep the vehicle, Chapter 7 would likely get rid of most of your other debts. Maybe then you could afford the vehicle payments. Or second, if you surrendered the vehicle, Chapter 7 would likely discharge (legally write off) the deficiency balance. If you had a way to get another reliable vehicle, or could do without, this might solve your problem.

What Chapter 7 doesn’t do is give you the power to change the terms of your vehicle loan. It’s “take it or leave it.” If you want to keep your vehicle, you’re virtually always stuck with the contract terms. That includes the monthly payment amount, the interest rate, etc.

Plus, you’re almost always required to “reaffirm” the debt. This legally excludes the vehicle loan from the discharge of your debts. You continue to owe it in full in exchange for keeping the vehicle.

This is economically risky. You’re paying for something that isn’t worth what you’re paying. And if you later surrender the vehicle or it’s repossessed, you would owe a deficiency balance. You’d owe it in spite of your prior Chapter 7 case because you reaffirmed the debt.

If You’re Behind on Your Vehicle Loan, or on Insurance

It’s worse if you aren’t current on your loan payments at the time of your Chapter 7 bankruptcy filing. Almost always your vehicle lender would require you to quickly catch up—within a month or two of filing. This would be on top of keeping current on the ongoing monthly payments. Or else you’d lose the vehicle in spite of filing bankruptcy.

If you’ve also let your insurance lapse, it’s even more problematic.  Your lender knows how dangerous lack of insurance is for itself, so it would “force-place” insurance on your vehicle. Your contract almost certainly allows it to do this. Force-placed insurance tends to be very expensive while at the same time provides you very little coverage. Under Chapter 7 you would likely have to pay for any such insurance, plus reinstate your own insurance. And you’d likely have to do this very quickly, not long after filing your Chapter 7 case.  

Chapter 13 Can Solve These Problems

Chapter 13 “adjustment of debts” can solve these problems that Chapter 7 can’t.

First, Chapter 13 can buy you much more time. A Chapter 13 payment plan would likely give you much more time to catch up on any missed loan payments. It would also likely give you lots more time to pay for any force-placed insurance.

Second, if you qualify for “cramdown” you would likely pay less on the vehicle loan—possibly much less. Cramdown is an informal term for the Chapter 13 procedure for legally re-writing the loan in situations in which the vehicle is worth less than you owe. With cramdown you could both pay less monthly and pay less overall before the vehicle became yours free and clear. And if you’re behind on loan payments, you would not need to catch up at all on any of those missed payments.

Next week we’ll tell you how Chapter 13 could both buy you time and save you money on your vehicle loan(s).

 

The Surprising Benefits: Chapter 13 Potentially Discharges Divorce Property Settlement Debts

Chapter 13 can write off some or all of the non-support debts included in your divorce. But it comes with some potential disadvantages. 


Last week we explained how Chapter 7 cannot write off non-support divorce debts, but Chapter 13 can. We said if you owe a significant debt created by your divorce decree (for other than child or spousal support) you should talk with a bankruptcy lawyer. Don’t necessarily think that Chapter 13 is your best option with this kind of debt. Chapter 13 has advantages and disadvantages. We get into these now so you can start to see which option is best for you.

Non-Support Divorce Debts

Support debts are not discharged (written off) under either Chapter 7 or 13. Only non-support debts can be discharged under Chapter 13 (and not Chapter 7). So we need a quick, practical reminder what we mean by non-support debts.

We said last week:

Most non-support debts are those obligations in your divorce decree related to the division of property and the division of debts between you and your ex-spouse.

The Division of Property

… often in a divorce one ex-spouse receives less assets than the other. For example, you may receive a vehicle worth much more than your ex-spouse. Or you may get the family home. So you’re required to pay your ex-spouse half of the equity in the home to make up the difference. Whatever specific amount you’re required to pay in these kinds of situations is a non-support divorce debt.

The Division of Debts

Also, for whatever reason your divorce decree may have required you to pay a debt arising from the marriage. This debt may be a jointly-owed one, one that you owe individually, or even one that only your ex-spouse owes. The decree orders that your ex-spouse no longer has to pay that marital debt. You have to pay it by yourself.

… . This obligation by you to your ex-spouse to pay the debt is a non-support divorce debt.

Disadvantages of Chapter 13

The main advantage of Chapter 13 for this kind of debt is that you could avoid paying most or even all of it. Also, Chapter 13 has many other potential advantages over Chapter 7, some of which may well apply to your situation. These are beyond the scope of today’s blog post.

