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Conditions for Stopping Support Collections in Chapter 13

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Chapter 13 immediately stops the collection of past-due child or spousal support. But to keep that protection you must meet some conditions.  


Last week we showed how Chapter 13 stops the collection of unpaid child and spousal support, while Chapter 7 doesn’t. But we ended by emphasizing that anyone can quickly lose this huge benefit of Chapter 13 “adjustment of debts”. Avoiding this requires strictly complying with some conditions. These conditions are arguably sensible ones. But you need to know and understand them so you don’t lose this crucial Chapter 13 benefit. Because these conditions are so important we focus today’s entire blog post on them.

Ongoing Child and Spousal Support

But before we get to these conditions we need to make a strong point. We’re talking here about child and/or spousal support that is unpaid, past-due, at the time of the bankruptcy filing. This past-due support is different from ongoing support. 

Ongoing support is the support you need to keep paying, usually on a monthly basis, after your bankruptcy lawyer files your bankruptcy case. Past-due support is any amount of support that you’re behind on as of that filing date.  Ongoing support is the support due after that filing date.

Filing bankruptcy does NOT stop the collection of any ongoing support, under either Chapter 7 or Chapter 13. The “automatic stay” that protects you from creditor collections does not apply. (See Section 362(b)(2)(B) of the U.S. Bankruptcy Code—where ongoing support is called “domestic support obligation.”) So, if you are paying support by direct payments, you need to keep paying those after filing bankruptcy.  If you are paying through a payroll deduction or by garnishment, those should continue. You can only change those forward-looking payments through the divorce court which ordered them.

Chapter 13 only stops the collection of past-due support—which, again, Chapter 7 does not. (Past-due support is also sometimes called support arrears or support arrearage.) So the conditions we discuss now are ones you need to meet to stop the collection of past-due support.

Inform Your Collector of Support

Your bankruptcy lawyer’s Chapter 13 filing will immediately stop the collection of past-due support.  This does assume that either you or your lawyer informs your ex-spouse or the support enforcement agency about your Chapter 13 filing. The automatic stay applies at the moment of filing, but the creditor needs to know about it to be able to comply. Coordinate this with your lawyer.

Most support enforcement agencies understand this special power of Chapter 13 and will comply immediately. Although sometimes it may take some lawyerly persuasion.

Ex-spouses are more likely under the misimpression that your Chapter 13 filing has no effect whatsoever on your support obligation. He or she probably has never heard about this special benefit of Chapter 13 for past-due support. If so, your lawyer will likely contact him or her, or his or her lawyer if there is one, to inform him or her about the law.  

The Conditions to Avoid Collection of Past-Due Support

Once the automatic stay stops collection of past-due support, you’ll lose this benefit if you don’t maintain the following conditions:

1) keep current on your ongoing support

2) show in your Chapter 13 payment plan how you will pay off all the support arrearage during the 3–to-5-year life of the plan

3) consistently make your Chapter 13 plan payments so that you are in fact making continued progress towards paying off the past-due support

4) finish your Chapter 13 case successfully, which includes paying off the entire past-due support

Let’s look at these one by one.

1) Keep Current on Ongoing Support

Assuming you continue to owe ongoing support, you absolutely must keep paying it as long as you are obligated to. Otherwise you’d be going financially backwards instead of forwards. You’d be called on it by the support enforcement agency or your ex-spouse. The very likely result would be that you’d lose the automatic stay protection against collection of the past-due support.

Plus you need to be very strict on the timing. You have to pay the monthly payments precisely by the due dates. Otherwise there’s a good chance that your ex-spouse/support enforcement will inform the bankruptcy court and ask permission to resume collection.

In particular be fully aware of the first support payment due after your Chapter 13 case filing date. For example, if your case is filed on January 25 and your monthly support payments are due on the first of every month, you need to make that first after-filing support payment by February 1. Talk with your bankruptcy lawyer about the timing of your Chapter 13 filing so that you have the funds to pay that first support payment.            

2) Payment Plan Includes Planned Pay-off

Bankruptcy law requires you to pay off all your past-due support during the 3–to-5-year life of the plan. Your Chapter 13 lawyer will make the necessary calculations to show how you will so so. Your monthly plan payments will be based on what you can afford to pay to all of your creditors. Incorporated into those monthly payments is money that will go to pay off the past -due support. You and your lawyer have to show that these plan payments are enough to accomplish this.

Otherwise your ex-spouse/support enforcement agency can object to the plan. He/she/it could also ask for permission to resume collections because the plan would not catch up on the past-due support.

3) Make ALL Chapter 13 Plan Payments 

Your Chapter 13 plan not only has to pencil out correctly, but you also must pay the plan payments timely. Otherwise you’re not doing what you agreed to do in the court-approved plan.  Paying the plan payments on time shows that you are actually making continued progress towards paying off the past-due support.

If you got late on the plan payments, your Chapter 13 trustee could ask that your case get thrown out. (The trustee is the person you pay your plan payments to, and who then pays your creditors.) Or any creditor—including your ex-spouse/support enforcement agency—could do the same. Or could just ask for permission to resume collection.

