ALERT: Being over the median income is not an automatic bar to filing bankruptcy
I’m so used to railing against deliberate campaigns of misinformation about bankruptcy that I forget that there’s a lot of innocent ignorance out there.
Start with “qualifying” for bankruptcy.
A very earnest and ethical financial counselor was telling me about a client of hers trying to find the right moment in time to file bankruptcy.
She was targeting the point in time after the job loss, but before the new business got established. After the severance pay ran out and before the child left for college.
Yet the story involved a home with a mortgage and tax debts.
I couldn’t get my head around why, on those facts, the means test was a bar to filing a Chapter 7.
Til something she said tipped me off. She thought the means test barred families with incomes over the median from Chapter 7.
Wrong, wrong, WRONG.
Only half must take the means test
Median income only determines whether you have to take the means test to qualify for Chapter 7.
Families with income below the median income in their state automatically are allowed to file.
Families with income above the median have to take the test. Pass the test, and you are free to file Chapter 7.
In almost 10 years of dealing with the means test, I’d guess less than a dozen of my clients have been kept from filing Chapter 7 by the means test. Median income by state.
The means test is ugly, obscure, time consuming, and still subject to a lot of uncertainty. But if it was designed to keep people out of bankruptcy, it hasn’t worked very well.
What’s on the means test
In broad strokes, the means test looks at your average monthly household income and deducts from it
some kinds of expenses at the rates provided by the IRS collection standards
some kinds of expenses in amounts that you actually expect to spend
the secured debt payments and non dischargeable taxes you will owe in the next 5 years
While some parts of the formula are rigid and disconnected from the reality of day-to-day living, it presents many ways to qualify a family to file bankruptcy.
The cruelest part of the means test is it seems to favor people with big mortgages, car loans, unpaid child support and back taxes. Those debts are all deductible on the means test.
It’s the folks with upper middle class incomes who pay their taxes, rent, and drive paid-for cars that are disadvantaged by the means test.
So where ever the misconception that the means test just looks at gross family income got started, I want it stopped, you hear<g>.
If you’re above median
Being over the median income is not an automatic bar to filing bankruptcy.
It just means you need sophisticated bankruptcy counsel and some additional work to crunch the numbers so that you have a choice about your choice of bankruptcy chapter.
Remember that the supposed purpose of the means test was to funnel consumers into Chapter 13. And most of the Chapter 13 cases we file pay little or nothing to unsecured creditors. The money paid into the plan goes to creditors my clients want to pay, like delinquent mortgages, car loans, and recent taxes.
The borrower, a single woman of many decades, took out the reverse mortgage and drew down on the loan.
She has passed away, leaving the house to my client.
The house may have as much as $300,000 in equity over and above the reverse mortgage.
But because the borrower has passed away, the lender won’t take payments from anyone else. The loan is due and full, says the lien holder, and that’s that.
The climate for a refinance of the property in the hands of my client isn’t auspicious, so the house, and all that equity, may go, not to the relative of choice, but to the “friendly”, reverse mortgage lender.
A bankruptcy filing may solve this particular problem. We’ll see.
Bankruptcy is an option only because the heir to the house is an individual. Individuals can file bankruptcy. Trusts and estates cannot.
If the elderly borrower had left the house to her estate, the automatic stay that comes with a bankruptcy filing, would not be available to the probate estate. The probate estate isn’t eligible for bankruptcy relief.
In the bigger picture, the pressure to tap home equity to support retirement is the predicable result of regarding your home as your piggybank or your retirement nest egg.
The only way to take advantage of that nest egg is to either sell the house or to borrow against it. By retirement age, most homeowners aren’t great candidates for a conventional loan contemplating monthly payments.
And as we’ve seen in the Great Recession, you can’t count on a robust real estate market when you need that equity for retirement.
So, the gap in the retirement safety net is created, and in steps Fred Thompson and the company he shills for.
As the sergeant on Hill Street Blues said every shift: Hey, let’s be careful out there.
