Bankruptcy Can Solve Your Debt Problems Even If You Can't Write Off Every Debt

Don’t disregard bankruptcy as an option just because it does not write off the debt which is your immediate big headache. There’s likely some good medicine for that headache after all.

Let’s say you owe a dreadfully large income tax debt from a couple of years ago. The IRS is getting aggressive about collecting it. You know for a fact that bankruptcy doesn’t discharge (legally write off) income tax debts, so you’re not seriously considering that option and have not seen a bankruptcy attorney.

You may or may not be right about whether or not that tax debt can be discharged. That’s almost always a matter of timing. So if indeed you could not discharge your debt a few months ago, that might not be true today, or might not be true a few months from now.)But whether or not the debt can be discharged,  either way, you would probably be wrong about not getting legal advice about it.

Why? Whether that special debt that you know can’t be discharged is a tax debt, back child support, student loans, or some other troublesome debt, here are six reasons you should STILL get legal advice about the bankruptcy  option:

1. Some debts which look like they can’t be discharged actually can. Certain income taxes can be discharged in either a Chapter 7 or Chapter 13 case, depending on how old they are and a series of other factors. Sometime a portion of an otherwise not dischargeable tax debt—such as the penalties—can be discharged, sometimes significantly reducing the amount you need to pay. Student loans are difficult to discharge, but in some unusual situations can be. And even though true child support obligations are not dischargeable, in rare situations a debt which you thought was a support obligation might not fit the legal definition for bankruptcy purposes. It’s certainly worth finding out whether the debt you assume can’t be discharged actually might be able to be.

2. Some debts that can’t be discharged now may be able to be in the future. Almost all income taxes can be discharged after a series of conditions have been met. So your attorney can put together for you a game plan coordinating these tax timing rules with all the rest of what is going on in your financial life. Timing issues can sometimes also be important with student loans, especially if you have a worsening medical condition or are simply getting close to retirement age

3. Even if you can’t discharge a debt, bankruptcy can permanently solve an aggressive collection problem.  In many situations your primary problem is the devastating way a debt is being collected. For example, you may want to pay an obligation for back child support but the state support enforcement agency is about to suspend your driver’s and/or occupational license. A Chapter 13 case will stop these threats to your livelihood, and protect you from them while you catch up on the back support.

4. You have more control over the amount of the monthly payments on debts that cannot be discharged. Debts which the law does not allow to be discharged in bankruptcy also tend to be ones that give the creditors a lot of leverage against you. Chapter 13 takes most of this leverage away from them and puts their power on hold while you pay what your budget allows, not what these creditors would otherwise be gouging out of you.

5. Bankruptcy can stop the adding of interest, penalties, and other costs, allowing you to pay off a debt much faster. Unpaid income taxes and certain other kinds of debts are so much more difficult to pay off because a part of each payment goes to the ongoing interest and penalties. Some tax penalties in particular can be huge. Most of these ongoing add-ons are stopped by a Chapter 13 filing, allowing you to become debt-free sooner.

6. Bankruptcy allows you to focus on paying off the debt(s) that you can’t discharge by discharging those you can. You may have both a debt or two that can’t be discharged and a bunch of debts that can be. Even if bankruptcy can’t solve your entire debt problem directly, discharging most of your debts would likely make that problem much more manageable. Under Chapter 7, you would be able to pay off those surviving debts much faster, which is especially important if they are accruing interest or other fees. And under Chapter 13 you would have the benefit of a predictable payment program, one that focuses your financial energies on those nondischargeable debts while protecting your assets and income from them.

So don’t let the fact that you have a debt or debts that can’t be discharged in bankruptcy stop you from getting legal advice about how your overall financial life could still be much improved through one of the bankruptcy options.  

Debts with Collateral--THE Fixation of Many Bankruptcies

Your vehicle loan, home mortgage, account at the appliance or electronics store, and maybe a debt that’s resulted in a judgment lien—these debts with collateral are the ones that grab the most attention during a bankruptcy case. And that includes the attention of the creditors, very interested in “their” collateral.

 

General unsecured debts, which I talked about in the last two blogs, are pleasantly boring in most bankruptcy cases. In a Chapter 7 case, they are generally discharged (legally written off) without any opposition by the creditors, who usually get nothing. And in a Chapter 13 case, general unsecured debts are often just paid whatever money is left over after the secured and priority debts, and trustee and attorney fees, are paid. Nice and boring. That’s because the creditors don’t have much to fight about.