4) Finish Your Chapter 13 Case

So if you have a good payment plan, and you make all the payments, you’ll eventually complete it successfully. (Your plan very likely has some other requirements and this assumes you comply with them as well.) When you complete your plan, you will have paid off the entire past-due support. So it’s really important that you get all the way to the end of your Chapter 13 case successfully.

 

Unpaid Child and Spousal Support in Chapter 13

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Chapter 13 DOES stop the collection of unpaid child or spousal support from your after-filing income and other assets. Chapter 7 does NOT.    

Last week we discussed situations in which Chapter 7 would help if you’re behind on child or spousal support payments. We made clear that Chapter 7 “straight bankruptcy” provides only limited help. Mostly it gives you relief from your other debts so that you can concentrate on catching up on support.  Chapter 13 “adjustment of debts” is a much more powerful option when Chapter 7 is not enough.

The Main Benefits of Chapter 13 When Behind on Support

Chapter 13 takes much, much longer than Chapter 7, and is generally more expensive. But it provides some remarkable benefits compared to Chapter 7. These benefits can make the longer time and greater expense of Chapter 13 more than worthwhile. The main benefits of Chapter 13 are that:

1) Filing Chapter 13 immediately stops the collection of unpaid child or spousal support. Chapter 7 does not.

2) Chapter 13 gives you a relatively flexible and protected way to catch up on the support. With Chapter 7 you have to make your own payment arrangements, without any protection or much leverage.

Basically, have a serious conversation with your bankruptcy lawyer about Chapter 13 if you need these significant benefits.

How Does Chapter 13 Stop the Collection of Unpaid Support?

Chapter 7 is a very straightforward kind of bankruptcy. It focuses on a point in time: the moment your bankruptcy lawyer files your Chapter 7 case. Your case essentially imagines your financial life frozen in time at that moment, including your debts and assets, income and expenses, and such.

Chapter 13 also cares a lot about your financial life at the moment of filing. But it also takes a longer view—the next 3 to 5 years of your court-approved payment plan. In particular, Chapter 13 is designed to protect you during that period of time from your ongoing creditors.

Chapter 7 mostly just writes off (“discharges”) certain debts and does not discharge others. It leaves you on your own to deal with those debts you still owe, such as support.

In contrast, in Chapter 13 the protection from creditors—the “automatic stay”—can last the full 3-to-5 years.  Specifically regarding spousal and child support owed at the time of filing, the automatic stay protects your employment income earned after the filing. This means that as of your filing date your paycheck is protected from wage garnishment or other kinds of forced payment.

Why Doesn’t This Happen under Chapter 13 But Not 7?

Here’s the legal answer. (You can skip this section if you don’t need this level of detail.)

The pertinent federal bankruptcy statute states that the automatic stay does not stop the collection of support out of “property that is not property of the [bankruptcy] estate.” See Subsection 362(b)(2)(B) of the U.S. Bankruptcy Code.  This means that a bankruptcy filing does stop the collection from property that is “property of the bankruptcy estate.”

In a Chapter 7 case the bankruptcy estate is essentially everything you own at the moment of filing the case. See Subsection 541 of the Bankruptcy Code on “Property of the estate” generally. This does not include what you earn and assets you acquire after that moment. Since those after-filing earnings and assets are not “property of the estate,” they can be targeted for support collection.

Chapter 13 is different for a simple reason: “the estate” does include after-filing earnings and assets. Only under Chapter 13 the estate includes “earnings from services performed by the debtor after the commencement of the case.” See Subsection 1306(a)(2).

This means that the automatic stay legally prevents your ex-spouse or support enforcement agency from continuing or starting to collect on your unpaid child or spousal support you’re your after-filing earnings the moment your bankruptcy lawyer files your Chapter 13 case. This is true even though a Chapter 7 filing would have absolutely no such effect.

This Chapter 13 Protection Comes with Important Conditions

We said that the automatic stay can last the entire 3-to-5-year period of your Chapter 13 payment plan. But especially when it comes to unpaid support that protection comes with some conditions.

Why are there conditions? Imagine the example of a vehicle loan. You want to keep the vehicle and prevent your lender from repossessing it. The automatic stay can protect your vehicle under Chapter 13 during the entire length of the case. But you have to meet some reasonable conditions like making payments and keeping the vehicle insured. If you don’t, the creditor can get the court to exclude the debt from being covered by the automatic stay. It can get permission to repossess your vehicle after all.

It’s similar with child and spousal support debt. Here the conditions are very time sensitive and are often enforced very strictly. Being able to stop support collection is a huge benefit of Chapter 13. It may even be a major reason for choosing this more time-consuming option. You don’t want to lose this benefit because you didn’t clearly understand and comply with the conditions.

Because of how important these conditions are, we’ll dedicate all of next week’s blog post to them.

 

Unpaid Child and Spousal Support in Chapter 7

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Chapter 7 does not stop the collection of child or spousal support, nor provide any procedure to pay the support. It may still help enough.  


If you are behind on child or spousal support payments Chapter 7 may or may not be a good solution.