You can look a long time in the Bankruptcy Code without finding Chapter 20.
Chapter 7 is there; so are Chapters 11 and 13. But no 20.
But you find it in bankruptcy courtrooms and in the arsenal of good bankruptcy lawyers.
So, what’s up?
Chapter 20 is really bankruptcy slang. It’s a Chapter 7 case followed by a Chapter 13. Together the two chapters, 7 plus 13, make a “Chapter 20” case.
Why would you need two bankruptcy cases? Let’s explore.
Chapter 20 beats the debt limits
All of the powerful provisions and flexibility of Chapter 13 are only available to individuals whose debts are under the Chapter 13 debt caps.
Go over the limit for either the unsecured or secured debt cap and you aren’t eligible.
Enter Chapter 7. There are no debt limits in Chapter 7. You can owe as much or as little as may be and still be entitled to file Chapter 7.
The Chapter 7 discharge can be expected to wipe out your personal liability for most unsecured debts and allowing you to fit into Chapter 13.
The power of Chapter 13
The things Chapter 13 can do that Chapter 7 can’t so is long and enticing.
Getting time to get current on mortgages
Paying off taxes that didn’t go away in Chapter 7
Stripping liens down to the value of the collateral
Providing a forum for a lawsuit against your lender
Reducing the interest rate on usurious car loans
Any one of those things might be necessary to get a genuine fresh start.
No discharge in Chapter 20
Since bankruptcy “reform” in 2005, someone who files a Chapter 13 right after their Chapter 7 doesn’t get a discharge in the Chapter 13 case.
Four years must pass between the filing of a Chapter 7 and the filing of a Chapter 13 for a discharge to be available in the Chapter 13.
So what you get in the no-discharge 13 is the opportunity to strip liens; satisfy secured claims; and get current where you want to. Debts where your personal liability wasn’t discharged in the Chapter 7 that don’t get paid in full in the following 13 will live past the end of the second case.
A powerful consensus is building in the courts that debtors can strip off underwater mortgages on their homes even in bankruptcies where they don’t get a discharge. But in Chapter 20, you’ve already gotten a discharge of your personal liability on the debt, so it’s not a big deal.
Chapter 20 becomes appealing when the debtor’s prospects are improving. When real estate is rising or a positive change in your earning power is in the offing, having that increased prosperity exposed in the first instance to a Chapter 13 trustee is scary.
The law is clear that a Chapter 13 debtor’s earnings during the Chapter 13 may trigger a motion to increase plan payments after confirmation. It’s less clear what the impact of increased property values, property sales, or inheritances are on the rights of creditors in Chapter 13.
So, if better times are likely ahead, a Chapter 20 works to par down the list of creditors who have unsatisfied claims in the Chapter 13. The Chapter 7 discharge has wiped out most of those creditors and the remaining creditors are ones you want/need to pay anyway.
Even in a world where people attempt almost any skilled task with the help of Google, YouTube, or Legal Zoom, people continue to ask: is this contract legal?
They aren’t asking (usually) whether the subject matter of the contract is permitted by law.
They really want to know: will what I’ve written be enforceable.
What makes it a contract
There are no magic words or phrases that make a contract enforceable by a court.
Enforceability is not acquired by adding “whereas” or “notwithstanding“.
A contract need only establish that one party made a promise to the other for consideration. Consideration is legalese for money. Or something else of value.
If I promise to join you for dinner next Friday, we have not created an enforceable contract, because there was no valuable consideration exchanged. My promise was gratuitious. You didn’t offer me anything but your good company over a meal.
If , on the other hand, I promise to speak at the event you’re planning, for which you’ll pay my fee, then we have an enforceable contract. I will appear and speak, and you will pay.
If either of us fails to do what we’ve promised, a court will attempt to give the injured party the benefit of the bargain.
So here are four tips on drafting a contract that does the job.
