How to Eliminate Your Tax Debt

How to Eliminate Your Tax Debt Bankruptcy Solutions for Tax-Burdened Individuals A White Paper Presented by MARKOWITZ O DONNELL

How To Eliminate Your Tax Debt Bankruptcy Solutions for Tax-Burdened Individuals Burdensome tax debt affects the lives To give you a better idea of how bankruptcy of untold numbers of people throughout can help you eliminate your tax debt, we our country. In many cases, however, will explore a number of considerations this burden stems more from a lack of that should go into your decision. First, knowledge than from any legal necessity. whatever kind of tax you may be seeking Contrary to what many people believe, you to eliminate, time-sensitivity is a key factor can indeed eliminate tax debt in bankruptcy to consider. The timing of a bankruptcy is by filing what is commonly referred to as tightly interwoven with something called Chapter 7 bankruptcy 1. Where your tax the Means Test, a mathematical formula debt cannot be eliminated, it often can be designed to determine your eligibility managed in Chapter 13 bankruptcy 2. for filing a Chapter 7 bankruptcy. Those concerns weigh heavily on your ability to protect your property, including your house 71% OF ALL (whether your house has equity or not). BANKRUPTCY Your decision also must take into account CASES ARE the bankruptcy trustee and other local CHAPTER 7 considerations, both legal and personal. Other times, you can combine Chapter 7 bankruptcy and Chapter 13 bankruptcy to eliminate debt. That combination is colloquially referred to as Chapter 20 bankruptcy. Income Tax Is Not the Only Kind of Tax Eliminating tax debt in bankruptcy, like other types of debt, comes with its own set of rules. You must follow these rules exactly. In fact, your ability to eliminate taxes can sometimes depend on whether you file bankruptcy on the correct day after you do all the timing calculations. First, it is important to note that there are several kinds of taxes. Taxes such as property taxes and taxes incurred through operating your business are classified by the U.S. Bankruptcy Code as priority taxes. Keep in mind that unique complications arise with respect to unpaid property taxes and unpaid employment taxes. In the case of a foreclosure, for instance, if you protect your home, the property taxes that have been paid by your bank cannot be eliminated. You still will owe those property taxes. Owners of small businesses and sole proprietorships may be held personally liable for any unpaid employment taxes. These cannot be discharged either. For our limited purposes here, however, we will not be focusing on those tax situations. Instead, we will be restricting the scope of our discussion to what the Bankruptcy Code classifies as nonpriority income taxes. 1 11 U.S.C. 701, et seq. 2 11 U.S.C. 1301, et seq. 2 3