Chapter 7 “straight bankruptcy” is the most common type of consumer bankruptcy case.  It is more likely to be a sensible solution if 1) the support isn’t being collected aggressively and 2) you don’t owe terribly much. Why? Because:

1) Filing Chapter 7 does not stop collection of unpaid child or spousal support. Chapter 13 can.

2) Chapter 7 does not give you a procedure for catching up on the support. Chapter 13 “adjustment of debts” does so.

So why would you file a Chapter 7 bankruptcy if you were behind on support?

Filing Chapter 7 When Owing Support

Chapter 7 is usually the most straightforward type of bankruptcy. A case lasts only about 4 months from when your bankruptcy lawyer files it to when it’s completed. A Chapter 13 case involves a formal payment plan that almost always takes 3 to 5 years to finish.

As mentioned above Chapter 13 can stop the immediate collection of unpaid support, and give you time to catch up.

The much quicker Chapter 7 makes sense if you don’t need these kinds of help.

If you stopped paying the debts that Chapter 7 would discharge, could you quickly catch up on support? Would your ex-spouse be willing to accept monthly catch-up payments at an amount you could afford? Or if the debt is being collected by a support enforcement agency, would it accept such voluntary payments? Could you reliably make such payments, while presumably keeping current on the ongoing monthly support?

If you have a feasible way along these lines to catch up on your support obligation during and after your Chapter 7 case, then it may well be your best option.

Other Advantages and Disadvantages of Chapter 13

But you and your bankruptcy lawyer will discuss two other considerations revolving around your other debts.  Chapter 7 and Chapter 13 deal with debts quite differently.

The first consideration is about debts secured by your assets or other ones that you must pay. Secured debts include home mortgages, vehicle loans, and any others with a lien on anything you own. Debts you must pay—besides support—include recent income tax debts. Chapter 13 often handles these kinds of debts much better than Chapter 7. Without getting into the details here, Chapter 13 protects you while you pay such special debts as your budget allows. If you have such debts, how Chapter 13 helps with those may be reason enough to choose that option. Or this, along with the benefits it gives you with unpaid support, may swing you in that direction.

The second consideration is about the rest of your debts—those that are neither secured nor ones you must pay.  These are your “general unsecured” debts. Usually you can discharge (legally write off) all or most of such debts in either Chapter 7 or 13. In most Chapter 7 cases you pay nothing on your general unsecured debts. However, In a Chapter 13 case you often pay a portion of these debts. Whether and how much you pay on your general unsecured debts depend on lots of factors. The biggest factors are your income and expenses and the amount of your special debts (secured and otherwise) that you are paying in full. So you need to weigh the benefits of Chapter 13 regarding your unpaid support and other special debts against the likelihood that you would be paying something instead of nothing on your general unsecured debts.

What Happens to Your Unpaid Child/Spousal Support Debts in a No-Asset Chapter 7 Case?

A “no-asset” Chapter 7 case is one in which everything you own is covered by property exemptions. Exemptions usually allow you to keep certain dollar values of assets in various categories. Most Chapter 7 cases are “no assets” ones. If yours is, you’re able to keep everything (with the exception of collateral you decide to surrender).

In a no-asset Chapter 7 case your bankruptcy trustee does not get any of your assets to liquidate and pay to any of your creditors. (That’s why it’s called “no asset.”) Your bankruptcy lawyer will tell you if yours is expected to be.

Since the trustee doesn’t collect any money to pay your creditors anything, your support debts also receive nothing. So, a support debt gets no money directly from a no-asset Chapter 7 case. You have to deal with the support debt yourself (perhaps with the help of your lawyer), and be prepared to do so right away.

 

A Chapter 13 Plan to Pay Income Tax

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Here’s an example of a Chapter 13 payment plan to pay income tax, showing how you pay what you can afford and avoid some interest, penalties. 

 

Today we put the facts of last week’s blog post into a Chapter 13 plan, showing how it actually works. You’ll see how Chapter 13 saves you money and avoids stress as you pay off your priority income taxes.

The Example: The Tax, Interest, and Penalties

Assume you owe $10,000 to the IRS for income taxes from the 2016 tax year. That’s for the tax alone without the penalties and interest. Plus you owe interest of $1,200 (currently 5% annually), $2,000 for a failure-to-file penalty (which the IRS assesses  at 5% per month of being late), and $1,650 for a failure-to-pay penalty (calculated at 0.5% per month). So including the current interest of $1,200 and a total of $3,650 in penalties this $10,000 tax has turned into a total debt to the IRS of $14,850. And the interest and failure-to-pay penalty just keep on accruing.

As we showed two weeks ago, this relatively recent $10,000 income tax itself can’t be discharged (written off) in bankruptcy. You’d have to figure out a way to pay it after completing a Chapter 7 “straight bankruptcy” case. In a Chapter 13 case you pay that amount through your court-approved payment plan.