1. Write the complete expression of the deal
The biggest failing of DIY contracts is incompleteness. They don’t describe fully the performance that is promised. They miss one of the essential terms:
If you hope that a judge will enforce a contract, it has to be written such that an absolute stranger to the deal, the judge, can read the contract and know what was agreed.
Too many self-drafted contracts don’t contain enough for a stranger to understand the deal.
Now, contracts with missing terms or ambiguities can be enforced. The contract is still “legal”. It’s just that there is a great risk that the missing terms as the judge fills them in don’t match the intent of the parties.
Enforcement of a fragmentary contract is far more expensive than had the contract been complete.
Enforcement of the unwritten terms becomes victim to what each party remembers but didn’t write down.
2. Flush out & write down assumptions
Often, the contracting parties each come to the table with a collection of assumptions about the arrangement. And each party assumes that the other party shares their assumptions.
Only, until you articulate your assumptions, you can’t test whether you are both, really, on the same track.
The unwritten assumptions form part of the deal. A good contract lays the assumption out on paper. If they aren’t shared when you sit down to write the contract, discussion or negotiation ensues.
The exercise of writing it out becomes as important as the writing itself.
3. Explore the “what ifs”
Well crafted contracts provide for the rights of the parties if things don’t go just as hoped when the contract was formed.
one party gets sick and performance is delayed
the materials aren’t available on schedule
the product doesn’t perform as anticipated
My rule of thumb is that the more money that is involved, or the more critical the contract is to your business, the more what ifs the contract should address.
If the consideration is $1000, it’s not worth extended negotiating or drafting to deal with remote possibilities. If it’s a $100,000, it’s worth more to lay out the details.
4. Provide for attorney’s fees
If you expect to enforce the contract in court if it’s breached, then your contract should provide that the injured party can collect its attorneys fees from the other in addition to any other damages.
Because the American Rule about attorneys fees says that each party pays their own attorney, win or lose. That is, unless the contract, or a statute, says differently.
Without a provision that grants the prevailing party the attorneys fees necessary to enforce the contract, it may simply be too expensive to go to court. Or, the cost of representation may consume the damage award.
With these principles in mind, you can draft a contract that is certain and enforceable. Strive for clarity and completeness.
And if this seem too daunting, take your draft to an attorney and pay only for review and repair of your document.
Because, at the end of the day, a contract only works if you can enforce it.
The money advice columnist gave the right answer to the wrong question.
She got it backwards. So did the man with the question.
She advised that bankruptcy was more damaging given that the nagging debts were already three years old and would drop off his credit report in four years, whereas bankruptcy would show for seven to ten years from the bankruptcy filing.
Right, assuming that your credit history is the important issue.
But your credit record is a sideshow in life.
Dealing with old debt
I would challenge the question the way the guy phrased the question in the first place.
When you look at the alternatives to debts you can’t pay, I think the first concern should be for your balance sheet.
Which of the alternatives makes you better off NOW, not when you want to incur more debt in the future.
For the man writing in about settling a $13,000 debt for $5,000, I would have a series of questions that didn’t center on his ability to get new credit.
How old are you?
Do you support others?
Do you have any emergency savings?
How are you doing on retirement savings?
Got health insurance?
If he is young, single, and employed with a bit of money in the bank, perhaps paying $5,000 to make eliminate a $13,000 debt is a good deal.
If he’s middle aged, supporting children or aged parents, and living paycheck to paycheck, I would be inclined to suggest there are better uses for $5000. At the most basic level, put it in an IRA, and your creditors can’t take it.
If he’s approaching retirement and looking at a future of reduced income and with little need for future credit, chances are that there are crying needs for that $5000 other than dealing with an old debt.
It’s not about the credit score
As you can see, settling versus a bankruptcy discharge is not just a matter of which impacts your credit record more negatively.
The decision needs to take in your ability to spend money on old debts when faced with current and future demands on your assets.
It’s all backwards to think that protecting your credit record is the central issue..
