Fundamental Misunderstandings

No one expects the average person without legal training and experience to be an expert on bankruptcy.  I have, however, encountered a number of questions in the past couple of weeks that demonstrated a fundamental misunderstanding of what bankruptcy is and how it works.  So I thought now would be a good time to clarify a few things.
“Am I likely to win my bankruptcy case?”  OR  “How will the Trustee decide if my bankruptcy goes through or not?”
Bankruptcy is NOT an adversarial area of law – at least not in the vast majority of cases.  Bankruptcy is highly bureaucratic, and although it technically doesn’t fall into the realm of “administrative law”, that’s basically what it is.
In bankruptcy, an individual files a petition with the bankruptcy court.  Once filed, a discharge is PRESUMED to be the end-result, and really only doesn’t happen in a small set of circumstances and mostly only if/when a creditor or other party objects to that discharge.
Assuming you’ve hired an attorney to determine that you meet eligibility requirements, disclosed all of the relevant information, provided all of necessary paperwork, etc. – the rest of process should be relatively simple.  A lot of “pro forma” stuff to make sure all of the i’s have been dotted and t’s crossed.  There are opportunities for creditors to file objections, or for the Trustee to object to exemptions, or for disputes over the Means Test.  But in the majority of cases, these things never happen.  A good and experienced bankruptcy attorney will have already litigated the case before he files the bankruptcy case, ensuring that whatever issues may affect your bankruptcy case and your ultimate result have been addressed or mitigated in some way before the petition is filed.
In other words, this isn’t a “win” or “lose” situation.  You get the discharge automatically unless someone steps in and objects to the discharge.  Furthermore, the Trustee doesn’t make any sort of determination about your discharge or qualifications.  Trustees (especially in Chapter 7) are there to take your testimony and look for assets or preferences that he/she can recover – that’s it.  The scope of their duty is extremely limited.
“How do my creditors get paid?”
There MIGHT be payments to unsecured creditors if you file Chapter 13, or if your Chapter 7 case has non-exempt assets or recoverable preferences.  Also, you might reaffirm secured debts or other debts might not be dischargeable, and therefore you’ll remain responsible for them after your case is filed.  But I’m not talking about any of these exceptions.
There is a common misconception that whatever is “discharged” in bankruptcy must be paid from somewhere.  And that is not the case.  A bankruptcy discharge is basically a formal court order that requires most of your creditors to write-off the debts you owe them without being paid, and to cease and desist any further collection efforts for those debts.
Creditors make their money from interest and other miscellaneous fees they charge, and if a lender’s business is doing well, those forms of revenue will wash out any debts that get discharged in bankruptcy.
“How/when does the judge determine what debts are discharged?”
Again, I’m going to stick to Chapter 7 just to keep things easy and clean.  Many of these questions get a bit more complicated when we talk about Chapter 13.
Most debts are dischargeable.  This includes secured debts, such as mortgages and auto loans.  Most people will “reaffirm” on secured loans (and continue to pay them) in order to retain the collateral that secures the loan.  Reaffirmed debts are not discharged by virtue of the reaffirmation agreement.
Apart from that, the bankruptcy code specifically lists all of the types of debts that are not dischargeable.  That list can be found at 11 U.S.C. § 523.  It’s a pretty long list, but for most people, there are only three types of debts that aren’t discharged: student loans, certain taxes, and domestic support obligations.
Of the items listed under section 523, all of them except for three are statutory.  That means that if you owe a student loan, it is automatically not part of the discharge.  Your student loan creditor is not required to go to bankruptcy court and have their debt declared non-dischargeable – it’s automatic.  No judicial determination required.
If a creditor asserts that their debt is non-dischargeable under any of those subsections, and you disagree, you can file an action with the bankruptcy court for a violation of the discharge injunction, and then have the court rule whether or not the debt in question is non-dischargeable.
There are only three subsections of 523 that require a judicial determination: 523(a)(2), 523(a)(4), and 523(a)(6).  523(a)(2) is for fraudulently-incurred debt.  523(a)(4) is for fraud committed while acting in a fiduciary capacity.  523(a)(6) is for willful or malicious injury.  Any creditor who wants their debt declared non-dischargeable under one of those three subsections must get the judge to make a ruling in their favor.

Unfiled Claims in Chapter 13

No creditor who doesn’t file a proof of claim will be paid by a Chapter 13 Trustee.