The Tax and Interest vs. the Penalties

In either a Chapter 7 or Chapter 13 case the $1,200 in accrued interest has to be paid in full as well. The interest continues accruing nonstop during and after a Chapter 7 case. The difference is that interest effectively stops accruing under Chapter 13. You don’t have to pay any interest beyond the case filing date as long as you successfully complete your case.

The situation is usually the same with any penalties that accrue beyond the bankruptcy case filing date. Under Chapter 7 the penalties continue to accrue, during the case and after it’s completed. Penalties keep getting added on until the tax is paid in full. But under Chapter 13 the penalties generally stop accruing. This is true as long as the IRS did not record a lien on this specific tax before you filed the Chapter 13 case.  (Prior-recorded tax liens create a number of complications that we don’t get into here.)

So, in a Chapter 7 case (or outside of bankruptcy altogether) you’d have to pay the full $14,850 of tax/interest/penalties. Plus the interest and penalties would continue to accrue until you finished paying off the entire debt. If you’d pay it off slowly in an extended monthly payment plan, the additional interest and penalties would be substantial. Conceivably you could end up paying around $20,000 for the $10,000 tax.

In contrast, in a Chapter 13 case you may only pay the $10,000 tax plus prior-accrued $1,200 of interest. Assuming no tax lien and a successfully completed 0% Chapter 13 case, you’d be paying about $11,200 instead of as much as $20,000. (In a 0% case there’s no money for the general unsecured debts.)

The Chapter 13 Plan

To keep this explanation as straightforward as possible, assume you owe this IRS tax debt and only other simple debts. That is, all your other debts are “general unsecured” ones. They are not secured—such as a vehicle loan, home mortgage, and a debt with any other collateral. They are not special, priority debts like unpaid child support or other recent tax debts. Chapter 13 is actually often very good at handling multiple secured and priority debts. In fact it’s often the very best tool if your situation is complicated with such other tough debts. But for the sake of this example we focus on how Chapter 13 handles this single income tax debt.

So assume you have a lot of medical bills, credit cards, and/or other general unsecured debts—say $90,000 total. Your prior accrued income tax penalties of $3,650 are also general unsecured debts, so now the total is $93,650. This plus the 2016 tax-plus-interest amount of $11,200 means you have just under $105,000 in debt. Here’s how a Chapter 13 plan with these debts could look like.

You and your bankruptcy lawyer would put together your monthly budget. Let’s say that after subtracting you and family’s reasonable living expenses from your monthly income, you’d have $385 per month left in “disposable income.” That would not even come close to paying monthly payments on your $105,000 or so of debt.

The Great Result Here

But this $385 amount would be enough—just enough—to pay off your IRS debt in full in just 3 years. $385 for 36 months is enough to pay off the $10,000 base tax, plus the $1,200 in already accrued interest. It would also pay a relatively modest amount of Chapter 13 trustee’s fees (generally a set percentage of whatever you pay into your payment plan) and your own attorney’s fees (whatever you didn’t pay before filing your case). The law usually allows (indeed requires) these “administrative costs” to get paid before the general unsecured debts receive anything.

So in this example $385 per month for 36 months would pay off the $11,200 priority portion of your tax debt. ($10,000 + $1,200.) But beyond that there would not be any money for the general unsecured debts. This means there would be nothing for the $3,850 in prior accrued tax penalties.

As a result all of your “disposable income” during the 3 years of the plan would go just to pay the tax and prior interest. (Plus the mandatory “administrative costs.”)  Then after the 36th month of payments, your Chapter 13 plan would be finished. At that point all of your general unsecured debts would be legally discharged. This includes the $3,850 in prior tax penalties. In addition, the IRS would then wipe off its books any penalties and interest that would have accrued since the date of your Chapter 13 filing.

After only paying the $10,000 tax plus $1,200 in prior interest, you’d owe the IRS nothing. You’d also be free and clear of all the rest of your debts. After paying only as much as your budget allowed for 3 years, you’d have a completely fresh financial start.

 

If I Have a Trust, Do I Need a Will?

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The process of setting up your estate plan may seem overwhelming. There are a lot of questions that come up. One of the most common questions we hear is, “If I have a trust, do I need a will?”

Many people believe that the two tools are interchangeable. Even if you have a trust, it is likely that you still need a will in your estate plan. Our estate planning attorney in Palm Springs can help you understand your best options.

If I Have a Trust, Do I Need a Will?

Trusts and wills are separate estate planning tools. Having one does not mean that the other is redundant or unnecessary. Both options have shortcomings that can be addressed by using the other.

A will can do several things that a trust cannot. For example, with a will:

  • Parents can name guardians for their minor children.
  • You can ensure that property not included in a trust is  distributed appropriately.

If I Have a Will, Do I Need a Trust?

Some individuals start their estate planning process by drafting a will. While a will is a valuable estate planning tool, many people find it beneficial to have both a will and a trust.

Assets included in a will must go through the probate process. Probate can take months or years. It delays asset distribution and requires the personal representative or executor to spend a lot of time managing the estate. Assets in a trust do not have to go through probate and may be immediately distributed.

When you create a trust, you can also plan for the possibility of becoming incapacitated. A will does not go into effect until the testator dies. If you become incapacitated, the trust’s named trustee can take over. This allows them to maintain your assets right away, rather than having to go through court.