Eliminating Tax Debt Is Time-Sensitive Bankruptcy law places several time restrictions on your ability to eliminate tax debt. These restrictions relate to the age of the tax debt, the date on which you filed the taxes and the date on which the tax debt was assessed. Generally speaking, to eliminate a tax debt in bankruptcy, keep in mind the numbers three and two: Extension-Filing Deadlines 3 2 Three is how many years old your tax debt must be in order to eliminate it in bankruptcy. Two is how many years prior to your bankruptcy that you must have filed the taxes. In other words, along with specifying the number of years, the law requires that you filed your returns (the Internal Revenue Service cannot have filed the returns for you). The law also requires, of course, that the return not be fraudulent. Finally, the law mandates that the tax to be discharged was assessed against you at least 240 days prior to filing the bankruptcy. To ensure that you have all of these dates straight, you should consider getting a tax transcript from the IRS. The tax transcript will show you when the taxes were assessed against you, when they were due and which ones still may be outstanding. You might be surprised to find that you owe even more in taxes than you thought. Fully Dischargeable Tax Debt To be completely or partially erased, income tax debt must meet all of the following requirements: The corresponding tax return was due at least three years prior to your bankruptcy filing. You filed the tax return at least two years prior to your bankruptcy filing. The taxes were officially assessed by the IRS at least 240 days prior to your bankruptcy filing. You did not commit fraud or intentionally evade tax laws on your tax return. The Means Test Even aside from the taxes themselves, timing remains crucial in a bankruptcy case. Introduced in 2005, the Means Test requires the court to consider your income for the six months prior to filing a bankruptcy petition. The Means Test takes this six-month window and uses that figure to determine whether you have the means to pay some or all of your debt in any bankruptcy. The Means Test makes that determination in a two-step process. First, it looks to see if your income is less than or more than the median income for someone in your situation in your geographic area. If you are not above the median income, then the Means Test declares you eligible to file a Chapter 7 bankruptcy. State Median Family Income State Median by Family Size Income by Family Size Family Size Family Size STATE 1 EARNER 2 PEOPLE 3 PEOPLE 4 PEOPLE* STATE 1 EARNER 2 PEOPLE 3 PEOPLE 4 PEOPLE* AL $41,370 $49,806 $55,289 $65,381 MT $44,074 $54,839 $61,043 $67,614 AK $60,079 $82,156 $85,867 $95,010 NE $42,446 $60,389 $65,804 $78,363 AZ $43,749 $54,236 $57,927 $67,800 NV $42,988 $55,467 $58,399 $68,560 AR $38,530 $47,017 $51,773 $58,149 NH $55,804 $67,659 $81,709 $94,432 CA $49,185 $63,745 $67,817 $78,150 NJ $60,265 $70,845 $89,413 $105,737 CO $51,552 $67,129 $70,827 $84,998 NM $40,722 $53,385 $53,385 $61,837 CT $59,582 $72,352 $87,071 $107,360 NY $48,840 $60,743 $71,706 $88,156 DE $51,686 $61,849 $74,300 $84,179 NC $40,412 $51,857 $56,782 $69,370 DC $48,638 $77,117 $77,117 $77,117 ND $47,629 $67,024 $76,620 $88,887 FL $42,036 $51,584 $57,052 $66,461 OH $43,276 $53,551 $62,134 $77,367 GA $40,985 $52,827 $57,858 $68,066 OK $41,544 $52,995 $57,087 $63,419 HI $61,107 $67,463 $80,681 $88,217 OR $46,304 $57,182 $64,107 $71,508 ID $42,918 $51,791 $55,949 $61,353 PA $48,200 $56,946 $71,703 $84,396 IL $47,469 $61,443 $72,342 $83,546 RI $47,742 $62,190 $71,977 $88,389 IN $42,716 $53,074 $61,056 $73,020 SC $39,983 $50,679 $54,028 $66,561 IA $43,792 $61,104 $67,062 $81,219 SD $40,427 $57,383 $57,383 $73,089 KS $45,246 $59,610 $65,010 $74,804 TN $40,977 $50,169 $56,091 $66,846 KY $41,330 $48,355 $57,617 $68,680 TX $42,223 $57,730 $60,520 $70,824 LA $41,016 $49,279 $57,289 $72,828 UT $52,021 $58,595 $66,552 $72,274 ME $41,908 $54,267 $61,527 $75,290 VT $46,494 $61,671 $72,558 $82,047 MD $59,475 $76,489 $88,221 $105,382 VA $52,436 $67,021 $75,044 $91,859 MA $55,356 $69,673 $85,637 $106,812 WA $52,384 $65,802 $74,428 $84,786 MI $44,504 $53,640 $62,973 $76,622 WV $43,554 $46,658 $54,097 $66,009 MN $50,121 $65,503 $79,750 $93,294 WI $42,969 $58,786 $68,489 $82,350 MS $35,213 $44,116 $46,583 $58,182 WY $49,721 $64,086 $75,456 $80,477 MO $41,700 $51,940 $61,119 $71,550 * Add $8,100 for each individual in excess of 4 Based on the figures from the U.S. Census Dept. as of January 2015. 4 5

If you are above the median income, then the Means Test puts you through a second step that involves pages of calculations, much like an extended tax return, to make How does that work? Chapter 13 bankruptcy enables you to do two things you cannot do in a Chapter 7. First, Chapter 13 lets you take that large tax You Must Consider Other Complicating Factors: Exemptions and Local Matters a more detailed assessment of your income for eligibility for filing a Chapter 7. Even if eligible, however, you might have reasons not to file Chapter 7. While most people think of Chapter 7 as the default method of bankruptcy, there are very good reasons to choose Chapter 13 bankruptcy even if you qualify for Chapter 7. You might file Chapter 13 instead of Chapter 7 if you owe a large tax debt now that cannot be immediately discharged. You can use Chapter 13 to manage that debt. debt and spread it out over three to five years, thereby making paying the debt more manageable. For instance, if you owed $20,000 in tax debt, you could file a Chapter 13 that would allow you to pay that amount back over five years. In the process, Chapter 13 allows you to do a second thing you cannot do under Chapter 7: stop the clock. Stopping the clock in tax matters means you are no longer accumulating interest and penalties on that tax debt. As noted above, you may even find yourself in a situation where coordinating the filing of a Chapter 7 with a Chapter 13 would best address your tax debt. That situation (sometimes referred to as Chapter 20 bankruptcy) can arise, for instance, when you eliminate dischargeable tax debt in Chapter 7 bankruptcy and then file a Chapter 13 bankruptcy to manage any tax debt that could not be discharged in the Chapter 7 bankruptcy. Were the unique rules governing the elimination of taxes our only concern, we could conclude our paper now. Unfortunately, that is not the case. Instead, on top of the concerns you must address regarding the taxes themselves, you also must consider how you will protect those assets you do have. Protecting assets is made possible under the Bankruptcy Code by something called exemptions. The Bankruptcy Code provides several categories that allow for the protection of assets. These categories, in turn, place a limit on the number and value of the assets that can be protected. For instance, in New Jersey, you can choose between two exemption options: federal and state. Generally speaking, most people in New Jersey choose the federal exemptions because, in most situations, they allow you to protect more of what you own, including your home. The Bankruptcy Code allows each filer to protect one primary residence. The Code will exempt $22,975 of equity, plus any lien and other costs involved in selling your house. On the other hand, if your house is worth less than what is owed against it, the house can still be protected by the Code. If your primary residence has more equity than allowed for the exemptions, other options still remain. Federal 11 USC 522(b) Exemption Amounts EXEMPTION RAISED FROM Homestead $21,625 to $22,975 Motor vehicle $3,450 to $3,675 Wild card $10,825 to $11,500 Tools of trade $11,525 to $12,250 Limit on IRA $1,171,650 to $1,245,475 Debt Limits EXEMPTION RAISED FROM Chapter 13 $360,475 to $383,175 (unsecured debt) Chapter 13 $1,081,400 to $1,149,525 (secured debt) 6 7

