Making a Choice Between Bankruptcy and Short Sale

Homeowners who are underwater on their home mortgages (underwater mortgage means that the homeowner owes more than his/her house is worth) often attempt to do a short sale. A short sale occurs when the homeowner sells the home to a third party for less than what is owed on the note, and the mortgage lender accepts the proceeds of the sale in full satisfaction of the note. The mortgage lender must approve the short sale before it can go through. A short sale can be a good option for homeowners who do not want to keep their homes, and are willing to move out almost right away.

However, before going through with a short sale, a homeowner should see if Chapter 7 Bankruptcy would be a better option. In a Chapter 7 Bankruptcy, the homeowner’s liability on the note is discharged and the home does not have to be surrendered right away and the homeowner does not have to immediately move out of the house. The homeowner can continue to live in the house without making any payments while the lender goes through the lengthy process of foreclosure. In New York, foreclosures can take years before the mortgage lender can hold a foreclosure sale. Even after the house is sold at foreclosure sale, the new buyer (which is often the mortgage lender itself) has to start eviction proceedings to evict the homeowner from the home. This may give the homeowner time to save up money for a move or a new home. Any shortfall that may result from the sale of the house is eliminated in the bankruptcy, meaning the homeowner owes the mortgage lender nothing when they move.

A final, and highly significant, difference between Chapter 7 Bankruptcy and short sale is tax advantages of a bankruptcy filing. When a mortgage lender accepts a short sale, the homeowner will have to pay taxes on the amount forgiven by the lender. Under the tax code, debt forgiveness is considered income and the mortgage lender will generally send the homeowner IRS Form 1009-C form for it. The homeowner will have to report it as income on his/her tax return. As a result, the amount of forgiven debt will be added to the homeowner’s income as miscellaneous income, and while not subject to self-employment or social security tax, it will be subject to income taxes. If the amount of the forgiven debt is significant, the debtor may face an unexpected tax liability amounting to thousands of dollars. In a Chapter 7 Bankruptcy, there is no tax liability for the debt that is eliminated as a result of the filing.

Deed in lieu of foreclosure is similar to a short sale. The main difference is that unlike short sale where the property is transferred to a third party, in deed in lieu of foreclosure, the property is transferred directly to the lender. It has tax consequences identical to those of a short sale.

Short sales and Chapter 7 Bankruptcies are both good options for homeowners who want to walk away for their homes and their mortgages. When your home is underwater and you are considering a short sale, it is important to talk to an experienced bankruptcy lawyer first. That way you can review your options and make an informed decision.

If you contemplating filing Chapter 7 Bankruptcy or Chapter 13 Bankruptcy, or are dealing with debt problems in Western New York, including Rochester, Canandaigua, Brighton, Pittsford, Penfield, Perinton, Fairport, Webster, Victor, Farmington, Greece, Gates, Hilton, Parma, Brockport, Spencerport, LeRoy, Chili, Churchville, Monroe County, Ontario County, Wayne County, Orleans County, Livingston County, and being harassed by bill collectors, and would like to know more about how bankruptcy may be able to help you, contact me today by phone or email to schedule a FREE initial consultation with a Rochester, NY, bankruptcy lawyer.

Bankruptcy, Cancellation of Debt and Tax Issues

I am often asked if the debt discharged in bankruptcy is treated as debtor’s income and is subject to taxes.  The answer to that question under the Bankruptcy Code, for both Chapter 7 Bankruptcy and Chapter 13 Bankruptcy is unequivocally no.  Debt discharged in bankruptcy does not result in taxable income to the debtor.

While I have written previously about the problems with debt settlement, this is one more advantage that bankruptcy has over various debt settlement arrangements.  If the debtor has his debt reduced or cancelled, the creditor may issue an IRS Form 1009-C form and the debtor would have to report it on his taxes.  As a result, the amount of cancelled debt will be added to the debtor’s income as miscellaneous income, and while not subject to self-employment or social security tax, it will be subject to income taxes.  If the amount of the cancelled debt is significant, the debtor may face an unexpected tax liability amounting to thousands of dollars.

One exception to the above is cancellation of mortgage debt. The Mortgage Debt Relief Act of 2007 generally allows debtors to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief as well.

This provision applies to debt forgiven in calendar years 2007 through 2012. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). The exclusion does not apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition.  For a detailed discussion of IRS’ position on these issue, please follow this link.