Let me repeat that…

No creditor who doesn’t file a proof of claim will be paid by a Chapter 13 Trustee.

What does that mean?

Let’s say John Doe has 4 credit cards, one with Wells Fargo, one with Chase, one with Bank of America, and one with HSBC.  Let’s also say that each one has a balance owed of $5,000 – or a grand total of $20,000.

Let’s further pretend that John files a Chapter 13 Bankruptcy which proposes to pay 10% to each of his unsecured creditors.  If Wells Fargo, Chase, BoA, and HSBC all file claims, then each will get 10% of their claims, or about $500 each and a total of $2,000.

But what happens if BoA doesn’t file a claim?  Then there are only $15,000 in claims.  John still pays the $2,000 that his disposable income was calculated out to.  But now the 3 creditors who did file claims (Wells Fargo, Chase, and HSBC) all share that $2,000 – $667 each.  That means that each creditor gets paid 13% of their claims – except BoA who gets paid $0 because they didn’t file a claim.

What if BoA is the only creditor who files a claim?  Well, then John is still paying the $2,000 of disposable income, but now BoA is getting paid 40% of their $5,000 claim, while each of the other 3 creditors gets paid $0.

In short – John Doe pays the exact same amount – $2,000 – no matter which creditors file claims or how many creditors file claims.  But if certain creditors don’t bother to file claims – they don’t get paid, and the creditors that did file claims get paid a bigger share.

What if we keep the facts exactly the same, but instead of $2,000, John’s disposable income shakes out to $7,000 over the life of his Chapter 13 case?  $7,000 is 35% of $20,000, so if all creditors file claims, they’ll get 35%, or $1,750 each.

But now let’s say again that only BoA files a claim.  Their total claim is $5,000, which is less than the $7,000 in disposable income that John has to pay his unsecured creditors.  BoA gets paid their claim in full – at 100%.  Since there are no other claims to pay, his Chapter 13 Plan ends early, and he gets to keep the extra $2,000.  The other 3 creditors are shit out of luck.

Now, all of this is overly simplistic because we’re assuming nothing but unsecured and dischargeable creditors.  Let’s stop talking about hypothetical numbers and start discussing the issues that affect the analysis.

  1. In the above examples, we’re assuming that John Doe is eligible for a discharge.  If he is, then whatever is not paid to these 4 creditors (whether they files a claim or not) is wiped out upon receipt of the discharge.  These 4 creditors cannot pursue John for the unpaid balances after his bankruptcy is over.
  2. What if John isn’t eligible for a discharge?  Maybe he filed a prior bankruptcy case too recently.  Maybe he failed to complete his financial management course.  Maybe he fell behind on child support after his bankruptcy case was filed.  Or maybe he failed to make his plan payments and his case got dismissed.  Without a discharge, creditors can then pursue John for any unpaid balances owed after his bankruptcy is over – whether they filed a claim or not.
  3. If a debt is non-dischargeable (like a student loan) and they don’t file a claim, the debt is still non-dischargeable, which means the full balance and interest will be due when John exits bankruptcy.  Since student loans share the same dividend of funds as other unsecured creditors, it is in John’s interest to make sure his student loan creditors file claims so that they can at least get paid down a bit – and to reduce the amount of money his other dischargeable creditors can get their hands on.
  4. Remember the example where BoA got paid in full, John still had $2k in disposable income, but since the other 3 creditors didn’t file claims, they got paid $0?  Why don’t those creditors file claims then?  Because all creditors are under a deadline to file their claims.  Once that deadline has passed, they can’t file a claim – no matter what else may have changed about the debtor’s bankruptcy case.  If the creditor was not duly notified of the bankruptcy in time to file a claim, then their claim is likely going to be non-dischargeable.  But if they were duly notified and chose not to file claims on-time, it’s their loss.

Discharging Tax Debts in Bankruptcy

Most people who owe taxes to the government cannot have those tax debts discharged in bankruptcy.  Although most tax debts are non-dischargeable, some actually can be discharged.  And while those dischargeable tax debts are the exception to the rule, those exceptions are worth knowing about.
Morgan King, an attorney from California, put together this handy little flowchart in 2011 that shows how to determine if a tax debt can be discharged and/or whether it is a priority or non-priority debt.  Whether a tax debt can be discharged generally depends on the type of tax that is owed and the age of the debt, although several other factors also come in to play.  While the chart itself is pretty straightforward, actually finding out the information to answer some of the questions in this chart is often more problematic.

