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Unsecured Debts in Bankruptcy

December 8th, 2017 at 8:00 am

Your debts are either secured by something you own, or they are unsecured. Unsecured debts are either “priority” or “general unsecured.”  


Unsecured Debts

Debts that are unsecured are those which are not legally tied to anything you own. The creditor has no “security” attached to the debt, no “security interest” in anything. It has no right to repossess or seize anything of yours if you don’t pay the debt.  It can only pursue the debt itself.

It’s usually easier to deal with unsecured debts than secured ones in bankruptcy. Most unsecured debts can be discharged—legally written off—through either Chapter 7 “straight bankruptcy” or Chapter 13 “adjustment of debts.”

An Unsecured Debt Can Sometimes Turn into a Secured One

Under some circumstances an unsecured debts can become secured if you don’t pay it.

For example, you could be sued by the creditor on a debt, resulting in a judgment against you. The creditor may be able to turn that judgment into a lien against your home and other possessions. The debt would then be secured by your home and/or other possessions. (The details of this depend on your state’s laws.)

Another example: if you get behind on income taxes the IRS can record a tax lien against your real estate and personal property. It does not need to sue you.

Filing bankruptcy can stop a lawsuit from turning into a judgment lien. It can often stop the recording of an IRS tax lien. In these and similar situations it’s much better to file bankruptcy before creditors can turn unsecured debts into secured ones.

Also, Sometimes a Secured Debts Can Turn into an Unsecured One

After a secured creditor repossesses or seizes its “security,” and sells it, any remaining debt would then be unsecured.

 A secured debt could become unsecured in various other ways. The “security” could be lost or destroyed, leaving the creditor with nothing to seize. Another secured creditor with prior rights could seize the “security,” leaving the creditor with the “junior” position no longer secured. There are various tools in bankruptcy for turning secured debts into unsecured ones.

Seemingly Secured Debts May Actually Be Unsecured

Creating a “security interest”—a creditor’s rights over its “security—takes specific legal steps. If the creditor fails to take those steps appropriately, a debt that seemed to be secured actually isn’t. Your bankruptcy lawyer may ask you (or the creditor) for documentation to find out if a certain debt is really secured.                                   

Two Kinds of Unsecured Debts

There are two kinds of unsecured debts: “priority” and “general unsecured.”

“Priority” debts are those that the law treats as special for various reasons. Past-due child support and unpaid recent income taxes are “priority” debts. The law treats them as special, mostly by putting them ahead of other unsecured debts. Generally, “priority” debts have to be paid in full in bankruptcy before other unsecured debts receive anything.

“General unsecured” debts are simply the rest of the unsecured debts, those that aren’t “priority.”  “General unsecured” debts include most unsecured ones. Examples are almost all medical and credit card debts, retail accounts, personal loans, many payday and internet loans, unpaid utilities and other similar bills, claims against you arising out accidents or other bodily injuries, damages arising from contracts and business disputes, overdrawn checking accounts, bounced checks, the remaining debt after a vehicle repossession or real estate foreclosure, and countless other kinds. If the debt is not secured, and isn’t “priority,” then its “general unsecured.”

Unsecured Debts in Bankruptcy

In the next blog posts we’ll look at how Chapter 7 and Chapter 13 treat “priority” and “general unsecured” debts. Depending on which kinds of debts you have, these will help you understand and choose between these two options.

 

Timing: Writing Off Income Taxes

September 22nd, 2017 at 7:00 am

Usually you can discharge—write off—an income tax debt by just waiting long enough. Here’s how to discharge a tax debt under Chapter 7.  

 

Timing is Just About Everything

If you owe an income tax debt and file a Chapter 7 “straight bankruptcy” case, one of two things will happen to that debt:

  1. It will be discharged—permanently written off—just like any medical bill or other ordinary debt, or else
  2. Nothing will happen to that tax debt; you’ll continue to owe it as if you hadn’t filed bankruptcy.

The difference, most of the time, is timing—when you file your Chapter 7 case.

The Timing Rules

In most situations a Chapter 7 case will discharge an income tax debt if you meet two timing conditions. The date you and your bankruptcy lawyer file that case must be both:

  1. at least 3 years after the tax return for that tax was due, and
  2. at least 2 years after that tax return was actually submitted to the IRS or state tax authority.  

See Sections 507(a)(8)(A)(i) and 523(a)(1)(B) of the U.S. Bankruptcy Code.

One important twist: IF you got an extension to file the applicable tax return, then the above 3-year waiting period doesn’t begin until the end of the extension. Section 507(a)(8)(A)(i). For example, let’s say you got a 6-month extension from April 15 to October 15 of the pertinent year. So then the 3-year period starts on that October 15 instead of on the usual April 15 return filing due date.