Occasionally, even the debtor who filed fro bankruptcy may receive 1099-C from one of his creditors. Nonetheless, if the debtor received a discharge as a result of either Chapter 7 Bankruptcy or Chapter 13 Bankruptcy, the debtor is able to file IRS Form 982, which will inform the IRS that the debtor went through the bankruptcy and any discharged debt should not be included in his gross income.  If you are considering your options between a bankruptcy or debt settlement, one of the issues that you should discuss during a consultation with a bankruptcy lawyer is what impact either approach would have on your tax liability.

If you contemplating filing Chapter 7 Bankruptcy or Chapter 13 Bankruptcy, or are dealing with debt problems in Western New York, including Rochester, Canandaigua, Brighton, Pittsford, Penfield, Perinton, Fairport, Webster, Victor, Farmington, Greece, Gates, Hilton, Parma, Brockport, Spencerport, LeRoy, Chili, Churchville, Monroe County, Ontario County, Wayne County, Orleans County, Livingston County, and being harassed by bill collectors, and would like to know more about how bankruptcy may be able to help you, contact me today by phone or email to schedule a FREE initial consultation with a Rochester, NY, bankruptcy lawyer.

Top Ten Bankruptcy Myths

There are lot of myths and misinformation regarding debtors’  rights to file bankruptcy.  In my practice, I see a lot of debtors who seek to file Chapter 7 Bankruptcy or Chapter 13 Bankruptcy, who have heard a lot of rumors and incorrect information with respect to their rights and obligations when they file for bankruptcy relief.  The following is a compilation of the typical questions, and correct answers to the questions I frequently hear from the debtors.

1.  I will not be able to buy a house for ten years since I will not be able to obtain a mortgage.

Although Chapter 7 Bankruptcy will appear on your credit report for a period of ten years, you will be able to buy a house again much sooner than that, because the bankruptcy is likely to improve your credit rating.  Chapter 13 Bankruptcy is likely to improve your credit sooner and is likely to disappear from your credit report much sooner as well.

2.  I won’t be able to buy a car for ten years since I will not be able to obtain a car loan.

Although Chapter 7 Bankruptcy is likely to be on your credit report for a period of ten years, you will be able to borrow money to purchase a car again because because the bankruptcy is likely to improve your credit rating.

3.  I won’t get a credit card or a good credit score for ten years.

Both Chapter 7 Bankruptcy and Chapter 13 Bankruptcy are  likely to improve your credit rating.  In my experience, although I do not recommend it, the debtors are able to obtain credit cards again within 1 to 2 years.

4.  I won’t be able to get a student loan for myself or my children.

Since guaranteed student loans must be repaid, and cannot be discharged in bankruptcy, therefore, there is little concern that student loans will not be paid back.  Any private lender may deny a student loan based on the debtor’s credit score, however most student loans are government backed.

5.  My employer will fire me because I filed for bankruptcy.

While bankruptcy information is available as a public record, employer, or prospective employer, is not allowed to discriminate against you based on debtor’s decision to file Chapter 7 Bankruptcy or Chapter 13 Bankruptcy.  If a prospective employer asks you for a copy of your credit report, questions you about bankruptcy, most employers are prefer to know that the debtor no longer has any financial issues which may affect work performance.  Discharging the debt is preferable to an employer as opposed to a situation where the debtor is receiving phone calls at work from collectors or a credit report that shows a pattern of irresponsibility. Further, in Chapter 7 Bankruptcy, employers are not notified of the filing.  In Chapter 13 Bankruptcy, the employer is likely to be aware of the filing since here in Rochester, New York, the Bankruptcy Court requires a wage deduction order that is sent to the debtor’s employer and requires a portion of the wages to be remitted directly to the Chapter 13 Trustee.

6.  I don’t qualify for chapter 7 bankruptcy because I own a house.

You can file for a Chapter 7 Bankruptcy even if you own a home.  Most states, including New York, allow a homeowner a certain amount of equity in their residence.  In New York, pursuant to its homestead bankruptcy exemption, a single filer can have $50,000 worth of equity in their residential property, and joint filers (husband and wife) can have $100,000 worth of equity in their property.

7.  I will lose my car if I file for bankruptcy.

If the debtor has a financed car, and can afford the payments, the bankruptcy court will not take away the car, unless the amount of equity in the vehicle is considerably greater than New York’s vehicle exemption.  Further, the lender is likely to ask the debtor to reaffirm the car loan.  Most Chapter 7 Bankruptcy filers who have car loans, tend to reaffirm them.

