Los Angeles Bankruptcy Law Monitor : Los Angeles Bankruptcy Lawyer & Attorney : Christine Wilton Law Firm : Southern California Chapter 13 & Chapter 7 Bankruptcy, Foreclosure

The November, 2009 issue of ABA Journal article entitled, The Bad-Debt Blues, explained the need to take federal taxes into consideration when restructuring debt as, "crucial."  The article provides an excellent overview of the federal tax rules that apply to debt workouts, and focuses on the impact to individual debtors.

The recent media blitz touting the end of the recession is an illusion caused only by government spending.  Bankruptcy filings are still up over last year and climbing to record numbers since the BAPCPA in 2005. Americans continue to struggle with what to do about their debt.

The so-called housing bubble we appear to be experiencing is caused by the fact that banks are holding foreclosed homes in their inventory rather than selling them because putting them on the market will only reduce already depressed housing values.  Similarly, the banks are also refraining from foreclosing on homes and moving toward more workout programs and modifications because they're starting to realize the error of their greedy ways. 

When faced with the tax consequences of the restructuring of individual consumer debt; either through foreclosure, repossession, or modification; filing bankruptcy provides a safe harbor and important IRS exclusions.  There is another exclusion under the Mortgage Forgiveness Debt Relief Act of 2007 that applies to Qualified Principal Residence Indebtedness on or after Jan. 1, 2006. 

It is important to remember that most financial transactions have tax consequences and we all know that ignoring the IRS with its hand out is never a good idea.  Consult with your lawyer to fully understand the tax consequences and restructure debt in the way that best minimizes tax liabilities for you. 

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In determining eligibility to file for a chapter 7 bankruptcy, the basic qualifying factor is income under the Means Test as set forth in 11 U.S.C. 707(b)(2).  The debtor's income must fall below the Census Bureau's Median Income by Family Size.   Thus, the Means Test is a two prong test:

• The first prong being the size of the household; and

• The second prong being that of the debtor's gross income for the six months preceding the bankruptcy filing. 

Debts generally not dis chargeable in Chapter 7 bankruptcy include:  taxes, child or family support payments, student loans [absent undue hardship], traffic tickets, government fines, alcohol related accident judgments, judgment for willful or malicious conduct resulting in serious physical injury or death.

Debtors are required to submit a copy of their recent tax transcripts to the Trustee prior to the meeting of creditors, 11. U.S.C. 341(a).  A copy of the tax transcripts can be obtained by the debtor by calling the IRS 1-800-829-1040 and the debtor can even authorize the transcripts be faxed directly to counsel.  The IRS attorney line for transcripts is 1-866-860-4259. 

In California, their are certain exemptions that can be taken under California Code of Civil Procedure Sections 703, 704.  Exemptions allow a person to keep certain assets after the bankruptcy.  You must select only one set of exemptions.  If spouses are filing jointly, they must select the same set of exemptions.

A qualified bankruptcy attorney will review your individual financial situation and determine whether you qualify for chapter 7 or need to file chapter 13 bankruptcy.   

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Generally, taxes are treated the same as other debts in a chapter 7 bankruptcy case.  Taxes may be treated as secured, unsecured, or non-priority unsecured, or some combination.  IRS Code, found in 26 U.S.C. 6321, states that the government is secured if it has recorded a notice of lien.  Taxes that have been recorded as a  lien are a priority and must be paid in bankruptcy and cannot be discharged.  

A colleague of mine,  John Greifendorf, addressed the question, Can I discharge Federal Income Tax in Bankruptcy?  His article is concise and outlines five conditions for discharging what the debtor owes to the IRS and even sets forth and example to follow. 

The Five Conditions are:

1. The due date for filing the tax return was not less than three years ago
2. The tax return was filed at least two years ago
3. The tax assessment is at least 240 days old
4. The tax return was not fraudulent
5. The tax payor is not guilty of tax evasion

If the debtor meets the qualifications, then the tax liability is not a priority and is discharged in bankruptcy; 11 U.S.C. 523(a)(1).  Unsecured taxes that are deemed a priority, fall outside the scope of the conditions discussed by Mr. Greifendorf and cannot be discharged in bankruptcy.

Timing is a critical component in deciding to file for bankruptcy protection and the advice of a bankruptcy attorney will address this issue.  Best practices include filing all tax returns prior to filing a bankruptcy petition with the court.  Seek the advice of a CPA or tax attorney regarding IRS claims. 

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