These Rules Applied

Assume you owe $7,500 in income taxes for the 2013 tax year. You’d asked for a 6-month extension to October 15, 2014. But then you didn’t actually submit the tax return until December 31, 2014.  

If you’d file a Chapter 7 case at any point before October 15, 2017, you’d continue owing the $7,500 tax. If you’d file on or after October 15 you would likely not owe a dime.

That’s because on October 15, 2017:

  1. At least 3 years would have passed since the extended due date of October 15, 2014, and ALSO
  2. At least 2 years would have passed since actually submitting the tax return on December 31, 2014.

Or, take with same $7,500 tax debt for the 2013 tax year with similar facts but a couple differences. You didn’t ask for an extension, but also didn’t submit the tax return until December 31, 2015.

Under these facts you’d have to wait until after December 31, 2017 to file the Chapter 7 case.

That’s because:

  1. 3 years since the tax return was due—on April 15, 2014—would have passed on April  15, 2017, but
  2. 2 years from the day the return was actually submitted would not pass until December 31, 2017.

Other Conditions

Earlier we said that “in most situations” Chapter 7 discharges income taxes debt when you meet the two timing conditions. So what are the other situations when taxes would not be discharged, even after meeting the 2-year and 3-year conditions?

There are two sets of them.

The first set comes into play if you made an “offer in compromise” to the IRS or state to settle the debt, or if you had filed a prior bankruptcy case involving this same tax debt. Since these are unusual situations, and the rules are detailed, talk with your bankruptcy lawyer if they apply to you.

The second set applies in situations in which the taxpayer “made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.” Section 523(a)(1)(C).  Different bankruptcy judges interpret this language differently. For example, is it a willful attempt to evade a tax to merely not submit its tax return when due, even if you submitted it voluntarily a year later? How about if you didn’t submit the tax return until the IRS personally contacted you to do so? Again, talk with your bankruptcy lawyer about how this part of the Bankruptcy Code is interpreted by your court. 

 

Chapter 13 Buys Time

July 21st, 2017 at 7:00 am

Chapter 13 is very different from Chapter 7 “straight bankruptcy.” It buys you time to deal effectively with your special debts. 


The Main Overall Benefit of Chapter 13

The main benefit of Chapter 7 “straight bankruptcy” is the discharge—legal write off—of your debts.

You also get a discharge in Chapter 13 “adjustment of debts.” But a more immediate and often more important benefit is that you’re protected from collection action by creditors while you pay all or a portion of certain special debts. Those special debts are usually ones that Chapter 7 does not discharge, or does not help in a meaningful way.

Buying Time

Here are some examples of the kinds of debts that buying time under Chapter 13 helps you with.

  • Home Mortgage: If you’re behind on your first mortgage Chapter 13, can give you as much as 5 years to catch up. An ongoing foreclosure is stopped. Future ones can be prevented. This buying of time gives you a much more practical way to save your home. And a much more peaceful one.
  • Recent Income Tax Debts: Taxes that don’t qualify for discharge (usually because they are too recent) are subject to immediate collection as soon as a Chapter 7 is completed. Interest and penalties continue to accrue. In contrast, under Chapter 13 the tax creditors must stop collections throughout the 3 to 5-year payment plan. And generally interest and penalties both stop accruing.
  • Child or Spousal Support: Chapter 7 does not buy you ANY time if you’re behind on support. Chapter 13 stops collection on the arrearage (although ongoing monthly support can continue being collected). You then have time to catch on the support over time, based on what you can afford.
  • Vehicle Loans: If you’re behind on your car or truck, in Chapter 7 you have to catch up in a matter of weeks. Chapter 13 gives you years. And if the debt is more than the value of the vehicle, through “cramdown” you would probably not need to catch up at all. Plus the monthly payment can often be reduced. The term of payments may be stretch out over a longer period of time. These all buy you time. The end result is that you can keep the vehicle less expensively and with less worry.
  • Unpaid Property Taxes: If you’ve fallen behind, just like a mortgage you get years to catch up. And you don’t have to worry about a property tax foreclosure in the meantime. Also, your mortgage lender can’t use your being behind on property taxes as a reason to foreclose on the mortgage.
  • Student Loans: Generally you can stop paying on your student loan during your Chapter 13 case. This is especially beneficial if you do not currently qualify for an “undue hardship” discharge but expect to more likely do so later in your case. Ask your bankruptcy lawyer about how the law is enforced because it varies by region.