8.  I am not a citizen, and therefore I can’t file for bankruptcy protection.

You can qualify to file bankruptcy even if you are not a United States citizen.  If you have the right to reside in the United States, have a social security number, and have filed income tax returns, you can file for Chapter 7 Bankruptcy or Chapter 13 Bankruptcy protection.

9.  Bankruptcy can’t help because I have unpaid federal and state taxes.

Under appropriate circumstances, even taxes can be discharged in Chapter 7 Bankruptcy.  Chapter 13 Bankruptcy can reduce debtor’s monthly payment to the IRS or New York Department of Taxation and Finance and allow for payments over the life of the plan, as long as five years, without interest.

10.  My creditors tell me they will still sue to recover the money owed to them.

Once the bankruptcy is filed, the automatic stay, imposed by the bankruptcy law, protects you from any further attempts to collect a debt or any pending or future lawsuits.  While secured creditors may ask for their property back if you do not continue to make payments, they must seek consent of the bankruptcy court before attempting to recover the property.

If you contemplating filing Chapter 7 Bankruptcy or Chapter 13 Bankruptcy, or are dealing with debt problems in Western New York, including Rochester, Canandaigua, Brighton, Pittsford, Penfield, Perinton, Fairport, Webster, Victor, Farmington, Greece, Gates, Hilton, Parma, Brockport, Spencerport, LeRoy, Chili, Churchville, Monroe County, Ontario County, Wayne County, Orleans County, Livingston County, and being harassed by bill collectors, and would like to know more about how bankruptcy may be able to help you, contact me today by phone or email to schedule a FREE initial consultation with a Rochester, NY, bankruptcy lawyer.

Chapter 7 Bankruptcy and Unpaid Tax Liabilities

One issue that periodically comes up in  Chapter 7 bankruptcy cases is unsatisfied tax liability.  As of late, the IRS and New York State Department of Taxation and Finance, have been aggressive in enforcing their claims with respect to unsatisfied tax liabilities.

One common problem associated with back taxes is that the amount owed by the debtor tends to grow rapidly because of the interest and penalties that are imposed by the taxing authority.  In their collection efforts, the government agencies can engage in a variety of collection activities, including garnishment, levies, tax liens, seizure of physical assets, intercept of tax refunds, and other collection activities.

For many people with unpaid taxes, bankruptcy may be a way to improve their situation by either improving their financial state and having funds available to pay the taxes owed, or by discharging certain tax liabilities.

In Chapter 7 bankruptcy, certain past due taxes can be eliminated depending on how old the unpaid taxes are and whether the debtor filed an income tax return for the year the taxes came due.  For some people filing a Chapter 7 bankruptcy will be a way to permanently eliminate their past-due taxes without having to pay them. To figure our whether or not your taxes can be discharged in bankruptcy you will need to know exactly what taxes you owe and for what years.

There are four general requirements for discharging an income tax in bankruptcy. In this post, I will discuss the first: The tax must be one for which the return was not last due within three years of the filing of the bankruptcy. Therefore, if a 2005 income tax return was last due on April 15, 2006, the three-year requirement would be met after April 15, 2009.
A complication concerns the “last due” requirement. What happens when the debtor requests and receives an extension? The answer is that the three-year clock starts after the last extension. See In re Wood, 866 F.2d 1367 (11th Cir. 1989).
The three-year period is also tolled during the time when the taxing authority is barred from collecting the debt because of a prior bankruptcy.

There are four general requirements for discharging an income tax in bankruptcy.  Initially, the tax must be one for which the return was not last due within three years of the filing of the bankruptcy.  Therefore, if a 2006 income tax return was last due on April 15, 2007, the three-year requirement would be met after April 15, 2010.

Second, for an income tax to be dischargeable, it must not have been assessed with 240 days of the filing of the bankruptcy.  When a return is timely filed, the assessment date is usually around the time a return is filed.

Third, if a return is filed late, it must not be filed within two years of a bankruptcy for the tax to be discharged. This requirement is subject to the following limitations:  (1) amended returns count as returns for purposes of this rule; (2) if in the course of correspondence with the IRS, the debtor gives financial statements with all the information needed to complete a return, this can also be deemed to be a return.; and (3) the two-year period begins once the taxing authority actually receives the return, not when the return is mailed, as is the case with timely-filed returns.