Days before the end of the tax year, the massive tax bill changed the rules retroactively. And for once, the change benefited individual taxpayers.
The tax bill revived, for tax year 2017, the exclusion from income accorded to phantom income upon foreclosure, short sale, or loan modification.
The provision that created an exception protecting struggling homeowners from a tax hit for debt canceled upon foreclosure of their principal residence. It expired with tax year 2016.
So, for instance, if you got a loan modification in 2017 that reduced the principal on your home loan, that reduction was once again going to be treated as income, and subject to tax.
But Congress restored for one more year the qualified principal residence indebtedness exclusion. (That’s a mouthful).
The details are beyond me. NCLC reported the change here. Kenneth Harney of the WashingtonPost talked about the exclusion in the middle of his look at real estate and tax issues.
A Google search for the IRS publication on cancellation of debt tax issues seems to be wrong, now that the tax bill is law. It treats canceled mortgage debt as if the exclusion wasn’t available in 2017.
The latest IRS scam is happening in bankruptcy, out in the open.
Now usually when I write about IRS scams, I’m talking about genuine bad guys either pretending to be the IRS to hijack your money or pretending to the IRS to be you, to hijack your money.
But nobody is pretending in the trick I first saw last week. The IRS is simply trying to collect the Affordable Care Act penalty twice.
What the IRS did
My client filed Chapter 13, owing income taxes. The most recent of those taxes must be paid in full to get a Chapter 13 discharge. So, the amount that must be paid is critical to the success of the plan.
The IRS filed a proof of claim for the unpaid income taxes.
But then, weeks later, the IRS amended their claim to add an “excise tax” , for the penalty under the Affordable Care Act, for not having health insurance.
The IRS conveniently “overlooked” the fact that the filed tax return already included the penalty on line 61 of the 1040.
So, they wanted to get paid twice by putting a benign label, “excise tax”, on the form, and hoping that you didn’t dig deeper.
No right to double payment
The tax law for the years in question, 2015 and 2016, imposed a penalty for not having insurance, to be collected by the IRS.
The IRS form includes a line where you add the penalty to your taxes if you didn’t have appropriate insurance. So when my client filed his return, he’d already added the penalty to what he owed.
And the IRS dutifully used his return to claim payment for the unpaid amount.
But it’s not OK to double dip and add a duplicate penalty with another name.
When I challenged the IRS agent who filed the claim, his response suggests that he’d not looked at the client’s tax return; he’d just added the penalty to the claim by rote.
Conversations with fellow bankruptcy specialist William Brownstein suggests the IRS confusion runs more broadly on this issue. He reports the IRS assessing non-bankrupt tax payers with penalties for not including form 1095-B with their returns, even though the form itself says “don’t file with your return”.
So, the first step is to eliminate the duplicate claim.
But there’s more.
Is the ACA penalty entitled to priority payment
Recent taxes are given a priority for payment under the Bankruptcy Code. If the ACA penalty is a “tax” within the meaning of the Bankruptcy Code, it must be paid in full in Chapter 13.
But, is this exaction a tax?
A Louisiana bankruptcy court recently said no in a case called Chesteen. It’s not a tax, it’s a penalty. And as a penalty, it isn’t entitled to payment in full, and as a penalty, it is dischargeable at the completion of the plan. Great work by NACBA member Rachel Thyre Anderson, who reports that the decision has been appealed.
Where do we stand on ACA penalty
While the issue of whether the penalty is a tax or not may not yet be settled by the Chesteen decision, it is clear that the IRS, at best, only gets to collect the penalty once.
If the penalty is properly included on the tax return as filed, then any additional “excise tax” that claims priority status should be challenged.
But both escape routes for delinquent taxes start counting from the filing of your tax return. (More precisely, the statute of limitations starts from assessment, but filing the return is a self assessment).
Last year’s figures drive this year’s withholding
The most important reason to prepare last year’s tax return now is to get your withholding right for the current year.