Let’s focus instead on three main potential disadvantages of Chapter 13 for this kind of debt. These are: 1) delay in discharge, 2) risk of no discharge, and 3) likely partial payment of the nonsupport divorce debt.

Delay in Discharge

A Chapter 13 case takes a lot, lot longer than a Chapter 7 one. It takes years instead of months. That is, a Chapter 13 case usually doesn’t finish for 3 full years, and often goes as long as 5 years. Contrast that with a Chapter 7 case, which usually takes less than 4 months from filing date until completion.

And you don’t get a discharge of your debts—including the non-support divorce debt(s)—until the end of the case.  Again, that’s 3 to 5 years.

Usually your ex-spouse can’t do anything to collect on that debt in the meantime. So the delay may not be much of a practical problem. But you’re still living in a sort of limbo in the meantime.

If you have other reasons to be in a Chapter 13 case the delay may well be worthwhile. Or if the amount of you non-support divorce debt is very large that alone may make the delay worthwhile. Just be aware of this downside.

Risk of No Discharge

Almost all Chapter 7 cases, especially those in which the person is represented by a lawyer, get successfully completed. But Chapter 13s are riskier. That’s because they involve a monthly payment plan that you and your lawyer put together, it gets court-approved, and then you pay on it for 3-to-5 years. In the right situations a Chapter 13 case can accomplish much more than Chapter 7. But there are more things that can go wrong.

As we said above, you don’t get the discharge of debts until the end of the case. So you have to get to the end successfully to discharge the non-support divorce debt. There’s a risk that you would not get to the discharge.           

Likely Partial Payment of the Non-Support Divorce Debt

The Chapter 13 payment plan referred to above very seldom results in all debts being paid in full. In fact, in some cases you’d pay certain debts nothing before they get permanently discharged. In the majority of cases a non-support divorce debt would get paid in part, but often only a small percentage.

Non-support debts would be treated like all your other “general unsecured” debts. These are all debts that are not secured by collateral and are not “priority” debts (such as recent income taxes) which must be paid in full. All of your “general unsecured” debts are put together into a single pool of debt. The extent to which you’d pay that pool of debt would be based on a bunch of factors, such as:

  • how much you can afford to pay all your creditors per month throughout the length of the case
  • the length of your Chapter 13 plan, generally 3 years or 5, determined by your income
  • the amount of your priority debts, which you paid in full before the “general unsecured” debts get paid anything
  • how much your plan must pay in administrative expenses—the Chapter 13 trustee fees and the attorney fees you did not pay before your case was filed—all paid before paying any of the “general unsecured” debts

As a result sometimes the “general unsecured debts, including your non-support divorce debts, get paid nothing at all. All of your available money is exhausted elsewhere. (This assumes your local bankruptcy court allows such “0% plans”). On the other hand, in rare cases the “general unsecured” debts get paid in full. This is more common when you have little or no priority debts and the general unsecured debts are relatively small. Most of the time your non-support divorce debts get paid a relatively small portion of the total you owe. It depends on all these factors.

 

The Surprising Benefits: Discharge Divorce Property Settlement Debts

Chapter 13 enables you to discharge—legally write off—some or all of any non-support debts included in your divorce. Chapter 7 does not do this.

                               

“Discharging” a Debt or Legal Obligation

When you successfully complete a consumer bankruptcy, you get a discharge of some or all of your debts. When a debt is discharged the creditor is legally forbidden to take any action “to collect, recover or offset any such debt.” See Section 524 (a)(2) of the Bankruptcy Code. The debt has become legally uncollectible. So, one of your main goals in bankruptcy is to discharge all your debts, or as many debts as the law allows.

Chapter 7 vs. Chapter 13 Discharge

Chapter 7 “straight bankruptcy” discharges most debts. But there are exceptions.

Some debts you may want to continue paying and don’t want to discharge. One reason may be because you want to keep the collateral securing that debt. So, for example, you might legally agree to continue paying your vehicle loan in order to keep that vehicle.

Certain other debts the law does not allow to be discharged. Examples include child and spousal support, many student loans, and recent income taxes.

The kinds of debts that a Chapter 13 case does not discharge are mostly the same kinds as under Chapter 7.  These include the kinds mentioned above. You can voluntarily pay a vehicle loan under a Chapter 13 “adjustment of debts” case. (Plus you may well get some extra advantages).  And Chapter 13 does not discharge child and spousal support, many student loans, and recent income taxes. (Again, you may well get some major advantages under Chapter 13 in dealing with these special debts.)