Benefits of Working With a Palm Desert Estate Planning Attorney

Creating a thorough estate plan is complex. Unfortunately, errors made during the planning process often do not come to light until it is too late to fix them. We recommend that you work with an experienced estate planning lawyer.

Our estate planning attorney in Palm Springs can ensure that your documents are written (and filed) properly, reviewed on a regular basis, and updated to reflect legal and family changes.

Meet Your Goals With a Palm Desert Estate Planning Attorney

Attorney Robert L. Firth understands how important it is to have a solid estate plan. He works with clients from all walks of life to help them create plans that protect their assets and family. Having drafted over 2,500 estate plans, he rarely sees something he hasn’t dealt with before. Take the first step now and call Law Offices of Robert L. Firth at (760) 202-5939 to set up an appointment.

Additional Reading:

Paying Income Taxes through Chapter 13

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Chapter 13’s advantages in paying off your priority income taxes become clearer when you see what you don’t have to pay.

 

Last week we got into the advantages of paying priority income taxes through a Chapter 13 “adjustment of debts” case. Those are the usually-recent income taxes which cannot be written off (“discharged”) in bankruptcy. Today we show more clearly how Chapter 13 can be tremendously helpful with income taxes.

The Example: The Tax Breakdown

This example expands on one we introduced last week. Assume that you owe $10,000 to the IRS for income taxes from the 2016 tax year.

In addition there’s a failure-to-file penalty of $2,000 for filing 4 months late without getting an extension. The IRS assesses that penalty  at 5% per month of being late. So here, 4 months at $500 per month = $2,000.

Plus there’s a failure-to-pay penalty of $1,650. That’s calculated at 0.05% each calendar month or partial month that the tax remains unpaid. So here, 33 months or partial months from the April 2017 payment due date to December 2019, at $50 per month = $1,650. (Note that this penalty is reduced to 0.025% per month if you’re in an IRS payment plan.)

You also owe interest on the unpaid tax. It’s more complicated to calculate because the rate changes. It’s been at 5% per year since April 1, 2018 and 4% for two years before that. Plus it compounds daily. To keep it simple, assume for this example that $1,200 of interest has accrued on the $10,000 tax owed.

So combining these, assume you owe $10,000 in 2016 income tax, plus $3,650 in penalties ($2,000 + $1,650), plus $1,200 in interest, a total of $14,850 owed to the IRS for this tax year.

The Tax and Interest vs. the Penalties

1. Accrued interest. If an income tax does not qualify for discharge (under the rules discussed last week), neither does the interest. So during a Chapter 13 case you’d have to pay the tax and the interest (accrued up to the date of bankruptcy) in full. In our example that’s the $10,000 in straight tax plus the $1,650 of interest, or $11,650.

2. Accrued penalties. But the accrued penalties are quite different. These are usually not treated as priority debt but rather as general unsecured debt. (This assumes there’s no recorded tax lien on the tax, which could make the debt partly or fully secured.) In a Chapter 13 case you pay general unsecured debt only to the extent you can afford to do so. This is AFTER paying all priority and appropriate secured debts. Often you don’t have to pay general unsecured debts, including tax penalties, much. It’s not uncommon that you pay nothing.

In our example the $3,650 in penalties is general unsecured debt. So during the course of your 3-to-5-year case you pay this portion only as much as you can afford. You may pay nothing.

3. Ongoing interest and penalties. Usually you don’t pay any ongoing interest or penalties on the tax during the Chapter 13 case. The IRS continues to track it. But as long as you finish the case successfully you will not have to pay any of it. This lack of ongoing interest for 3 to 5 years saves you a lot of money. It also often enables you to end your case more quickly.

Filing the Chapter 13 Case

Now assume you filed a bankruptcy case on December 10, 2019. You were in a hurry to file because the IRS was threatening to garnish your paycheck. The 2016 income tax is not discharged in bankruptcy because it’s  less than 3 years from the tax return filing deadline of April 15, 2017 and the December 10, 2019 filing date.

If you filed a Chapter 7 “straight bankruptcy” that would have provided only limited help. It would have stopped the IRS’s garnishment threat for 3 or 4 months while the Chapter 7 case was active. Then if discharging your other debts would free up enough cash flow so that you could reliably get on an installment payment plan with the IRS to pay off the $14,850 reasonably quickly, then Chapter 7 might make sense.

But that’s a big “if” which doesn’t happen often in the real world.  And even if this scenario were possible, you’d likely pay much more than under Chapter 13. After a Chapter 7 case, you’d have to pay the $3,650 in accrued penalties in full (instead of only in part or not at all under Chapter 13). Interest, and the failure-to-pay penalty, would continue accruing non-stop, until paid off. This adds to the amount you eventually have to pay. Each time you’d make a payment, part would go to that month’s new interest and penalties. So you have to keep paying longer.

Chapter 13 Instead

We’ve explained why his situation should play out much better under Chapter 13. But we’ll show how it actually works over the course of a payment plan in our blog post next week.