The fourth requirement is that the income tax return must be filed by the tax payer, it must not be fraudulent, and the debtor must not have attempted to evade the tax.

If the above requirements are satisfied, a bankruptcy lawyer can help you by obtaining a discharge of unpaid taxes.

If you are dealing with debt problems in Western New York, including Rochester, Canandaigua, Brighton, Pittsford, Penfield, Perinton, Fairport, Webster, Victor, Farmington, Greece, Gates, Hilton, Parma, Brockport, Spencerport, LeRoy, Chili, Churchville, Monroe County, Ontario County, Wayne County, Orleans County, Livingston County, and being harassed by bill collectors, and would like to know more about how bankruptcy may be able to help you, contact me today by phone or email to schedule a FREE initial consultation with a bankruptcy lawyer.

Discharging Income Taxes in Bankruptcy

There are four general requirements for discharging an income tax in bankruptcy. Initially, the tax must be one for which the return was not last due within three years of the filing of the bankruptcy. Therefore, if a 2006 income tax return was last due on April 15, 2007, the three-year requirement would be met after April 15, 2010.

The “last due” requirement may be complicated by the debtor’s actions. If the debtor requests and receives an extension, the three-year clock starts after the last extension. See In re Wood, 866 F.2d 1367 (11th Cir. 1989). The three-year period is also tolled during the time when the taxing authority is barred from collecting the debt because of a prior bankruptcy.

The second requirement is known as the 240-day rule. For an income tax to be dischargeable, it must not have been assessed with 240 days of the filing of the bankruptcy. When a tax is assessed is sometimes complicated and depends on the practices of the federal or state taxing authority. For federal taxes, the I.R.S. regulations state that “the date of the assessment is the date the summary record is signed by an assessment officer.” This is not the same time as when the return is filed. However, when a return is timely filed, the assessment date is usually around the time a return is filed.

A debtor will know that a tax has been assessed when they are notified by the taxing authority of the tax claim. The exact date of assessment of a federal tax can be obtain by requesting and analyzing a debtor’s tax transcript.

Another related requirement is that, to be discharged in a bankruptcy, an income must not be not yet assessed but be assessable at the time that the bankruptcy is filed. Pursuant to 26 U.S.C. § 6501(a), tax liability must be assessed within “three years after the return was filed….” Therefore, even if a tax has not yet been assessed for some reason at the time a bankruptcy case is filed, and the case postdates the applicable return by three years, this requirement for dischargeability will met.

The third requirement relates to the timing of when the return is filed.  If a return is filed late, it cannot not be filed within two years of a bankruptcy for the tax to be discharged. Under this rule, amended returns are treated as original filed returns. Also, if the debtor provides to the IRS with correspondence containing financial statements with all the information needed to complete a return, this can also be deemed to be a return. The two-year period begins once the taxing authority actually receives the return, and not when the return is mailed, as is the case with timely-filed returns.

The final requirement is the following.  The return must be filed. A substitute return filed by a taxing authority on behalf of a taxpayer is not considered a return for these purposes. There is, however, a split of authority on whether a return filed by a debtor after a substitute return is filed can is considered a return for this test. The return must not be fraudulent and the debtor must not have attempted to evade the tax.

Tax evasion is generally rare and courts disagree on what is deemed to constitute tax evasion for purposes of this test. Tax evasion is found usually in situations where a debtor is hiding assets, constructing complicated transactions for tax purposes, or making false and misleading statements to avoid tax. However, evasion has also been found to exist in some cases in which a debtor has simply not paid a tax while having the ability to do so.

If you have pending tax liabilities, and you believe that you can satisfy all or some of the above requirements, you should meet with a bankruptcy lawyer to determine whether a Chapter 7 bankruptcy will result in a discharge of some or all of your tax liabilities.

If you are dealing with debt problems in Western New York, including Rochester, Canandaigua, Brighton, Pittsford, Penfield, Perinton, Fairport, Webster, Victor, Farmington, Greece, Gates, Hilton, Parma, Brockport, Spencerport, LeRoy, Chili, Churchville, Monroe County, Ontario County, Wayne County, Orleans County, Livingston County, and being harassed by bill collectors, and would like to know more about how bankruptcy may be able to help you, contact me today by phone or email to schedule a FREE initial consultation with a bankruptcy attorney.