 

Priority Creditor Proofs of Claim in Chapter 13

November 21st, 2016 at 8:00 am

Priority proofs of claim need to be carefully monitored in a Chapter 13 case. Make sure one’s filed so it gets paid, and at the right amount.

 

Priority Debts and Chapter 13

One major reason you’d file a Chapter 13 “adjustment of debts” case is if you have “priority” debts. These are special debts that generally can’t be discharged—legally written off—under Chapter 7 “straight bankruptcy.” So they must be paid.

The main priority debts consumers tend to owe are:

Chapter 13 is often better than Chapter 7 for dealing with substantial priority debts because it can shield you much better from those debts, as you pay them on your own terms. A Chapter 7 cases usually last about four months, shielding you from priority debts only during that short time.  In fact Chapter 7 does not protect you at all from collection of current or back child and spousal support.

In contrast, a Chapter 13 case lasts three to five years. You have that much more time to pay the priority debts, and usually the creditors can’t collect throughout that time.

Proofs of Claim of Priority Debts

Your creditors file “proofs of claim” in your bankruptcy case to assert how much you owe them. A creditor doesn’t get paid under your court-approved payment plan if it doesn’t file one. But if it doesn’t and you want it paid, you or the Chapter 13 trustee can file one for them. Section 501(c).

You generally want priority debts to be paid. Assuming so, your Chapter 13 payment plan would earmark funds to pay them. So you or your bankruptcy lawyer needs to monitor whether the creditors do file proofs of claim, and file one on behalf of any that neglect to do so.

Unexpectedly Large or Small Proofs of Claim

The priority creditors’ proofs of claim also need to be monitored to see if the amount of debt is accurate. The amounts need to match or be quite close to the amounts used in calculating your Chapter 13 plan.

If a priority proof of claim is significantly larger than expected, your case may take longer to finish than planned. But there’s a limit: a Chapter 13 case is generally not allowed to take longer than 5 years. So you may have to increase your monthly plan payments to complete it on time. Or your lawyer may be able to “modify” (amend) your plan to reduce what you are paying to other creditors to make up for the increase in a priority proof of claim.

Similarly, if a priority proof of claim is lower than expected your case may be done faster. But usually you must pay all of your disposable income into the plan for a certain period of time. That’s usually either three or five years, depending on your income at filing. If that’s true in your case, money that had been earmarked for that priority debt would usually just go to other creditors.

 

“Priority” Debts in Chapter 7 Bankruptcy

September 7th, 2016 at 7:00 am

Here’s what happens to “priority” debts in an “asset case.

 

Our last blog post introduced “priority” debts. They are debts that are favored in bankruptcy because Congress has decided they are of a type that should be favored. Today we focus on how they’re favored in Chapter 7 “straight bankruptcy.”

Chapter 7 Trustee Usually Doesn’t Pay Any Debts, Including Priority Ones

Last time we said:

In most Chapter 7 cases the bankruptcy trustee does not take possession of any of your assets to distribute to your creditors. Because there are no funds for the trustee to pay any debts, priority debts do not come into play. But there are (relatively few) cases where there are unprotected assets for the trustee to liquidate. In those cases the trustee must pay the priority debts in full before paying the general unsecured ones anything.

So, in most Chapter 7 cases you get to keep everything you own; the bankruptcy trustee gets nothing. Those are called “no asset cases”—the trustee has no assets to collect and distribute among your creditors. And because the trustee is paying none of your debts out of your unprotected assets, the order in which the trustee would pay the debts makes no practical difference. It doesn’t matter whether you owe any priority debts because the trustee is paying nothing to anybody.

So let’s look at the more unusual situations where you owing priority debts would make a difference. These are “asset” cases, in which the bankruptcy trustee does pay some of your debts, likely your priority ones.

Consumer Priority Debts

Let’s first remember that there are only two types of priority debts in most consumer bankruptcy cases: 1) all child and spousal support owed at the time of the bankruptcy filing; and 2) income taxes that meet certain conditions.

Of these two, support debts have a higher priority. That is, the Chapter 7 trustee pays a support debt in full before paying anything on a priority income tax debt. And the trustee would pay both priority taxes in full before paying any other debts.

In an “Asset Case” the Priority Debts Are Paid in Full Ahead of Other Debts

So let’s now show how this works in an example of an “asset case.”

Imagine that you owe $4,000 in back child support and $5,000 in income taxes for last year. These are both priority debts. The support is because that’s always a priority debt. The income tax is a priority debt because it’s new enough to meet the conditions making it a priority debt.

You also owe $90,000 in other debts—credit card balances, medical bills, personal loans. None of these are priority debts.