However, there IS a significant kind of debt which Chapter 7 does not discharge but Chapter 13 does. These are non-support divorce debts. As a result you should consider Chapter 13 instead of Chapter 7 if you have this kind of debt. This is especially true if you owe a significant amount of non-support divorce debt. Chapter 13 would likely enable you to pay little or even none of your non-support divorce debts. If you either didn’t file bankruptcy or filed under Chapter 7 you’d be required to pay them in full.

What Are Non-Support Divorce Debts?

What we’re calling divorce debts are those financial legal obligations that arose out of your marital divorce. These can also come through separation decrees and other family court proceedings.

Non-support divorce debts are simply divorce debts not involving the payment of spousal or child support.

Most non-support debts are those obligations in your divorce decree related to the division of property and the division of debts between you and your ex-spouse.

The Division of Property

Your divorce decree may divide the marital assets in a very straightforward way. At the end of the divorce both of you could be in possession of what you’ve been awarded—all done.

But often in a divorce one ex-spouse receives less assets than the other. For example, you may receive a vehicle worth much more than your ex-spouse. Or you may get the family home. So you’re required to pay your ex-spouse half of the equity in the home to make up the difference. Whatever specific amount you’re required to pay in these kinds of situations is a non-support marital debt.

The Division of Debts

Also, for whatever reason your divorce decree may have required you to pay a debt arising from the marriage. This debt may be a jointly-owed one, one that you owe individually, or even one that only your ex-spouse owes. The decree orders that your ex-spouse no longer has to pay that marital debt. You have to pay it by yourself.

This provision in the decree creates a new and separate obligation by you to your ex-spouse to pay that debt. This is over and beyond whatever obligation you may have had (or not had) already directly to the creditor.

This obligation to your ex-spouse to pay the debt is a non-support marital debt.

Discharged Only Under Chapter 13

Chapter 7 case simply does not discharge these non-support debts.

You’d continue to owe any obligation to pay your ex-spouse money for division of marital property. You would continue to owe any obligation stated in the divorce decree to pay a marital debt. This would be true even if you could discharge the debt to the direct creditor.

However, both division-of-property and division-of-debts obligations to your ex-spouse (and any other non-support divorce debts) could be discharged in a Chapter 13 case. So, again, if you owe non-support divorce debts you should look into Chapter 13 with your bankruptcy lawyer.

But Chapter 13 isn’t necessarily your best option if you have a non-support divorce debt. Chapter 13 has disadvantages, both of itself and in how it treats non-support obligations in particular. We’ll get into these next week. Then you’ll begin to see whether Chapter 13 really is the better solution for you.

 

The Surprising Benefits: Chapter 13 Handles an Income Tax Lien on a Tax that Can’t Be Discharged

Chapter 13 can be the best way to deal with a nondischargeable tax debt with a recorded lien: it buys more time, protection, and flexibility.

Last week we discussed how Chapter 7 handles a recorded tax lien on a tax that bankruptcy CAN’T discharge. The tax debt already can’t be discharged (legally written off in bankruptcy). So you can’t get out of paying it. The prior recording of a tax lien just adds another reason you have to pay the tax. If you fail to pay the IRS/state can take your assets that are subject to the recorded tax lien.

Filing a Chapter 13 “adjustment of debts” case can be a better way to handle such a tax debt than a Chapter 7 “straight bankruptcy” one.

Buys Time  

Whether you file under Chapter 13 or Chapter 7 does not affect whether you must pay this tax. But filing a Chapter 13 case can often buy you more time.

After completing a Chapter 7 case you must pay the not-dischargeable tax as fast as the IRS/state demands. Otherwise all the powerful tax collection tools can be used against you. With a recorded tax lien already on your real and/or personal property, the IRS/state has even more leverage against you.

What if you can’t pay the tax as fast as demanded? Among other things the IRS/state could garnish your wages and/or bank accounts, and seize your property.

Chapter 13 could prevent all of that because you’d be given as much as 5 years to pay the tax. You and your bankruptcy lawyer would incorporate that tax debt into your Chapter 13 payment plan. You’d pay the IRS/state along with any other special debts that you must pay. Often, you’d pay only a small portion of your remaining debts. Sometimes you’d pay nothing on such debts. As a result you can focus your financial energies for 5 years on your tax debt.

Buys Protection

During that 5 years (which can be as short as 3 years), your paycheck, your checking/savings and other financial accounts, and your property are protected. Bankruptcy’s valuable “automatic stay” protection from collection lasts only 3-4 months in a Chapter 7 case. But this protection lasts the full 3-to-5 years of your Chapter 13 case. The peace of mind that comes from this extended protection is often invaluable.

Buys Flexibility

Sometimes what you need more than time is flexibility in how you pay a tax debt.