But with secured debts—debts with collateral—both sides have something to fight about—the collateral. The creditors know that the vehicle or house or other collateral is the only thing backing up the debt you owe to them, so they can get quite pushy about protecting that collateral.

The next few blogs will be about how you use either Chapter 7 or Chapter 13 to deal with the most important kinds of secured debts. Today we start with a few basic points that apply to just about all secured debts.

Two Deals in One

It helps to look at any secured debt as two interrelated agreements between you and the creditor. First, the creditor agreed to give you money or credit in return for your promise to repay it on certain terms. Second, you received rights to—and usually title in—the collateral, with you in return agreeing that the creditor can take that collateral if you don’t comply with your first agreement to repay the money.

Generally, bankruptcy will absolve you of that first agreement—your promise to pay—but the creditors’ rights to collateral survive bankruptcy (except in certain rare situations we will highlight later). Your ability to discharge the debt gives you some options, and can sometimes give you a certain amount of leverage. But the creditors’ rights about the collateral give them certain options and leverage, too. You’ll see how this tug-of-war plays out with vehicle and home loans, and few other important secured debts.

Value of Collateral

In that tug-of-war between your power to discharge the debt and a creditor’s rights to the collateral, how much the collateral is worth as compared to the amount of the debt becomes very important. If the collateral is worth a lot more than the amount of the debt, the creditor is said to be well-secured. It has a much better chance of having the debt be paid in full. You’ll really want to pay off the relatively small debt to get the relatively expensive collateral free and clear of that debt. Or if you didn’t make the payments the creditor will get the collateral and sell it for at least as much as the debt.

If the collateral is worth less than the amount of the debt, the creditor is said to be undersecured. It is much less likely to have this debt paid in full. You’ll be less likely to pay a debt only to get collateral worth less than what you’re paying. And if you surrender the collateral the creditor will sell it for less than the debt amount.

Depreciation of Collateral, and Interest

With the value of the collateral being such an important consideration, the loss of value through depreciation is something that creditors care about, a concern which the bankruptcy court respects. Also, in most situations secured creditors are entitled to interest. So, you’ll see that in fights with secured creditors, this issue about the combined amount of monthly depreciation and interest often comes into play.

Insurance

Virtually every agreement with a secured creditor—certainly those involving vehicles and homes—requires that you carry insurance on the collateral. If the collateral is damaged or destroyed, this insurance usually pays the debt on the collateral before it pays you anything. And, if you fail to get the required insurance—or sometimes even if you simply don’t inform the creditor about having the insurance—the creditor itself is entitled to buy “force-placed” insurance to protect only its interest in the collateral, AND charge you the often outrageously high premium.

 

With these points in mind, the next blog will tell you your options with your vehicle loan under Chapter 7.

Short Sales: Seldom Easy and Often Not What You Expected

A short sale of your home is sometimes your best alternative. But short sales often do not successfully close, and even when they do you may get a rude surprise.

In a short sale, a house is sold by “shorting”—underpaying—one or more of the lienholders, because the value of the house, and thus the purchase price, is not enough to pay everyone in full. The liens can include not just voluntary ones such as the first and second mortgage, but also judgments, income taxes, support obligations, unpaid utilities, and property taxes. All lienholders must consent and release their liens, or the sale cannot occur. There may or may not be subsequent liability for the homeowners to those lienholders who were not paid in full.

The primary benefit of a short sale is that it avoids a foreclosure on the homeowner’s credit record—that is, it does so IF the short sale is successful. Even so, in the present economic climate there are some indications that there will be less credit record difference between a short sale and a foreclosure. So if you are using this credit record difference as the primary reason try to do a short sale, it may well not be your best course of action.

Short sales have two main problems.