Also imagine that you own a $10,000 boat free and clear. It is not protected from a bankruptcy trustee; it’s not “exempt.” You can no longer afford to insure, maintain, and operate the boat, so you don’t mind giving it up. You file a Chapter 7 case knowing that the bankruptcy trustee will get the boat from you, sell it, and pay the proceeds to your creditors.

You especially don’t mind this when you learn two things. First, you learn that the support and income tax debts are priority debts, to be paid ahead of your other debts. Second, you learn that those two debts would not be discharged in your Chapter 7 case. That is, you’d continue to owe them after your Chapter 7 case would be completed. You’re happy to hear that debts that you’d still have to pay would instead likely be paid in part or in full out of the boat’s sale proceeds.

So What Happens? 

The Chaper 7 trustee sells your boat for $10,000. The bankruptcy court gives permission to pay him or her $2,500 in compensation for services. (See Section 326(a) of the U.S. Bankruptcy Code.) That leaves $7,500. Out of that the trustee pays the $4,000 child support debt in full. He or she then pays the $3,500 that’s left towards the $5,000 income tax debt. That leaves $1,500 of the tax debt not paid. The trustee does not pay anything on the $90,000 in other debts because there’s no money left to do so.

The end result is that $7,500 of debts that you would have had to pay after bankruptcy are instead paid by the trustee through the boat sale proceeds. Yes, the $2,500 the trustee received is arguably wasted to you. And yes, you’d still need to pay off the remaining $1,500 in taxes (likely through a reasonable monthly payment plan).

But in the right circumstances it’s quite a good deal. If you didn’t owe any support or taxes the trustee would distribute the $7,500 among your $90,000 in general debts. Those are debts that most likely would have simply been discharged in the Chapter 7 case. You would owe nothing on them regardless what the trustee paid or didn’t pay. The boat proceeds would have done you no personal good.

In our scenario, in contrast, the majority of the boat proceeds ARE doing you personal good. Those sale proceeds are going to eliminate or reduce debts that otherwise you would have had to pay in full out of your own pocket after the bankruptcy case was over.  

 

“Priority” Debts in Bankruptcy

September 5th, 2016 at 7:00 am

What makes “priority” debts so special?

 

Your debts fall into three categories:

  • Secured
  • General unsecured
  • Priority

We’ve spent many blog posts covering secured and general unsecured debts. Today it’s time for priority debts.

Priority Debts

Just like it sounds, priority debts are treated in bankruptcy law as more important than other debts. They’re more important, essentially, than “general unsecured” debts.

Debts that are not secured by liens on anything you own are all unsecured debts. Just about all unsecured debts are “general unsecured” ones.

Priority unsecured debts are simply certain kinds that the law has selected to be treated with higher priority than other debts.

Why Are They Treated with Higher Priority?

For each type of priority debt there are reasons why it is treated special.

There are really only two types of priority debts in most consumer bankruptcy cases:

  • child and spousal support—the amount of support owed as of the time of the filing of your bankruptcy case
  • certain income taxes, and some other kinds of taxes—they are priority debts only if they meet certain conditions

Support payments are treated special simply because Congress has decided that this kind of debt should be favored over other debts in bankruptcy. In fact, it is treated with the very highest priority of all priority debts. When money is distributed through bankruptcy procedures, support debts are usually paid first, ahead of all other debts.

Certain income tax debts are treated special because taxes benefit the public, so Congress has decided taxes should be favored. Unlike unpaid support payments, for income taxes to be priority they have to meet certain conditions. Those conditions mostly have to do with how old the taxes are. The newer the tax is the more likely it is to be priority. Otherwise, (older) income taxes are just general unsecured debts.

How Do Priority Debts Have Higher Priority in Bankruptcy?

In bankruptcy, a lot turns on which debts get paid ahead of other debts. That’s because the amount of money available is usually much less than the amount of debt to be paid. So, often all of the money, or most of it, goes to priority debts.

This plays out differently under Chapter 7 “straight bankruptcy” and under Chapter 13 “adjustment of debts.”

In most Chapter 7 cases the bankruptcy trustee does not take possession of any of your assets to distribute to your creditors. Because there are no funds for the trustee to pay any debts, priority debts do not come into play. But there are (relatively few) cases where there are unprotected assets for the trustee to liquidate. In those cases the trustee must pay the priority debts in full before paying the general unsecured ones anything. And the trustee must pay higher priority debts in full before paying the lower priority ones anything at all.