You may have some other even higher-priority debt that your financial future depends on. If you’re behind on a vehicle loan you may need to catch up so you’ll have transportation to your job. Or, if you’re late on child support catching up may be crucial to avoiding wage garnishment. Chapter 13 can let you pay some debts ahead of taxes, even nondischargeable taxes with a recorded tax lien.

Or if you can’t pay the taxes until some event in the future, Chapter 13 can buy you that flexibility. The event can even be a few years into the future. For example, if you plan on selling your house and moving away in two years, say, after a child graduates from high school, you may well be able to delay paying all or most of the tax debt until that house sale.

Conclusion

Chapter 13 can be a much better way to deal with a nondischargeable tax debt with a recorded lien. It often gives you more time to pay it, protects you many times longer than Chapter 7, and gives you flexibility that could be crucial in your unique circumstances.

 

The Surprising Benefits: An Income Tax Lien on a Tax that Can’t Be Discharged

A recorded tax lien on a tax that already doesn’t qualify to be discharged makes you all the more want to pay that tax. Chapter 7 might help. 

 

We’ve been talking about the effect of a tax lien on an income tax that bankruptcy CAN discharge. A tax lien can turn that tax from one you don’t have to pay into one you have to pay in full. That’s because a tax lien recording turns an unsecured debt that bankruptcy can write off into a secured one. The tax becomes secured by your real estate, or your personal property, or both. So, if you want to keep what you own, you must pay the tax.

But what about a tax lien on a tax that bankruptcy CAN’T discharge? The tax already doesn’t qualify for being written off. What difference does the recording of a tax lien make on such a tax? And how can bankruptcy help in these situations?

A Tax Lien on a Non-Dischargeable Tax

It’s likely somewhat less common for a tax lien to be recorded on a nondischargeable tax. Broadly speaking, an income tax does not qualify for discharge because it’s not old enough. Often, by the time the IRS/state records a tax lien, the tax at issues has meet the conditions for discharge.

But that certainly isn’t always true. There are many circumstances when a tax has not qualified for bankruptcy discharge and the IRS/state records a tax lien. The taxing authority may be relatively quick on recording a tax lien because of the amount at issue. Or a prior history of unpaid taxes could encourage the same reaction. Also, if you owe more than one year of taxes, a tax lien would often apply to all taxes owed. Some of those taxes may be old enough to qualify for discharge while others may not.

So what’s the practical effect of a tax lien recording on a tax that already doesn’t qualify for discharge? The effect is much less than it would be on a dischargeable tax—making you pay a tax you could have avoided paying. In both situations the tax lien turns an unsecured tax into a secured one. With a nondischargeable tax this simply means that you have one more reason to pay a tax which you already had to pay after a Chapter 7 bankruptcy. Besides their usual collection tools, the IRS/state can now take your assets if you don’t pay.

Chapter 7’s Effect

Filing Chapter 7 only makes sense when you have a recorded tax lien secured by assets you own and want to keep (worth at least  the amount of the tax) if you are prepared to pay the tax. That’s true if the tax at issue is dischargeable or not dischargeable. With a nondischargeable tax that’s all the more true—the lien just gives you more reason to pay the tax. It gives you more reason to pay it more quickly.

There are concrete ways that a recorded tax lien gives the IRS/state that much more leverage to make you pay. The lien increases the ways the IRS/state can directly hurt you, through the seizure of your assets. In the case of a tax lien on a home, it can prevent you from refinancing your mortgage. It could even jeopardize the sale of a home. The lien is also a black mark on your credit record.

You don’t have to be prepared to pay it in full. But you need to have the cash flow—after discharging your other debts—to make appropriate monthly payments. Or, in special circumstances, you need to have strong confidence that you can successfully reduce or eliminate the tax through an offer in compromise.

What If You Can’t Pay, or Not Fast Enough?

Chapter 13 is a better option if you can’t pay the tax at issue fast enough to satisfy the IRS/state. We’ll tell you about this next week.

 

The Surprising Benefits: Chapter 13 AFTER the Recording of an Income Tax Lien

Chapter 13 protects you from a recorded tax lien in crucial ways, and can reduce how much you pay on the underlying dischargeable tax debt. 

 

Last week’s blog post was about dealing with a recorded tax lien by filing a Chapter 7 “straight bankruptcy” case.  Usually the IRS’ or state’s recording of a tax lien against you effectively requires you to pay the underlying tax. That’s true even if that tax otherwise qualifies for total discharge—legal write-off in bankruptcy. That’s because a recorded tax lien converts that tax debt from being unsecured to being fully secured by your property and possessions. You pay the tax—sooner or later—to avoid losing what you own.