And here’s the relevant statutory text:
11 U.S.C. § 523

(a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt—
(1) for a tax or a customs duty—
(A) of the kind and for the periods specified in section 507(a)(3) or 507(a)(8) of this title, whether or not a claim for such tax was filed or allowed;
(B) with respect to which a return, or equivalent report or notice, if required—
(i) was not filed or given; or
(ii) was filed or given after the date on which such return, report, or notice was last due, under applicable law or under any extension, and after two years before the date of the filing of the petition; or
(C) with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax;

11 U.S.C. § 507

(a) The following expenses and claims have priority in the following order:
(8) Eighth, allowed unsecured claims of governmental units, only to the extent that such claims are for—
(A) a tax on or measured by income or gross receipts for a taxable year ending on or before the date of the filing of the petition—
(i) for which a return, if required, is last due, including extensions, after three years before the date of the filing of the petition;
(ii) assessed within 240 days before the date of the filing of the petition, exclusive of—
(I) any time during which an offer in compromise with respect to that tax was pending or in effect during that 240-day period, plus 30 days; and
(II) any time during which a stay of proceedings against collections was in effect in a prior case under this title during that 240-day period, plus 90 days; or
(iii) other than a tax of a kind specified in section 523(a)(1)(B) or 523(a)(1)(C) of this title, not assessed before, but assessable, under applicable law or by agreement, after, the commencement of the case;
(B) a property tax incurred before the commencement of the case and last payable without penalty after one year before the date of the filing of the petition;
(C) a tax required to be collected or withheld and for which the debtor is liable in whatever capacity;
(D) an employment tax on a wage, salary, or commission of a kind specified in paragraph (4) of this subsection earned from the debtor before the date of the filing of the petition, whether or not actually paid before such date, for which a return is last due, under applicable law or under any extension, after three years before the date of the filing of the petition;
(E) an excise tax on—
(i) a transaction occurring before the date of the filing of the petition for which a return, if required, is last due, under applicable law or under any extension, after three years before the date of the filing of the petition; or
(ii) if a return is not required, a transaction occurring during the three years immediately preceding the date of the filing of the petition;
(F) a customs duty arising out of the importation of merchandise—
(i) entered for consumption within one year before the date of the filing of the petition;
(ii) covered by an entry liquidated or reliquidated within one year before the date of the filing of the petition; or
(iii) entered for consumption within four years before the date of the filing of the petition but unliquidated on such date, if the Secretary of the Treasury certifies that failure to liquidate such entry was due to an investigation pending on such date into assessment of antidumping or countervailing duties or fraud, or if information needed for the proper appraisement or classification of such merchandise was not available to the appropriate customs officer before such date; or
(G) a penalty related to a claim of a kind specified in this paragraph and in compensation for actual pecuniary loss.
An otherwise applicable time period specified in this paragraph shall be suspended for any period during which a governmental unit is prohibited under applicable nonbankruptcy law from collecting a tax as a result of a request by the debtor for a hearing and an appeal of any collection action taken or proposed against the debtor, plus 90 days; plus any time during which the stay of proceedings was in effect in a prior case under this title or during which collection was precluded by the existence of 1 or more confirmed plans under this title, plus 90 days.

Unlisted Creditors

I have written several times about how important it is to disclose all debts on your bankruptcy schedules

  • regardless of whether the debt can be discharged
  • regardless of your intention to repay the debt, and
  • regardless of your relationship to the creditor

as a matter of due process requirements.
Nevertheless, cases like Guseck pretty much nullify any need to worry about unlisted schedules for no-asset Chapter 7 cases.  11 U.S.C. § 523(a)(3) limits the non-dischargeability of unlisted debts to cases involving distributions where a creditor must file a claim, such as Chapter 7 cases with non-exempt assets or voidable preferences or Chapter 13 cases.
In any case where a creditor must file a claim to be paid out of the bankruptcy estate, the creditor must file a claim before a particular deadline, and the bankruptcy rules (Fed. R. Bankr. P. 9006(b)(3)) prohibit the deadlines from being expanded except under specific circumstances.  Therefore, it is usually the case that by the time an omitted creditor finally learns about the bankruptcy, it is too late for them to file a proof of claim.
The good news for the creditor is that their debt is non-dischargeable.  The bad news is that, despite being barred from filing a claim, they are still bound by the automatic stay while the bankruptcy is pending.
Or are they?
Speaking at the Annual Bankruptcy Update in Milwaukee last month – Judge Halfenger suggested that such a creditor might also have grounds to obtain relief from the automatic stay under 11 U.S.C. § 362(d).
One more thing to keep in mind when you’re checking your schedules to make sure all creditors have been listed…