Extensions to file are seductive, but dangerous. It delays adjusting your withholding long into the current tax year to match your actual tax liability. You don’t want to be in the hole again, do you?,
If you put off calculating just how much you owe for last year til October, you have only a few months before next April to get this year’s taxes paid in.
Closing your eyes to an underwithholding problem won’t make it go away.
Calculate what you owe, make a plan to pay it if possible, and fix your withholding or quarterly payments so you’re OK next year.
Income taxes for years more than three years before the bankruptcy filing are dischargeable. You count the three years from the due date of the return. If there is a tax lien, the lien survives on existing assets, but doesn’t attach to new property. More on taxes in bankruptcy
Social Security overpayments can be wiped out in bankruptcy. After a bankruptcy filing, your current benefits are not subject to reduction on account of a prior overpayment. More from SSA.
SBA loans are just loans, subject to discharge in bankruptcy. The complication with SBA loans is that they are often secured. It’s important to determine what assets, if any, are pledged to support the loan. A bankruptcy discharge will prevent the SBA from suing you to collect its loan from your wages, savings or other assets; the collateral you gave the lender when the loan was negotiated survives.
Student loans may be dischargeable
Government guaranteed student loans occupy the middle ground in our range of possibilities. A student loan guaranteed by a governmental entity can be discharged if the borrower can show a bankruptcy judge that repayment would create an “undue hardship” on the debtor or the debtor’s dependents. The standard is pretty tough.
Some bankruptcy courts will discharge part of a student loan. Those courts find that repayment in full is a hardship, but partial repayment is possible without undue hardship. The 9th circuit which includes California, is one of those circuits allowing partial discharge of student loans.
Government debts that survive bankruptcy
Fines and penalties owed to a government that are imposed to punish, rather than compensate, can’t be discharged in Chapter 7. There is an exception for tax penalties: if the tax is dischargeable or the event that triggered the penalty occurred more than three years ago, the penalty can be wiped out. 11 USC 523(a)(7). In Chapter 13, fines and penalties are dischargeable.
Trust fund payroll taxes are never dischargeable in bankruptcy. The trust fund portion of payroll taxes is the taxes withheld from the employee’s paycheck for payment to the government. Officers of corporations who short the government for trust fund taxes can be personally liable for shortfall.
Military scholarships and incentive pay remain collectible despite bankruptcy. Most of these exceptions make the debt non dischargeable for a period of years, shorter than the usual statute of limitations. Here’s a more extensive list of governmental exceptions to bankruptcy discharge.
Non dischargeable debts in bankruptcy
Even if a debt is non dischargeable at the end of a bankruptcy case, some of the bankruptcy rules still apply.
Collection of non dischargeable debts is still stayed by the automatic stay. The stay remains in place til the debtor is otherwise discharged, or until a bankruptcy judge lifts the stay as to that debt.
The statute of limitations still controls how long a debt is legally enforceable. The running of time on statute of limitation is suspended while the stay is in place, and sometimes for a specified additional period. But just because a debt is not dischargeable in bankruptcy, applicable law may still allow it to die of old age.
State law may give you other rights not to be contacted.
Write a do-not-contact letter, keep a copy, and send it return receipt requested.
The squeaking should stop. Then start prioritizing.
Who to pay first
It’s your checkbook. You take control.
Take care of current living expenses first. Short the landlord and you’ll be homeless. Miss the car payments and you can’t get to work.
I’ve seen too many people tinker with their tax withholding to create cash flow to pay credit card bills. They have effectively made the toothless credit card creditor happy at the expense of taunting the big dog, the IRS.
Rest assured, the IRS has more collection rights than a credit card company.
It’s tempting, if you’ve been wise enough to set money aside for retirement, to dip into that fund to get out of today’s money jam.
Don’t do it.
Retirement funds are precious and almost everyone I talk to has saved far too little. The older you are, the less time you have to restore what you’ve already saved, when you should be adding to that store.