When Chapter 7 Might Help

Last week we outlined some circumstances in which Chapter 7 might satisfactorily deal with a recorded tax lien. Those circumstances were when the tax lien either failed to apply to any assets you own or the assets were worth much less than the tax debt at issue. For example, the IRS/state may record a lien on your home which in the process of getting foreclosed. If you’re letting the house go then that tax lien has no leverage over you. Your Chapter 7 case would discharge the income tax debt and the subsequent home foreclosure would undo the tax lien.

But these situations are quite rare. Usually a recorded tax lien (or more than one) covers everything you own. Usually the value of your assets encumbered by the lien(s) well exceeds the amount of the tax at issue. Or even if your assets’ value is less than the tax(es) owed, you don’t want to lose those assets. So you have no choice but to pay the tax owed. That’s true even if that tax otherwise qualified to be fully discharged.

However, if filing a Chapter 7 case takes care of all your other debts, maybe that’s okay. It would have been better to file before the tax lien’s recording so you could have just discharged the tax. But if it’s too late for that, clearing the deck of all or most of your other debts so you can concentrate on the tax debt afterwards may be your best option.

When Chapter 13 Could Be Much Better

The last paragraph assumes you could afford to pay the tax covered by the tax lien. But what if after finishing your Chapter 7 case you still didn’t have enough money each month? The protection from creditor collections (the “automatic stay”) you get from filing bankruptcy disappears when the case is over. That’s only about 3-4 months after your bankruptcy lawyer files your Chapter 7 case. With the tax lien putting your assets at risk you’d have tremendous pressure on you to pay the tax. So if you couldn’t afford to pay as fast as the IRS/state would demand you’d have a serious problem.

Filing a Chapter 13 “adjustment of debts” case could significantly help.

First, the automatic stay protection against the IRS/state usually lasts the 3 to 5 years that a Chapter 13 case takes to complete. That alone greatly reduces the constant tension of being at the mercy of the tax authorities. During the Chapter 13 case your assets that are encumbered by the lien are protected from seizure. And your income and other assets are protected from any other tax collection efforts.

Second, you usually have much more flexibility in your payoff of the underlying tax. You have much more control over the amount and timing of payments on the tax debt. Your monthly Chapter 13 plan payments are based on your realistic budget. In earmarking where the money from those payments goes you can often pay other even more urgent debts (such as catching up on a home mortgage or child suport) ahead of the tax debt. You can sometimes delay paying the tax until some future event, like the sale of your home or other asset.

When Chapter 13 Is Even Better

When the assets covered by the tax lien have no present value, Chapter 13 is particularly powerful.

Consider a tax lien on a home with no present equity beyond the prior liens. After a Chapter 7 case the IRS/state could just sit on that recorded tax lien until you built up equity in the home. You’d pay down the obligations and the property would rise in value until there was equity to cover the tax lien. The IRS/state would have huge leverage over you. But under Chapter 13 the bankruptcy judge would declare that there’s no present equity secured by the tax lien. The tax would effectively be unsecured—as if there was no tax lien. You’d lump that tax debt in with your general unsecured creditors. You would likely pay only a small portion of that tax debt. Often you would actually pay no more into your Chapter 13 payment plan as a result of that tax.

For example, assume you owed $10,000 in dischargeable income tax.  The IRS recently recorded a tax lien on your home for that tax. Your home is worth $250,000, has $5,000 in property taxes, $210,000 on a first mortgage and $40,000 on a second mortgage. Owing $255,000 you have no equity in the home. But as you pay down the property taxes and the mortgage, and assuming the property value increases, there’d soon be equity securing the tax lien. But Chapter 13 allows you to freeze the present equity situation. The tax lien presently does not cover any equity in your home, the tax debt is thus unsecured, and would be treated just like the rest of your unsecured debt. Adding the tax debt to your other unsecured debt would usually result in you paying no more than you would have otherwise.

 

The Surprising Benefits: Chapter 7 AFTER the Recording of an Income Tax Lien

Under certain circumstances a recorded tax lien does NOT require you to pay a dischargeable tax after Chapter 7, or at least not in full.

 

The last two blog posts have been about the benefits of preventing an income tax lien recording by filing bankruptcy. That’s especially helpful if the tax at issue is an older one that can be discharged—legally written off. The recording of a tax lien can turn such a tax debt from one you don’t have to pay at all into one that you have to pay in full. (See the IRS Notice of Federal Tax Lien form.)