Missed Debts, New Debts, and Conversion

You filed for bankruptcy.  A year later, you’re sitting at your dining room table staring at a billing statement for medical services.  Do you have to pay it?
Step 1 – Gather the Relevant Data

  1. When exactly (i.e. what date) was your bankruptcy case filed?
  2. What chapter of bankruptcy did you file under?  Chapter 7?  Chapter 13?
  3. Was this bill listed on your bankruptcy schedules?
  4. When was the debt incurred (in this example – what was the date of service)?
  5. What is the billing address and the statement date?
Step 2 – Determine What Kind of Debt This Is
  1. If the debt was incurred before your bankruptcy filing date, then it is a pre-petition debt.
  2. If the debt was incurred after your bankruptcy filing date, then it is a post-petition debt.
Pre-Petition Debts
  1. If the debt was listed on your bankruptcy schedules, then check the address to determine if notice was sent out to the right place.  Also check the statement date.  If within a few days of your bankruptcy filing date, then this may be a harmless “letters crossed in the mail” situation.  If the statement date is substantially after your bankruptcy filing date, then you are likely looking at a stay or discharge violation.
  2. If the debt was not listed on your bankruptcy schedules and you filed a Chapter 7 case that had no distributions (the trustee did not sell any non-exempt assets, recover any preferences, or void any transfers) and the debt was otherwise dischargeable, then the debt is discharged.  (This is a result of case law called “Guseck” in the Eastern District of Wisconsin.  If you filed bankruptcy in another district, a different result may occur.)
  3. If the debt was not listed on your bankruptcy schedules and you filed a Chapter 13 case or a Chapter 7 case that had distributions, then the debt is non-dischargeable under 11 U.S.C. sec. 523(a)(3).
Post-Petition Debts
  1. Post-petition debts are generally non-dischargeable with one exception.
  2. If you file Chapter 13, then later convert to Chapter 7, debts incurred between the filing and conversion dates may be dischargeable under 11 U.S.C. sec. 348(d).

Cases of Note: Fahey; and whether certain taxes can be discharged in bankruptcy.

Most people assume that taxes cannot be discharged in bankruptcy.  While it is true that some taxes cannot be discharged, some can.  11 U.S.C. § 523(a) reads as follows:
A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt—
(1) for a tax or a customs duty
(A) of the kind and for the periods specified in section 507(a)(3) or 507(a)(8) of this title, whether or not a claim for such tax was filed or allowed;

(B) with respect to which a return, or equivalent report or notice, if required

(i) was not filed or given; or

(ii) was filed or given after the date on which such return, report, or notice was last due, under applicable law or under any extension, and after two years before the date of the filing of the petition; or

(C) with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax;

For purposes of this discussion, I’m not going to go through a detailed analysis of § 507 nor discuss how the outcome is different if filing under Chapter 7 or Chapter 13 (though it is worth noting that taxes – even non-dischargeable taxes – can be folded into a Chapter 13 bankruptcy case, just like child support arrears and student loan debt).  Suffice it to say, taxes that are more than 3 years old are generally dischargeable, provided that one of about a half dozen exceptions doesn’t apply.  Whether a tax is dischargeable or not is intensely fact-specific, sometimes not entirely knowable in advance, and certainly not worth the effort of walking through all of the various contingencies.
What I do want to discuss is the hanging paragraph at the end of § 523(a)…
For purposes of this subsection, the term “return” means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements). Such term includes a return prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986, or similar State or local law, or a written stipulation to a judgment or a final order entered by a nonbankruptcy tribunal, but does not include a return made pursuant to section 6020(b) of the Internal Revenue Code of 1986, or a similar State or local law.
The First Circuit Court of Appeals has recently handed down a decision In re: Fahey, joining Fifth and Tenth Circuits in holding that taxes due for a retun that is filed after the date which the return is due cannot be discharged because a late-filed return does not meet the definition in the hanging paragraph, DESPITE § 523(a)(1)(B)(ii)’s apparent directive to the contrary.
Wisconsin falls within the 7th Circuit, so these rulings do not yet affect cases filed here.  Some courts have held to the contrary of Fahey.  If any of them is affirmed by their respective Circuit Court of Appeals, then a circuit-level split will occur which makes it likely that the U.S. Supreme Court will step in to resolve this question.