One of these other options may involve your wild card exemption. You are allowed around another $1,000 plus as much as $11,500 of unused portion of that homestead exemption mentioned above that you could apply to any asset 3. Aside from the wild-card exemption, you may have other bankruptcy strategies available to protect your home. These other strategies fall under an umbrella in bankruptcy law called exemption planning. Exemptions Planning Just as tax law allows tax planning, For that reason, exemption planning should bankruptcy law allows for bankruptcy be undertaken deliberately and with planning. The law does not require you to forethought. If you decide to rely on the walk into bankruptcy without being able to judgment of an experienced attorney who meaningfully anticipate the outcome. understands the mechanics of exemption planning as they are applied in your Exemption planning, in fact, forms an location, you will want to communicate with essential component of your larger that attorney as soon as possible. bankruptcy-planning process. For instance, exemption planning can involve the Because exemption-planning issues strategic disposition of assets so you keep are often time-sensitive, you will want only what you can protect. This disposition to examine your options promptly. The may involve selling assets at their fair more time you can give your attorney to market value. review the facts of your case and how the exemption laws apply, the better off you Done incorrectly, however, the law will be. will consider exemption planning to be fraudulent. Such a determination puts your entire bankruptcy at risk and potentially exposes you to federal criminal consequences. Trustees and Other Local Circumstances Bankruptcy law, however, is not only about legal rules; it also is about how those rules are applied by real people during the bankruptcy process. Perhaps the most important person involved in your bankruptcy is the trustee. Do not make the mistake many people do by believing the trustee has no stake in your case. Unlike the trustee of, say, a will or a trust, a Chapter 7 bankruptcy trustee is paid a percentage of whatever assets of your bankruptcy estate he or she can liquidate. As a result, bankruptcy trustees are motivated to examine a case closely to maximize their own income from the case. Your trustee will work hard to determine if you have left any assets unprotected or have made a mistake that enables the trustee to liquidate an asset you thought was protected. Not surprisingly, some trustees can be more aggressive than others. To determine the extent to which your case may be affected by a certain trustee, you will want to rely on someone who understands how different trustees in your area approach bankruptcy. EXEMPTIONS TAX One Final Note: Your Tax Refund TRUSTEE THE MEANS TEST As a side note to your general ability to discharge and manage old tax liability, keep in mind that your ability to file bankruptcy may be affected by any tax refund you might be due. In New Jersey, this tax refund can be considered income if you receive it within the six-month window examined by the Means Test, which may push you above the median income level and render you ineligible for a Chapter 7 bankruptcy. For that reason, you want to be all the more aware of the timing of your bankruptcy. Even after you receive a tax refund, you may need to protect it with exemptions if it has not been spent down yet. Your exemption planning, therefore, can be implicated by the existence of a tax refund. 3 If you did not use all of your homestead exemption, you can apply up to approximately $10,000 of that unused homestead exemption as a wild card against any other asset. 8 9

Next Steps If you have more questions about how taxes can be eliminated in bankruptcy, you can see an attorney. Many offer free initial consultations. During this consultation, you can learn more about the issues that most concern you about bankruptcy. You also can learn if you want to work with the attorney. Bankruptcy is a very personal decision, and you want to be able to work closely with the attorney you hire. MARKOWITZ O DONNELL Share this white paper The content of this paper is provided for informational purposes only and does not constitute legal advice. 2015 Markowitz O Donnell, LLP. All rights reserved. Design and editorial services by FindLaw, part of Thomson Reuters. Visit our site www.mgs-law.com Call our firm 866-437-1189 10