In Chapter 13 cases, you and your bankruptcy lawyer propose a payment plan that you present to the bankruptcy court.  That payment plan must show how you will pay all priority debts in full during the 3-to-5-year case. Creditors can object, and after any objections are resolved, the court approvals a plan. Then during the course of the case you must in fact pay all the priority debts in full before you can complete the case and get a discharge (legal write-off) of your remaining unpaid debts.

The next blog post or two will show how priority debts work in practice.

 

Prevent a Creditor with an Unsecured Debt from Turning it into a Secured Debt

June 29th, 2016 at 7:00 am

Because of Chapter 13’s much more powerful automatic stay, its ability to prevent judgment liens and tax liens is extremely valuable.  

 

Our last blog post described ways that the “automatic stay”—your protection from creditors’ collection actions—is so much more powerful in a Chapter 13 “adjustment of debts” case than in a Chapter 7 “straight bankruptcy.”

One way that this Chapter 13 protection from creditors is better is simply that it lasts much, much longer than under Chapter 7. This benefit is also related to today’s topic, how Chapter 13 can permanently stop unsecured creditors from turning their debts into secured ones. This is an underappreciated advantage of filing a Chapter 13 case.  

Prevent Creditors from Turning Unsecured Debts into Secured Ones

Creditors with secured debts generally have much more leverage than those with unsecured debts. In a Chapter 7 case most unsecured debts get “discharged”—legally written off—without any payment required. In a Chapter 13 case unsecured debts are only paid if and to the extent there is any money left over during the course of the payment plan after paying secured creditors and special “priority” debts (such as unpaid child support and recent income taxes).

Creditors with unsecured debts have a variety of ways of turning those into debts secured against your assets. Two examples are judgment liens and income tax liens, which we’ll discuss more in a moment.

Those liens, as well as other kinds, can turn a debt that can simply be discharged into one that has to be paid in full or in part. Or even if it was a debt that could not have been discharged (such as unpaid child support or recent income taxes), once the creditor has a lien the debt is more dangerous for you, even if you file a bankruptcy afterwards.

Filing bankruptcy—either Chapter 7 or 13—prevents a creditor from converting its unsecured debt into a secured one. The same law—the “automatic stay”—that stops other forms of collection action against you immediately upon the filing of a bankruptcy case, also stops creditors from creating liens against your assets. The U.S. Bankruptcy Code states that filing a bankruptcy “petition… operates as a stay… of–… (5) any act to create… against property of the debtor any lien” that secures a debt existing at the time the petition is filed. (See Section 362(a)(5) of the Bankruptcy Code.)

Preventing Judgment Liens

Any creditor with an unsecured debt you owe can sue you if you do not pay the debt according to its terms. Most of the time such a lawsuit turns into a judgment against you on the debt. State laws determine how the creditor can then collect on the judgment against you. But usually the judgment either automatically becomes a lien against some of your assets or the creditor can take additional steps to create a lien, such as a lien against your home for the amount of the judgment.

As soon as there is a lien, a debt which could otherwise be discharged as an unsecured debt may have to be paid in full or in part in order to get a release of the judgment lien on your real estate or other assets.

Filing either a Chapter 7 or 13 case on a debt that has not yet turned into a judgment will prevent that from happening. Even if a lawsuit has been filed the judgment can be prevented if the bankruptcy is filed quickly enough.

If the debt is the kind that can be discharged in a Chapter 7 case—which includes most unsecured debts—then that will take care of the debt. At the end of the case the debt is discharged and then the creditor has no more debt to sue you for and create a judgment lien on your assets.

But what if the debt is one that is not discharged in the 3 or 4 months that a Chapter 7 case takes to process? If you are accused of having gotten the debt through fraud or misrepresentation there is a good chance the debt would not be discharged in a Chapter 7 case, for example. If the creditor takes appropriate action during the case the debt would not be discharged and the creditor can turn that debt into a judgment and put a lien on your assets.

In a Chapter 13 case you can make arrangements to pay such a fraud/misrepresentation based debt during the course of the 3-to-5-year payment plan. The “automatic stay” prevents the creditor from converting the unsecured debt into a secured one (as long as the creditor does not get extraordinary permission to the contrary from the bankruptcy judge).

Preventing Income Tax Liens

Income tax debts either meet the conditions for being dischargeable in bankruptcy or they don’t meet those conditions. These conditions mostly turn on whether enough time has passed since the tax return at issue was legally due and since the tax return was in fact submitted to the IRS or state tax agency. If the tax meets the conditions for discharge, the tax is simply discharged in a Chapter 7 case, essentially like any other dischargeable debt.