 

Priority Income Tax Debts under Chapter 13

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Chapter 13 gives you huge advantages for paying off your priority income tax debts. You’re protected while you pay what you can afford.


Last week we discussed the advantages of paying priority debts through a Chapter 13 “adjustment of debts” case. We referred to recent income taxes as one of the most important kinds of priority debt. Today we show how Chapter 13 can greatly help you take care of recent income tax debts.

Recent Income Taxes Can’t Be Discharged

The law treats some, usually more recent, income tax debts very differently than other, usually older, income tax debts. Generally, new income taxes are “priority” debts and can’t be discharged (written off) in bankruptcy.

There are two conditions determining whether a tax debt can be discharged. (There are a few other conditions but they are not very common so we don’t address them here.) Bankruptcy does NOT discharge an income tax debt:

1. if the tax return for that tax debt was legally due less than 3 years before you file your bankruptcy case (after adding the time for any tax return-filing extensions) U.S. Bankruptcy Code Section 507(a)(8)(A)(i).

OR

2. if you actually submitted the tax return to the IRS/state less than 2 years before you file the bankruptcy case. Bankruptcy Code Section 523(a)(1)(B)(ii).

Two Examples

Assume you filed a bankruptcy case on December 10, 2019. You owe income taxes for the 2017 tax year. The tax return for that tax was due on April 17, 2018 (because of a weekend and holiday). (This assumes no tax return filing extension.) That’s much less than 3 years before the December 1, 2019 bankruptcy filing date. So, no discharge of the 2017 tax debt, because of the first 3-year condition above.

As for the second condition above, assume again that you filed your bankruptcy case on December 10, 2019.  This time change the facts so that you submitted the tax return late for the 2015 taxes, on October 1, 2018. That’s less than two years before the December 10, 2019 bankruptcy filing date. So because of the second condition above, taxes due for 2015 would not get discharged in bankruptcy

Meeting either of the two conditions makes the tax debt not dischargeable. In the second example immediately above, more than 3 years had passed since the deadline to submit the tax return. (The 2015 tax return was due on or about April 15, 2016.) But less than two years had passed since the actual submission of the tax return. So, no discharge of the tax debt.

With no discharge, you would have to pay that income tax debt after finishing a Chapter 7 case. But there are advantages of paying this priority debt in a Chapter 13 case.

Advantages of Paying Priority Income Tax Debts in Chapter 13

Under Chapter 13:

  1. You are protected from aggressive collection by the IRS/state not for 3-4 months as in Chapter 7 but rather 3-5 years.
  2. This includes preventing any new recorded tax liens, and getting out of any installment payment plans.
  3. The amount you pay monthly to all your creditors, including the priority tax, is based on your actual budget. It’s not based on the often unreasonable requirements of the IRS/state.
  4. The amount your priority tax gets paid each month (if any) among your other debts is flexible. You do have to pay all of the priority tax debt(s) by the time you finish your Chapter 13 case. That’s up to a maximum 5 years. But other more urgent debts (such as catching up on a home mortgage) can often get paid ahead of the taxes.
  5. Usually you don’t pay any ongoing interest or penalties on the tax during the Chapter 13 case. That takes away the need to pay it quickly. Plus the lack of additional interest and penalties significantly reduces the amount needed to pay off the tax debt.
  6. If the IRS/state recorded a tax lien against your home or other assets before you filed bankruptcy, Chapter 13 provides a very efficient and favorable forum to value and pay off that secured portion of the priority debt.

 

Priority Debts in a Chapter 13 Case

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Chapter 13 gives you some huge advantages over Chapter 7 for paying your priority debts. You’re protected while you pay what you can afford.


Priority Debts under No-Asset and Asset Chapter 7

Our last two blog posts described how Chapter 7 can sometimes be a sensible way of dealing with priority debts. (Those are ones you can’t “discharge”—legally write off, the most common being recent income taxes and child/spousal support.) Our blog post two weeks ago: a no-asset Chapter 7 case discharges all or most of your other debts. So then afterwards you can better afford to pay your priority ones. Last week: in an asset Chapter 7 case your bankruptcy trustee collects your unprotected asset(s). He or she then pays part or all of your priority debt out of the proceeds from selling those asset(s).

But Chapter 7 is not well-designed to deal with priority debts in many situations. Here are the main problems:

  • You get only brief protection, or none at all, from your priority creditor(s). With income taxes, the IRS/state can resume collections when your Chapter 7 case is over. That’s only 3-4 months after you and your bankruptcy lawyer file the case. With child/spousal support, there is no protection at all: collection continues even during your Chapter 7 case.
  • Because of this lack of legal protection, you have little or no leverage about the dollar amount of payments you pay on your priority debts. You are largely at the mercy of the IRS/state or the support enforcement agencies.
  • In an asset Chapter 7 case, you have no control over the trustee’s sale of your asset(s). Plus you have to pay a significant amount for the trustee’s costs and fee. That reduces what goes to your priority debt(s).

The Benefits of Chapter 13

In contrast, Chapter 13 is well-designed for you to deal favorably with your priority debts. Here are its main benefits and advantages.