The lesson?

Even if this patterns ends up reversed, § 523(a)(1)(B)(ii) will still prohibit discharge of late-filed returns filed within the past two years.  If you owe the IRS or your state department of revenue money for taxes and you can’t afford to pay those taxes, you achieve nothing by postponing the filing of your tax return or not filing your tax return at all.

File your tax returns by the due date.  Worry about paying the taxes later.  At the very least, by filing your returns on time, you open up more avenues of resolution down the road, especially if you ultimately end up filing for bankruptcy.  If you file your returns late – at the very best, you’re forcing yourself to have to wait even longer for them to be dischargeable, and at the very worst – you may be ensuring that they are never dischargeable.

Debt Collector Threats / Scaring People Away from Bankruptcy

I’ve written previously on the topic of debt collectors who threaten people with criminal charges if they don’t pay their bills.  That post is just over three years old, and so I wanted to update that post and also talk about another common threat – that your debt can’t be included in your bankruptcy case.
First and foremost, what CAN debt collectors do?

  1. Prior to filing for bankruptcy, any creditor has the right to file a lawsuit and obtain a judgment against you for the debt you owe.  Once your bankruptcy case is filed, any civil litigation that hasn’t begun is prevented and any civil litigation that is pending is terminated.
  2. Creditors who believe that they can make a criminal case for fraud can press charges with the appropriate prosecuting agency.  Bankruptcy does not stop these proceedings.
  3. If a creditor believes they can make a case for fraud or misrepresentation (523(a)(2)), fraud or embezzlement in a fiduciary capacity (523(a)(4)), or willful or malicious injury (523(a)(6)), then they can file an adversary proceeding to have the debt declared non-dischargeable.

But here’s what a debt collector can NOT do.

  1. Enforce a civil judgment that is discharged in bankruptcy.  Civil lawsuits and judgments – in and of themselves – are not special debts.  Just because a judgment has been entered against you does not mean that the debt cannot be discharged in bankruptcy.
  2. Creditors cannot seek to collect a debt by threatening criminal prosecution.  What does that mean?  It means that if they think they have a criminal case, then they should just press charges.  They cannot try to strike a deal with you where they drop the charges in exchange for payment from you.  If they do, then they are potentially guilty of two things…
    1. If a bankruptcy case has been filed and they make these threats, then they are in violation of the automatic stay.  Acts of criminal prosecution are distinguishable from threats of criminal prosecution.  The former is not stayed by bankruptcy, but the latter is stayed.  Desert Palace, Inc. v. Baumblit (In re Baumblit), 15 Fed. Appx. 30, 35-36 (2d Cir. N.Y. 2001) and Batt v. Am. Rent-All (In re Batt), 322 B.R. 776, 779 (Bankr. N.D. Ohio 2005).
    2. Even if a bankruptcy case is not filed, they would be guilty of criminal extortion in Wisconsin, under Wis. Stat. sec. 943.30.

Here are some other important things to remember…
Just because a creditor has the right to file an adversary proceeding under 523(a)(2, 4, or 6), and just because a creditor has the right to press criminal charges, that doesn’t mean that they’re going to.  The intent element to showing fraud is extremely difficult to prove.
99% of the time, the debt collector is blowing smoke – trying to scare you into paying the debt rather than filing for bankruptcy.  It’s an incredibly successful tactic, but also an illegal one.