But if the IRS/state records a tax lien before you file a bankruptcy case that turns the unsecured tax into a secured one. Depending on what the tax lien attaches to, you may have to pay the tax in part or in full to get the tax lien released from your assets. So it’s very important to file bankruptcy—either Chapter 7 or 13—before the tax lien is recorded.

But what if the tax is one that does not meet the conditions for discharge? Filing a Chapter 7 case will stop the tax lien for only the 3-4 months that the “automatic stay” is in effect. The IRS/state can record a tax lien on such a tax as soon as your case is closed.

However, if you file a Chapter 13 case instead the IRS/state will be prevented from recording at tax lien throughout the 3-to-5-year period that a case usually lasts. During that period you would pay that tax, on your own schedule and at the same time that you deal with your other important debts. After paying off the tax, without the threat of a recorded tax lien, and completing the case, there would be no more tax debt on which a tax lien could be recorded.

 

Dealing with a Recorded Tax Lien FULLY Secured by Home Equity

May 30th, 2016 at 7:00 am

A tax lien fully encumbered by the equity in your home is dangerous. Chapter 13 may be your best option. 

 

Today we finish a short series of blog posts on income tax liens recorded against your home. Last time we explained how to use Chapter 13 “adjustment of debts” to get the release of a tax lien when there is SOME equity in your home to secure the tax debt. The time before we got into what happens when there’s NO equity in your home to which the tax lien can attach. Today is about tax liens that secure the entire tax debt because the amount of home equity is enough to cover the ENTIRE tax.

Scenarios

To make better sense of this, here are three scenarios to illustrate the three above situations.

All of them involve a homeowner who owns a home worth $190,000 while owing an income tax debt of $20,000. Assume that this tax debt meets the conditions for “discharge”—legal write-off in bankruptcy. That usually just means that the tax return for that income tax debt was due more than 3 years ago and the tax return was submitted to the IRS/state more than 2 year ago.

  • In the first scenario, assume that the mortgage(s) and any other prior liens (such as for property taxes) against this $190,000 home total $180,000. So the home has $10,000 in equity. If the IRS or state tax agency recorded a tax lien against the home on the $20,000 tax, that tax would be partially secured, to the extent of $10,000. See our last blog post for how best to deal with this partially secured situation.
  • In the second scenario, assume that the mortgage(s) and any other prior liens against this $190,000 home total $195,000. Then of course the home has no equity at all. If a tax lien was then recorded on the $20,000 tax debt against the home, it has no home equity to which to attach. So in spite of the tax lien, the tax debt would still be effectively unsecured, at least unless and until equity built up on the home by an increase in its value or pay-down of the prior liens. See two blog posts ago about how best to deal with this completely unsecured situation.
  • In the third scenario, assume that the mortgage(s) and any other prior liens for the $190,000 total only $170,000. Now when a tax lien is recorded against the $20,000 tax debt, there is enough equity in the house to cover that full amount. The tax lien makes the tax debt fully secured. This is what we cover now.

You Must Pay the Tax to Keep the Home

If your home has enough equity to cover the amount of the tax on which the tax lien is recorded, you have to pay the tax. With the recording of the tax lien, your home involuntarily became collateral on the tax debt.

This is true even if that tax would otherwise meets the conditions for being legally discharged—completely written off (by meeting the 2-year and 3-year conditions, and occasionally another condition or two, mentioned above).

A recorded income tax lien—similar to a home mortgage—continues in effect after your bankruptcy case. So if you want to keep the home, again you have to pay the tax.

Because of this drastic effect of a tax lien, as we emphasized in a blog post a week ago, if at all possible try to file bankruptcy before a tax lien is recorded. This is especially true if you qualify for discharge of the tax debt AND there is equity in your home that would be encumbered by a tax lien.

Chapter 7 “Straight Bankruptcy” Might Help

Filing Chapter 7 case my help by:

  • discharging (writing-off) all or most of your other debts so that you could afford to make payments on the income tax debt until it was paid in full, including ongoing interest and penalties, and the tax lien was released from your home’s title.
  • discharging other income taxes that qualify for discharge and don’t yet have a recorded tax lien

But That Often Doesn’t Work

In practice Chapter 7 often isn’t the best option because even after discharging your other debts, you may not qualify for or be able to afford to pay what the IRS/state requires in a monthly installment tax payoff plan.

This would especially be true if you have other special debts to pay that Chapter 7 does not discharge and would have to be paid as well. Examples are student loans and child support arrearage.

Or if you are behind on a vehicle loan, and/or the home’s mortgage, property taxes, or homeowner association dues, you would have to pay these to hang onto the vehicle and/or the home. 