First, they are generally much harder to pull off than expected, taking much longer, and often fail to close, putting the homeowners further behind, with dashed expectations. They usually don’t work because:

• Unhelpful and slow mortgage lenders: To accomplish a short sale, usually the first mortgage holder has to give up some money to a junior lienholder or two. The benefit to the first mortgage holder is that getting a little less out of the sale is better than incurring the delay and cost of foreclosure. But many mortgage companies are not well organized or staffed to handle such negotiations. You are often forced to work through a servicing company, whose financial incentives may well not encourage short sales. So they may drag their heels, and can even sabotage your efforts.
• Since all lienholders must agree, any one of them can kill the deal: Everybody wants their “fair share” of a pie that is too small to make everybody happy. Just when you think you have a deal among the main players , someone else crawls out of the woodwork demanding a payment and jeopardizing the closing. They all have a legal claim against the property, and can delay or undo the whole deal.
• The middlemen have the most to gain: Realtors and others in the real estate sales industry often benefit more from a short sale than you do. Realtors without enough homes to sell have to close sales to survive—even if they are paid less in a short sale than otherwise to help the deal happen. Some “short sale specialists” are indeed expert in this type of transaction, but if it is all that they do then you need to be concerned that they may be like the proverbial “person with a hammer to whom everything looks like a nail.” There are good reasons that unbiased observers—like bankruptcy judges—tend to take a dim view of short sales, seeing them as mostly a way for the middlemen to make money on you.

Second, short sales are dangerous:

• Potential liability from unpaid balances on the junior mortgages and liens: Although you may be told that you will not be liable, you need to be sure that the settlement documents and the applicable law in fact cut off any liability. Also be aware that sometimes in the midst of the negotiations, especially if a junior lienholder is playing tough, and the closing has been delayed for a long time, you may be feel forced to accept some liability in order for the closing to occur.
• Potential tax consequences: This issue deserves a whole blog by itself. The key principle is that debt forgiveness can be treated as income subject to taxation unless you fit within one of the exceptions. Make sure you talk with an appropriate tax specialist about this before investing any time or expectations in the short sale option.

Three Big Ways Bankruptcy Helps with Income Taxes

Bankruptcy CAN 1) legally write off some income taxes; 2) stop IRS wage garnishments, bank account levies, and tax liens; and 3) enable a faster payoff of the taxes you must pay, by avoiding most ongoing interest and penalties.

In the last two blogs I explained what happens to tax refunds in Chapter 7 and 13. But what if instead you owe income taxes? The treatment of tax debts in bankruptcy is a complicated subject, but here today I’m covering the most basic and important powers of bankruptcy over taxes.

1) The ability to “discharge” (write-off) income taxes:

I’m not going into the detailed rules here, but let me clear up any possible confusion: income taxes can be discharged if they meet some very specific conditions. Among those conditions:

• the age of the particular tax
• whether and when the tax return was filed
• whether there was any effort to enter into an “offer in compromise”
• whether there is evidence of tax evasion

Generally the older the tax, the more likely it will be discharged, although some of the conditions are not time-based.  If you owe more than one year of income taxes, then each year of tax debt is analyzed separately. In fact portions of each tax year’s debt—tax, interest, and penalties—are treated differently in many situations. To be clear, taxes can be discharged under either Chapter 7 or Chapter 13. So determining which of these two options is better requires carefully comparing how each treats your tax debts, as well as all your other debts.

2) The “automatic stay” applies to the IRS, and to the state and local taxing authorities:

Changes in the law tend to cause confusion, to get blown out of proportion. The last major overhaul of the bankruptcy laws by Congress in 2005 allowed the IRS and other tax agencies to do certain very limited things in spite of the taxpayer having filed a bankruptcy. These limited exceptions to the automatic stay include:

• conducting (or continuing) a tax audit (but not taking any action outside the bankruptcy court to collect the tax resulting from the audit)
• issuing a notice of deficiency
• assessing the taxes
• issuing a “notice and demand” (although again without taking any collection action)

Otherwise, just like all other creditors, the IRS and its state and local cousins cannot pursue collection of any liabilities while your bankruptcy case is pending, except in the unusual event that the bankruptcy court gives special permission to do so.

3. As for taxes that cannot be discharged, Chapter 13 usually provides a way to avoid most ongoing interest and penalties, reducing the total amount of taxes to pay:

Back taxes often take a long time to pay off because interest and penalties keep accruing while you are making the payments. Especially if your payments are relatively small, the additional interest and penalties can greatly increase the total you end up paying. But in a Chapter 13 case, the penalties stop accruing as soon as soon as your case is filed. Even the earlier penalties are treated like normal debt and so are often paid little or not at all. And interest does not get added unless that tax debt is covered by a recorded tax lien.  In combination these benefits can save lots of money. This lack or reduction in accruing interest and penalties also allows you to pay other important debts before paying the taxes—such as vehicles or home mortgage arrears. This allows you to better protect those valuable possessions by paying their debts faster.