A Double Standard on Missing Creditors

A general rule in bankruptcy is that you are required to disclose all creditors on your bankruptcy schedules as a matter of due process.  All creditors – whether their debts are dischargeable or non-dischargeable, whether you intend to reaffirm their debts or not – have certain rights and responsibilities when the bankruptcy case is filed and the stay goes into effect, and therefore, they are entitled to notice so they can act appropriately.
11 USC 523(a)(3) generally makes debts non-dischargeable if they are not disclosed on your bankruptcy schedules, however, only under certain conditions.  Specifically, each one is predicated on the creditors ability to timely file a proof of claim.
Except… creditors of debtors in Chapter 7 Bankrputcy don’t file claims unless the trustee seizes an asset or recovers a preference for the benefit of creditors.  So unless there is an asset to liquidate in Chapter 7 or if the debtor files Chapter 13, there are no proofs of claim to file.
Combine this with Judge Kelley’s decision in Guseck, which holds that a case need not be reopened to add a garden-variety creditor that was inadvertantly ommitted from the debtor’s schedules.
The end result?  A debtor who forgets to list a debt in a no-asset Chapter 7 generally suffers no penalty if they forget a creditor.  They simply need to provide notice of the bankruptcy to the creditor after-the-fact, and – at worst – pay a filing fee to amend their schedules.  The debt is still discharged.
A debtor who forgets to list a debt in an asset Chapter 7 or in a Chapter 13 case will be stuck with a non-dischargeable debt if the error is not caught before the deadline for creditors to file claims.
It’s easy to know which chapter you’re filing under, but not always easy to know if a Chapter 7 case will be an asset case or a no-asset case.
The lesson?  Read your schedules of creditors (Schedules D-H) very carefully before your bankruptcy case is filed.  A credit report does not always reveal all debts.  Make sure that no debts are missing from the schedules.

Can I file bankruptcy against my tax debts?

Many people who are suffering from burdensome debt also count, among their creditors, the Internal Revenue Service and the Wisconsin Department of Revenue.  They wonder what – if anything – can be done about their tax debt.
To answer this question, we look to 11 U.S.C. § 523 – the statute that describes the types of debts that cannot be discharged.  § 523(a)(1) describes certain types of taxes that cannot be discharged in bankruptcy – the most common of which are being income taxes that are further described at 11 U.S.C. § 507(a)(8).  When you boil away the excess verbiage, § 507(a)(8) is basically describing income taxes owed for tax returns that were due within 3 years of filing.
For example – today is July 7, 2014.  Taxes owed for 2011, 2012, and 2013 would generally be considered priority taxes, and therefore non-dischargeable.  Notwithstanding any tax liens that may exist, any remaining tax debt would be considered non-priority, and dischargeable.
Now, there are a handful of ways for older tax debts to still retain priority status (the excess verbiage we boiled away) – such as any new assessments in the past 8 months, if the tax returns were filed late, or if there was a prior stay of collections.
So what does all of this mean?  Well, in Chapter 7 – the result is fairly simple.  Priority tax debts are non-dischargeable and will survive.  Non-priority tax debts are dischargeable (though tax liens will survive) and will go away after bankruptcy.
BUT – just because your tax debts are non-dischargeable doesn’t mean you can’t do anything about them in bankruptcy.  In Chapter 13, priority tax debts can be rolled into the plan.  Generally, they are paid in full with no additional interest (the taxing authority may – in rare cases – stipulate to be paid less than in full of their priority claim, though that stipulation will usually include a provision asserting that the unpaid portion will remain non-dischargeable and survive the bankruptcy).
By the way – what’s true of priority taxes is also true of other priority debts, such as domestic support obligation (child support, alimony, or maintenance) arrears.  Other non-dischargeable debts can also be folded into Chapter 13 bankruptcy, such as student loans.  But since student loans are not a priority debt, they do not have to be paid in full (though the unpaid balance would survive the bankruptcy).
If tax liens have been filed against you, those would also have to be paid in full in a Chapter 13 Bankruptcy (and with nominal interest), but they are secured only to the extent that there is equity in property.  For example, say that a person has a $100k house with an $80k mortgage, a $20k car with a $15k lien, and $10k in personal property – the available security would be ($20k + $5k + $10k) = $35k.  If the amount of tax lien is less than $35k, then the whole amount is treated as secured.  If the amount of the tax lien is more than $35k, then only $35k of it is treated as secured.
It’s a lot to digest, and worthy of a detailed discussion with your bankruptcy attorney.  But the main points to take away are that (1) some tax debts can be discharged in bankruptcy, and (2) tax debts that cannot be discharged can be addressed in Chapter 13.