But what if the IRS or state has already recorded a tax lien against you, before you could file bankruptcy? You’re likely in even more financial distress after that tax lien recording than you were before. Could filing bankruptcy still help with that tax debt even after the lien recording?

Yes, both Chapter 7 “straight bankruptcy” and Chapter 13 “adjustment of debts” could help. They could each do so in different ways. And they could each help whether the tax at issue met the conditions for discharge or instead was a newer tax that did not.

Today’s blog post covers how Chapter 7 can help with a recorded tax lien on a dischargeable tax debt. We’ll cover how Chapter 13 helps in this same tax situation next week.

The Effect of a Tax Lien Recording

In most situations the recording of a tax lien on an otherwise dischargeable tax requires to pay that tax. Again, it turns a tax that you wouldn’t have had to pay into one you have to pay in full.

How does it do that? Basically, IRS’/state’s recording of a tax lien turns an unsecured debt into a secured one. The tax meets the conditions for discharge (mostly by being old enough), but the IRS/state now has rights over your assets. You have to pay the otherwise dischargeable tax if you don’t want to lose those assets.

What assets? Which of your assets would you lose after the recording of a tax lien if you didn’t pay the tax? That’s a crucial question. That’s because under certain circumstances you might not need to pay all the tax, even after a tax lien recording.  You might not have to pay any of the tax. It depends on which of your assets, if any, the tax lien attached to.

Assets Attached by the Tax Lien

Let’s be clear. Most of the time the recording of a tax lien results in you having to pay the tax. That’s because that tax lien attaches to your assets or property that you don’t want to lose. A recorded IRS Notice of Federal Tax Lien, for example, applies to “all property and rights to property belonging to this taxpayer for the amount of these taxes… .”  So if it applies to everything that belongs to you, you pay the tax to avoid losing those assets.

But sometimes the tax lien might attach to little, or even nothing, of value. Or what it attaches to is worth much less than the tax debt. Then you may not end up paying the whole tax debt amount, or even any of it. (See the IRS’ Guidelines for Processing Notice of Federal Tax Lien Documents, including about lien releases and withdrawals.)

Examples

For example, assume you owe $10,000 in old, dischargeable income taxes but own very little—say a total of $2,500 fair market value in household goods and personal effects. There’s a recorded tax lien on that $10,000 debt covering all your property. With a Chapter 7 case you discharge the $10,000 debt, but recorded tax lien on the $2,500 in property survives. The IRS/state has limited leverage in making you pay any more than $2,500. So there’s a good chance you could settle the matter by agreeing to pay around that amount.

Another example: the IRS/state has recorded a tax lien in your county real estate recorder’s office, placing a lien on your home. (Under many state’s laws that recorded lien would only apply to real estate, not to any other personal assets.) But what if you do not own a home or any other real estate in that county? What if you recently lost your home to foreclosure? Or what if your home has no equity at that time and likely won’t for many years? In these scenarios the IRS/state would have to concede that its lien is essentially worthless. Your bankruptcy lawyer may well be able to convince the IRS/state to release or withdraw its lien as being of no collection value.  

 

The Surprising Benefits: Chapter 13 Stops the Recording of an Income Tax Lien

Chapter 7 and 13 can both prevent the recording of a tax lien. But if the tax qualifies for discharge Chapter 7 is quicker and less risky. 

 

Last week we showed how detrimental the recording of an income tax lien can be for you. It can turn a tax that you could fully discharge (legally write off in bankruptcy) into one you’d have to fully pay. We showed how Chapter 7 “straight bankruptcy” could prevent recording of the tax lien and could discharge the tax.

How about a Chapter 13 “adjustment of debts” case? Would filing one also stop an income tax lien recording?  If so, what would happen to that tax debt?

Chapter 13’s Automatic Stay

The filing of a Chapter 13 case stops the recording of a tax lien by the IRS or state just like a Chapter 7 would. Any voluntarily filed bankruptcy case by a person entitled to file that case imposes the “automatic stay” against almost all creditor collection activities against that person and his or her property. (See Sections 301 and 362(a)  of the U.S. Bankruptcy Code.) Those “stayed” or stopped activities specifically include “any act to create, perfect, or enforce” a lien. (See Section 362(a)(4) and (5).)

So filing under Chapter 13 stops a tax lien recording just as fast and just as well a Chapter 7 would.

But Would Chapter 13 Be Better than Chapter 7?

That depends. It depends at the outset on whether the tax is one that qualifies for discharge. If it does qualify (mostly by being old enough) then a Chapter 7 is actually often better.