1. Ongoing Protection, for Years

The protection from creditors called the automatic stay lasts not 3-4 months but rather 3-to-5 years in Chapter 13. You can lose this protection under Chapter 13, if you don’t follow the requirements. But usually this sustained protection is a very powerful tool. It gives you tremendous peace of mind. It forces otherwise very aggressive creditors like the IRS/state and support enforcement to cooperate. It gives you an incredible and practical second chance to do what you need to do. Instead of these tough creditors having the law and the leverage on their side, Chapter 13 puts you much more in charge.

2. Pay Monthly What You Can Afford to Pay

The practical leverage Chapter 13 gives you helps where it counts. It enables you to pay your priority debts under sensible and manageable payment terms. Priority debts are ones you have to pay regardless of bankruptcy. You mostly just wish that there was a way to do so that was doable. Chapter 13 fulfills that wish.

Here’s how it works You and your bankruptcy lawyer propose, and the bankruptcy judge approves a payment plan. (This approval comes after possible input from the Chapter 13 trustee and your creditors.) This payment plan is mostly based on how much you can actually afford to pay the pool of your creditors. You have to pay all your priority debts in full, but you have 3 to 5 years to do so.

You generally pay nothing on your other unsecured debts until you pay your priority debts in full. Sometimes you don’t pay anything on those “general unsecured” debts. At the end of your case whatever you haven’t paid is forever discharged. At that point you will have paid off your priority debts in full, and usually owe nothing to anybody.

3. Avoid Interest and Penalties

You can often avoid paying any interest or penalties on your priority debt(s) under Chapter 13.

For example, with recent income taxes, interest and penalties continue to accrue after you file your case.  But as long as there no prior-recorded tax lien, and you successfully finish your case, you don’t pay these additional interest and penalties. You only pay the initial priority tax debt.

Furthermore, in most situations the penalties that accrued before your Chapter 13 filing are not a priority debt. This portion of your tax due at the time of filing is treated as “general unsecured.” This means it’s treated just like your unsecured credit cards or medical bills. You only pay it to the extent you have money available after paying the priority debts, if at all.

This combination—no accruing interest and penalties, and no penalties treated as priority—can significantly reduce how much you must pay. The less you have to pay as priority means the less you pay in your Chapter 13 payment plan. The less you have to pay usually means you finish your plan quicker. It’s more likely to last closer to 3 years rather than 5 years. And if you have to pay less there’d be less pressure to pay more per month to get it done on time.

4. Pay Priority (and Secured) Debts Ahead of (and Instead of) Other Debts

If you have secured debts you have to pay—a vehicle loan or home mortgage arrearage, for example—you often can pay these ahead of the priority debts. Your priority debts generally just have to wait, as long as you are appropriately following the payment plan.

This flexibility, and being able to essentially force priority creditors to be this flexible, can be extremely beneficial to you. You not only get to pay your important priority debts ahead of your other unsecured debts. You often get to favor debts that are very important to you—for example, to save your home and/or vehicle—ahead of the priority debts. You do have to pay the priority debts in fully before you can finish your Chapter 13 case. But often you are allowed to fit those payments in only after paying your crucial secured debts.

 

Priority Debts in an Asset Chapter 7 Case

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Your Chapter 7 trustee may pay your priority debts—in full or in part—through the proceeds of the sale of your unprotected, not exempt assets.  


Our last blog post was about what happens to priority debts in a no-asset Chapter 7 case. Most consumer “straight bankruptcy” Chapter 7 cases are no-asset ones. This means that the bankruptcy trustee does not take anything from the debtor because everything is protected, “exempt.” The trustee does not take and liquidate any assets, and has nothing—no assets—to distribute to the debtor’s creditors. That’s a no-asset Chapter 7 case.

No-Asset Case Even If Some Assets May Not Be Exempt

To understand how this actually works, sometimes a Chapter 7 case is a no-asset one even when not all assets are exempt. That’s because the bankruptcy trustee has some discretion about whether to collect and liquidate an otherwise unprotected asset. Here are three reasons why he or she may not pursue an asset:

  • The value of the asset, or the amount beyond the exemption, is too small to justify the trustee’s collection efforts. Example: A vehicle worth only a couple hundred dollars more than the vehicle exemption.
  • Finding and/or selling the asset may be too expensive compared to its anticipated value. Example: A debt owed to the debtor by somebody who can’t be located and likely has no reliable income.
  • The asset could be more of a detriment than a benefit to the trustee. Example: real estate with hazardous waste contamination.

Usually your bankruptcy lawyer will be able to reliably predict whether your Chapter 7 case will be an asset or no-asset case. But not always. The trustees have wide discretion about this. Plus before filing your lawyer doesn’t know which trustee will be assigned to your case. So you can’t always know whether a trustee will pursue an asset or not.

Paying Priority Debt through a Chapter 7 Asset Case

If you know that you will have an asset case, you can pay a priory debt through your case.