Other obligations like these would likely make it hard to make the required installment payments on the income tax secured against your home by the tax lien.

Chapter 13 Can Be Much Better

Filing a Chapter 13 “adjustment of debts” case can protects you from the tax debt and its tax lien as follows:

  • The IRS/state is stopped from enforcing the tax lien through foreclosure of the lien, or any other collection methods. The protection that in a Chapter 7 case usually lasts only about 4 months, under Chapter 13 lasts throughout your 3-to-5-year payment plan.
  • Your payments on the tax debt at issue can be delayed or reduced while you pay other even more time-pressing debts (such as child support, home mortgage, or vehicle arrearage mentioned above).
  • If your circumstances change during your Chapter 13 payment plan, you can usually adjust your plan payments, including the payments being paid on the income tax debt. Instead of just hoping that the IRS/state would be willing to accept delayed or lower payments, Chapter 13 would very likely give you more flexibility and protection.

Summary

When you meet with your bankruptcy lawyer, together look very carefully into whether getting rid of your other debts through Chapter 7 would really free up enough of your cash flow so that you could enter into a reasonable monthly payment plan with the IRS/state.

If not, or if you have other special debts that need the other benefits that Chapter 13 provides, discuss with your attorney if that is the best way for you to go. 

 

Resolving a Recorded Tax Lien Partly Secured by Home Equity

May 27th, 2016 at 7:00 am

Chapter 13 forces the IRS/state to accept only partial payment on an income tax debt that is only partially secured by a tax lien.

 

We’re in a short series of blog posts on income tax liens recorded against your home. Last time we explained how to use Chapter 13 “adjustment of debts” to get the release of a tax lien when there is no equity in your home securing that tax lien. That happens when the mortgage(s), property taxes, and other prior liens soak up the whole value of the home.

But what if there is enough equity in the home to cover part of the tax lien but not all of it? That is, the prior liens soak up most of the home’s value but leave SOME equity for the tax lien but not enough to cover the full tax debt.

An Example

This situation will make much more sense with an example.

Take a home is worth $200,000, with a mortgage of $195,000, leaving equity of $5,000. This home equity is increasing over time as the neighborhood home values increase and the mortgage is paid down.

The IRS is owed $20,000 for the 2011 and 2012 tax years. Assume that this $20,000 could normally be “discharged” (legally written off) in a Chapter 7 “straight bankruptcy” without paying anything. That’s because the main conditions for discharge were met in this example: the tax returns for those taxes were due more than 3 years ago and were submitted to the IRS more than 2 year ago.

But recently the IRS recorded a tax lien on the home for that $20,000 owed, securing the tax debt against the home. But there’s currently only $5,000 equity in the home to cover that $20,000 tax lien. What happens?

The Disadvantage under Chapter 7

If no tax lien has been recorded against you and your home, Chapter 7 is an excellent way to get rid of older income tax debts, those that meet both the 2-year and 3-year conditions just mentioned. The problem is that by the time those conditions would be met, there’s a good chance that a tax lien will get recorded. After all, the IRS and state tax agencies know the bankruptcy laws quite well and want to make you pay the taxes!

A recorded tax lien survives a Chapter 7 discharge. So if that lien attached to some equity in the home, you finish the Chapter 7 case with that dangerous tax lien still encumbering your home and that equity. There is no legal mechanism under Chapter 7 to discharge the unsecured part of the tax and just pay on the secured part.

So the IRS or state will use that tax lien as leverage to make you pay as much of the tax as possible. Especially if the value of the home is increasing, the IRS/state will likely be able to make you pay all or most of the tax amount before releasing its tax lien.

The Solution under Chapter 13

Chapter 13 does have exactly the kind of legal mechanism that you need here. Through your court-approved payment plan, the bankruptcy law allows you establish the amount of equity in your home to which an income tax lien attaches as of the time your case is filed. Then that amount—that part of the tax lien—and no more, is paid over time through the Chapter 13 payment plan. That’s the secured part of the tax debt.

In our above example, that’s the $5,000 portion of the $20,000 tax debt, the part secured by the equity in the home.

The rest of the tax beyond the secured part, the additional $15,000 in our example, is treated as a “general unsecured” debt. That means it is grouped with the rest of your debts that are neither secured nor treated in any special way. These debts, including that portion of the taxes, are paid only to the extent that you have money left over after paying off the secured part, and after paying in full all your other legally more important debts.