Under Chapter 7 the automatic stay protection lasts only the 3-4 months that the case is active.  But that’s long enough since the discharge of the tax debt would happen just before the case was closed. Once the tax debt is discharged the IRS/state could no longer do anything to collect that tax. It would certainly have no further ability to record a tax lien on that tax.

What would happen in this situation under Chapter 13, with a tax debt that qualifies for discharge? It would get discharged like under Chapter 7, but with two big differences.

First, the discharge would happened not 3-4 months after case filing but usually 3 to 5 years later.  The automatic stay protection usually lasts throughout that time, preventing tax collection, including the recording of a tax lien. But that long period of time under Chapter 13 does create more opportunities for things to go wrong. That’s all the more true because throughout that time you have various obligations, such as to make monthly Chapter 13 plan payments. If for any reason you don’t successfully complete your Chapter 13 case, the otherwise dischargeable tax debt still won’t get discharged.

Second, under Chapter 13 you may have to pay part of the tax debt before it is discharged. This is in contrast to usually paying nothing on it under Chapter 7. (This assumes that you’d have a “no-asset” Chapter 7 case—in which all of your assets would be “exempt”, protected.) Whether  you’d pay anything on a dischargeable tax debt in a Chapter 13 case, and if so how much, depends on many factors, mostly the nature and amount of your other debts and your income and expenses. But why risk paying something on a tax debt under Chapter 13 if you wouldn’t have to pay anything under Chapter 7?

So Chapter 7 Is Usually Better at Dealing with a Dischargeable Tax Debt?

The answer is likely “yes” if you focus only on this one part of your financial life.

But you may have other reasons to file a Chapter 13 case. For example, you may owe a more recent income tax debt that does not qualify for discharge, in addition to the one that does qualify. Chapter 13 provides a number of significant advantages in dealing with the nondischargeable tax. These could make Chapter 13 much better for you overall.

Or you may have considerations nothing to do with taxes, such as being behind on a home mortgage, a vehicle loan, or child support. Chapter 13 gives you huge advantages with each of these kinds of debts. Your bankruptcy lawyer and you will sort out all the advantages and disadvantages of each legal option to choose the best one.

 

The Surprising Benefits: Chapter 7 Stops the Recording of an Income Tax Lien

The recording of a tax lien often immediately turns an unsecured debt into a secured one, forcing you to pay what you could have written off.

 

If you owe income taxes, stopping the IRS or state record a tax lien can be a huge benefit of filing bankruptcy. How much of a benefit turns on details about the taxes you owe and the type of bankruptcy you file. Today and in our next blog post we’ll look at income taxes that would be discharged (forever written off in full). Today we focus  on the benefits of filing Chapter 7; next week we’ll do the same for Chapter 13.

Secured and Unsecured Debts in Bankruptcy

The leverage that any creditor has over you depends a lot on whether its debt is secured by your property. For example, if a debt is secured by your home, the home is collateral on that debt. In most situations even after filing bankruptcy you have to either pay the debt or you could lose the home.

The Effect of a Tax Lien

If you can’t pay an income tax, that tax debt is an unsecured one. It’s not secured by anything you own. The IRS and state taxing authorities have some powerful collection techniques they can use to collect the tax. But they can’t simply take anything of yours to pay off the tax debt. That’s because that tax debt is not secured by anything you own.

This completely changes when the IRS/state records a tax lien against your tax debt. The recording legally converts the unsecured tax debt into a debt secured by your property. Which property becomes security against that particular tax debt depends on the details of 1) the tax lien itself and 2) your state’s property laws.

But regardless of these details, IRS/state tax liens can potentially turn pretty much everything you own into security on that tax debt. That means that if you don’t pay the tax, the IRS/state can often take whatever you own in payment of that tax debt. Usually the practical result is not that they take everything, or even anything. Rather, you end up paying the tax debt, sooner or later.

Unsecured Older Income Tax Debts in Bankruptcy

Contrast that from what would happen to that tax if there was no recorded tax lien.

Most ordinary unsecured debts can be legally forever written off in bankruptcy. This is true of some income tax debts as well, if they meet certain conditions. Basically, bankruptcy discharges (writes off) income taxes for which the tax return:

  • was due more than 3 years before your bankruptcy case is filed, AND
  • was in fact filed more than 2 years before bankruptcy.

An Older Income Tax Debt WITHOUT a Tax Lien Under Chapter 7

If you meet the above 2 conditions (and a couple other seldom applicable ones), filing Chapter 7 will simply forever discharge that tax debt. Within about 3-4 months after you file the case, it will be legally gone. You will not have to pay it.

You filed bankruptcy in time to stop the IRS/state from recording a tax lien. And after discharge they’ll never be able to record a lien, or collect in any other wayr.