In our last blog post our main point was that in a no-asset Chapter 7 case you have to pay any priority debts yourself directly to your creditors after completing the case. But in an asset case, the trustee would pay any of your priority debts before any other debts. The trustee collects and liquidates your assets (any not protected by exemptions). From the proceeds he or she then pays your debts, only to the extent there’s money available.

So in the right case you can pay all or part of your priority debt(s) in this way. Often, there only enough money to pay towards the priority debt(s), along with the trustee’s fee. If so, then there’s no money to pay anything to your other, general unsecured debts. This way, the trustee would pay those (priority) debts that you’d have to pay anyway, and nothing to those (general unsecured debts) that bankruptcy would discharge and you’d not have to pay.

For Example

Assume you owe $4,000 to the IRS for last year’s income tax. You also owe $75,000 in medical bills and unsecured credit cards. If you filed a Chapter 7 case in which everything you owned was protected, that would be a no-asset case. The IRS debt is a priority debt that you can’t discharge (legally write off). So you would have to make arrangements to pay it after your Chapter 7 case was over. Most likely the case would discharge the $75,000 in other debts.

But now assume that you have a boat that you no longer want because it costs too much to maintain.  There’s usually no exemption for a boat. So the Chapter 7 trustee takes and sells your boat. Let’s say the boat sells for $5,000. The proceeds of that sale would go to pay your tax debt before your other creditors would receive anything.

Usually a Chapter 7 trustee receives a fee of 25% on the first $5,000 of assets liquidated and distributed. U.S. Bankruptcy Code Section 326(a). That’s $1,250 on the $5,000 boat sale proceeds, leaving $3,750 left over. All of that would go towards the $4,000 IRS debt, leaving a $250 balance owed. The trustee would have no money left over to pay towards your $75,000 in other debts. You would not have to pay any of that yourself because your Chapter 7 case would very likely discharge it. You would only have to pay the not-discharged remaining balance of $250 on the tax debt.

Conclusion

In some circumstances paying a priority debt in a Chapter 7 case is not a bad deal. This is especially true if you have an asset not protected by an exemption that you don’t mind surrendering. Usually you would be personally on the hook to pay a priority debt after your Chapter 7 is finished. So if you surrender a non-exempt asset to the trustee and most of its proceeds go to pay towards your priority debt, that’s a good result.

These situations don’t necessarily fall together as neatly as in the above example. But this option is worth looking at with your bankruptcy lawyer whenever you have a the combination of a non-exempt asset and priority debt(s).

 

Top 5 Questions About California Probate

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You may have heard of probate, but what actually is it? Each state has their own probate laws, so it is important to be familiar with California probate requirements. Below, our estate planning attorney in Palm Springs discusses probate in California.

What Is Probate?

Probate is a legal process in which the court validates an individual’s will, ensures that debts are paid from the estate, and distributes assets to heirs and beneficiaries. California probate courts oversee this process. During probate, the court ensures that the proper heirs and beneficiaries receive assets. The court also uses the estate to pay remaining debts or tax liabilities.

When Is Probate Required in California?

Probate is required if someone passes away with a will or without any estate planning documents. If there are any assets that are not held in joint tenancy or that are not part of a living trust, the estate goes through the California probate process.

Can I Avoid Probate in California?

Many individuals choose to create a living trust. A living trust permits assets to be distributed without going through probate.

Other assets that do not go through probate include those with joint tenants, assets considered as survivorship community property, and those with a payable-on-death beneficiary. With the help of our estate planning attorney in Palm Springs, you can help your loved ones avoid the probate process.

What Happens in Probate Without a Will?

If there is no will, an individual’s estate follows the laws of intestate succession. The decedent’s closest living relatives get the property.

If an individual had children and no spouse, all property goes to the children. If the individual had a spouse and no children, the spouse inherits everything. A decedent with children and a spouse will have their property split proportionally.

Moving down the list, the court will look for parents, siblings, grandchildren, and nieces and nephews.

Do I Need An Attorney for the California Probate Process?

Working with a Cathedral City estate planning attorney during the probate process can save you time and stress. It can also help protect the executor. There are many benefits to hiring a probate attorney, including:

  • Finish the California probate process more quickly
  • Limit the executor’s personal liability during estate administration
  • Prevent potential disputes

Trying to go through probate on your own can lead to significant complications, unnecessary expenses and delays, and disputes between family members.

Working with the right probate attorney is important. You should do plenty of research before choosing an attorney. Look at their testimonials to find out how they have handled probate cases before. You can also read attorney profiles to see what experience they have in this area of law.

Let Us Help You Navigate California Probate Laws

Probate can put enormous stress on family members, particularly if the executor has not gone through the probate process before. At the Law Offices of Robert L. Firth, we can help your family get through this difficult time with minimal stress and delays. Contact us at (760) 202-5939 to explore your options.

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Attorney Robert Firth works with clients throughout the Coachella Valley and all courts throughout Riverside & San Bernardino Counties. We regularly work with clients in Palm Springs, Palm Desert, Indio, La Quinta, Rancho Mirage, Indian Wells, Desert Hot Springs, Yucca Valley, El Centro and Imperial County.

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