What’s important to understand is that In practice the unsecured part of the taxes—the $15,000 in our example—usually doesn’t increase the amount you pay into your 3-to-5-year Chapter 13 payment plan payments. This happens one of two ways:

  • Your payment plan doesn’t have any money left over for the “general unsecured” debts, including the unsecured part of the taxes. That’s when you budget only provides you enough “disposable income” over the life of your plan to pay the secured part of the tax and other legally more important debts—like catching up on your home mortgage, paying off your vehicle loan, and paying more recent income taxes that can’t be discharged. This is called a 0% plan—paying nothing of the “general unsecured” debts and paying nothing of the unsecured part of the income tax. In our example, the $15,000 would be paid 0%—it would be paid nothing.
  • In other Chapter 13 cases in which you are paying something to the “general unsecured” debt, that “something” is a definite amount based on what your budget allows. Adding the unsecured part of the lien tax debt to that pool of other “general unsecured” debts does not increase the amount of money you have to pay into that pool. You pay the same amount and that amount is just spread out among more debts, so that the other “general unsecured” debts just get less of that fixed amount that you pay. In our example, if you had $50,000 of other “general unsecured” debts, adding the $15,000 unsecured portion of the taxes would not increase the amount you would pay but rather the remaining $50,000 of debts would just get paid less.

 

Beating a Recorded Income Tax Lien on Your Home

May 25th, 2016 at 7:00 am

Once an income tax lien is recorded, Chapter 13 gives you a tool that may enable you to pay no more and yet get a release of that tax lien.

 

Our last blog post was about using bankruptcy to prevent the IRS or state income tax authority from recording a tax lien on your home. But what if a tax lien has already been recorded?

The Challenge of a Tax Lien

In our last blog we also focused on how bad it is for you if the IRS/state records a tax lien 1) on an income tax debt that could otherwise be discharged (legally written off) 2) against a home that has equity against which that tax lien can attach. Then the problem is that the tax can no longer be discharged since it’s now secured by your home.

But what if the home has no present equity for the tax lien to attach to?

Dealing with a Tax Lien with No Home Equity to Attach

Maybe the IRS/state didn’t know that there was no equity when it recorded the tax lien, or maybe it just didn’t care. A recorded tax lien is a matter of public record. It hurts your credit record and your ability to sell and refinance the home. It puts you under pressure to pay the underlying tax debt. The IRS and state know this and that lien hurts you regardless that your home may have no present equity.

Filing a Chapter 7 “straight bankruptcy” usually doesn’t help because an income tax lien is not affected by it. The tax lien continues to attach to your home. And within just 3-4 months after the case is filed it’s finished and the IRS/state can resume enforcing the lien.

Determining that a Tax is Unsecured in Spite of the Tax Lien

But filing a Chapter 13 “adjustment of debts” bankruptcy instead DOES help. That’s because it comes with a truly unique tool, the ability to get a legal determination that the home has no equity attachable by the tax lien. You simply establish that as of the time the case was filed the liens that come ahead of the tax lien eat up all of your home’s equity, leaving none for the tax lien. (See Section 506(a) of the U.S. Bankruptcy Code.)

As a result the tax debt is treated as a “general unsecured” debt.  It is put into the pool of all your other “general unsecured” debts—which include medical bills, most credit cards, and all other debts that are not treated special by the bankruptcy laws.   You would pay into that pool, including on that tax debt, only as much as you could afford to pay during the life of your 3-to-5-year Chapter 13 plan, if at all.

Indeed in many situations you would pay little or nothing because you would first be required to pay other higher-priority debts. Again, you would only pay “general unsecured” debts, including the tax debt in issue, to the extent you could afford to do so with any money left over within the length of time that your Chapter 13 plan is required to last.

And in most cases when you do pay some percentage of those “general unsecured” debts, the addition of your tax debt to that pool of your “general unsecured” debts usually doesn’t increase the amount you must pay. That’s because most of the time you pay a fixed amount of money into that pool of debts. So adding the tax debt simply reduces what the other “general unsecured” creditors receive without you paying any more.

Forcing the Release of a Tax Lien When It Does Not Attach to Any Equity

Then at the end of the Chapter 13 case, any portion of the tax debt that hasn’t been paid is discharged, legally written off forever. Then, the IRS/state—regardless how much it’s been paid or not paid—must release its tax lien.

Lack of Equity Fixed As of Date of Filing

The lack of any value in the tax lien is fixed as of the beginning of the Chapter 13 case. So the home’s ongoing appreciation in value (and increase in equity as you pay down mortgage and other debt) is put beyond the reach of the tax lien. The IRS/state does not benefit from the tax lien during the course of the case while you are protected from all collection activity. Then at the end of the case the tax debt is discharged and the tax lien is release.

Under these facts, this is an excellent way to beat a tax lien.

 

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