An Older Income Tax Debt WITH a Tax Lien Under Chapter 7

But it’s completely different if you did not file bankruptcy until after the tax lien recording.

If the tax debt meets the timing conditions, your Chapter 7 filing would technically discharge the tax debt itself. However, the IRS/state would still have a lien on your property after the bankruptcy case was completed.

Because of this surviving tax lien, the IRS/state would at that point be able to exert its rights under the lien. That means it could take and sell whatever property the lien attached to. That would usually be all your personal property or your real estate, or possibly both.

To prevent this from happening, you’d want to contact the IRS/state to make payment arrangements. As mentioned above, the result is usually that you have to pay the tax in full, along with its continually accruing tax penalties and interest.

The Lesson

The lesson is very clear. If you owe income taxes, file bankruptcy before the tax authorities record a tax lien. If the tax you owe meets the timing conditions, you’ll be able discharge the entire tax and pay nothing on it.

 

The Surprising Benefits: Fraud Debt Collections in Bankruptcy

Being accused of defrauding a creditor is unusual in consumer bankruptcy cases. A creditor would have to jump through significant hoops. 

 

Most Debts are Discharged (Permanently Written Off) in Bankruptcy

The federal Bankruptcy Code has a list of the kinds of debts that are not discharged. This list details the conditions under which these kinds of debts don’t get discharged. (See Section 523 on “Exceptions to discharge.”)

Essentially, all your debts get discharged unless any of them fit one of the listed exceptions.

The Fraud Exception

One of the most important exceptions to discharge is the one stating that debts, “to the extent obtained, by… false pretenses, false representation, or actual fraud,” might not be discharged. (Section 523(a)(2)(A) of the Bankruptcy Code.)

This is an important exception to discharge because it could apply to many different kinds of debts. The other exceptions to discharge apply to very specific categories of debts. For example, these other exceptions include child and spousal support, various taxes, and student loans. But the fraud exception could apply to just about any debt if it was incurred in a fraudulent way.

What Makes for a Fraudulent Debt?

Your creditor would have to demonstrate that its debt should not be discharged because you incurred that debt fraudulently. If the creditor fails to do so the debt WILL get discharged and you’ll no longer legally owe it.  

To avoid discharge of the debt, the creditor would have to present evidence and prove EACH of the following:

  1. you made a representation
  2. which you knew at THAT time was false
  3. you made that representation for the purpose of deceiving the creditor
  4. the creditor relied on this representation
  5. the creditor was damage by your representation.

For example:

  1. a person gets a loan by representing that he or she has a certain amount of income
  2. while knowing that income amount was inaccurate
  3. with the purpose of fooling the creditor into making the loan
  4. resulting in the creditor relying on this income information in making the loan
  5. and losing money when the person didn’t pay back the loan

What Happens When a Creditor Alleges Fraud

Proving all five of these necessary elements often isn’t easy. So creditors tend not to object unless they believe they have a strong evidence of fraud. In the vast majority of consumer bankruptcy cases no creditors raise any fraud-based challenges.

When a creditor does raise such a challenge it does so in a specialized lawsuit in the bankruptcy court. This “adversary proceeding” usually focuses directly on whether the creditor can prove the five elements of fraud.

Such adversary proceedings almost always get settled. That’s because the amount of money at issue doesn’t justify the expense in attorney fees and other costs that can accrue quickly for both sides.  

Staying Allegedly Fraudulent Debts

The “automatic stay” imposed against virtually all creditor collection action also applies to allegedly fraudulent debts. If the creditor has alleged fraud prior to your bankruptcy filing, the filing will at least temporarily stop all collection on the debt. The “automatic stay” stops “any act to collect, assess, or recover a claim against the debtor.”  (Section 362(a)(6) of the U.S. Bankruptcy Code.)

Then, as mentioned above, the debt will either get discharged or not. If the creditor doesn’t file an adversary proceeding in time, the debt DOES get discharged. If the creditor files an adversary proceeding but then doesn’t prove fraud, the debt is discharged.

On the other hand, if the creditor does prove fraud the debt is not discharged and the creditor can then pursue the debt. It gets a judgment stating that the debt is not discharged and collectible. Then the creditor can use all the usual collection methods to collect the debt.  

However, because these matters are usually settled, the settlement usually includes an agreed payment plan. So in the unlikely event that a creditor DOES allege fraud against you, files a timely adversary proceeding, AND convinces the bankruptcy judge that all the elements of fraud were present, you would still very likely have a workable way to pay the debt without worrying about being hit by unexpected collection actions.