Don’t Fear Chapter 13 Bankruptcy; In Fact, It May Be the Better Option

In the past, I’ve written about how people refuse to consider bankruptcy as a tool to help them get out of financial trouble based on rumors and myths that are – frankly – untrue.
For example, many people are afraid to file for bankruptcy because they have heard from someone else that they will lose their house, their car, or their tax refund.  And while it certainly is true that some people lose those things in bankruptcy, the circumstances required for that to happen are actually pretty rare.  Furthermore, those circumstances are almost always identifiable in advance.  Meaning, a competent attorney can tell you if you’re at risk of losing any of these things at the initial consultation, before you pay the attorney a single penny.  And if that wasn’t enough – even if those circumstances do exist, they are avoidable given proper strategy.
So, if you’re struggling financially, it doesn’t hurt to consult with an attorney to get the facts about bankruptcy so you can make an informed decision.  Don’t disregard the option until you know exactly how it will affect you.
Today, however, I want to delve into the mysterious world of Chapter 13.  Even if someone has accepted that bankruptcy is something that they need to do, many people are deathly afraid of Chapter 13.  They hear “3-5 year repayment plan” and they assume that means that they have to pay all of their debt back, and if they’re filing for bankruptcy, why on earth would they want to file Chapter 13?
Like many myths and rumors, there is some basis in reality.  For instance, yes, Chapter 13 does involve making payments on debts, and yes, the plans usually last from 3-5 years.  But very few people end up paying back all of their debt.  In fact, some people end up faring better in Chapter 13 than they would have in Chapter 7.
How?  Well, let’s consider a typical Chapter 7 case.  Family of four (mom, dad, son, and daughter) have a combined household income of $60,000.  They have a mortgage, two car loans, and let’s say $40,000 in credit card and medical debt.  They qualify for and file a Chapter 7 bankruptcy.  They make no payments to the trustee.  But are they still paying on debt?  Well, yes – they decided to reaffirm their home and car loans.  So, they’re still making monthly payments.  Chapter 7 didn’t wipe out all of their debts.  But it did wipe out the $40,000 in credit card and medical debt.  Is this family happy?  Yes.  Could they have been happier in Chapter 13?  Maybe.  It depends on the circumstances.
For instance…
  1. What if they had two mortgages, and they were already underwater with just the first mortgage?
  2. What if their vehicles are older and worth next to nothing, but they still have huge balances on them?  Or high interest rates?
  3. What if they have massive tax debts, child support obligations, or student loans?

In Chapter 13, we can do special things that we can’t do in Chapter 7.
For instance…
  1. If there is no equity for which a second mortgage to attach to your house, we might be able to get rid of the second mortgage.
  2. We can cram-down vehicle loans so that you pay what the car is worth instead of the actual balance.  We might also be able to reduce your interest rates on the auto loan.
  3. While taxes, child support, and student loans cannot be discharged in bankruptcy, they can be handled in Chapter 13 bankruptcy, which means you will exit bankruptcy with less debt, and while paying 0% interest on many of these debts.

In essence, most people who would qualify for Chapter 7 bankruptcy would get the same level of discharge of their unsecured debts in a Chapter 13, PLUS they would enjoy a few additional benefits that they could not have gotten in Chapter 7.  In the above example, the debtors still get a discharge of their $40k in credit card and medical bills, whether they file Chapter 7 or Chapter 13.  They also still must pay on their house and cars, whether they file Chapter 7 or Chapter 13.  But at least in Chapter 13, they got to pay less on their house and car loans, due to lien stripping and cram-downs.
In the interest of full disclosure, people who qualify to file Chapter 7 but choose to file Chapter 13 may end up paying some of their unsecured debt back.  This can be due to a variety of administrative concerns (interest-bearing priority and secured debts are paid before unsecured debts; rounding numbers; commitments of tax refunds; claims coming in lower than anticipated; etc.).  But an experienced and knowledgeable Chapter 13 bankruptcy attorney can help you minimize the amounts paid to unsecured creditors.  And even if the unsecured creditors do get some money (more than the $0 they would have gotten in Chapter 7), the other benefits of Chapter 13 could vastly outweigh any nominal amounts paid on unsecured debts.
It is also true that some Chapter 13 debtors end up paying back all of their debt.  This is because either their income to debt ratio is too high to permit a discharge, or there is some other circumstance in the case that requires it.  Why on earth would someone file bankruptcy just to have to pay it all back?
Again – it’s important to realize that while a discharge is the main benefit of bankruptcy, it is not the only benefit.  Even in a “100% Chapter 13 Plan”, the debtor still enjoys reduced or no interest rates (in this district, all debts receive 0% interest with the exception of tax liens, property taxes, auto loans, and other secured loans).  Bankruptcy also bestows the automatic stay, which prevents wage garnishment, utility shut-offs, repossessions, foreclosures, harassment, and other invasive debt collection tactics.  In short, you get to pay back the debt on your terms – in a structured manner – with court protection.