Articles Posted in Tax Debt

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Nicholas Eckhart [CC BY 2.0 (https://creativecommons.org/licenses/by/2.0/)], via FlickrChapter 7 bankruptcy enables qualifying debtors to pay down their debts by liquidating their non-exempt assets, followed by a discharge of many remaining debts. In order to qualify for a Chapter 7 discharge, debtors must demonstrate that they meet the criteria set out in the “means test,” 11 U.S.C. § 707(b). A trustee or creditor may ask the court to convert a Chapter 7 “liquidation” case to a Chapter 11 “reorganization” case for good cause, such as if they believe that the debtor does not qualify under the means test. Individual debtors rarely use Chapter 11, but a court cannot convert a Chapter 7 case to Chapter 13 without the debtor’s agreement. 11 U.S.C. § 706(c). A bankruptcy court recently ruled that a married couple could not file under Chapter 7 and essentially encouraged them to use Chapter 13 instead. In re Decker, No. A14-00065, memorandum (D. Alaska, Mar. 31, 2015).

The debtors in Decker have a complicated history of financial problems, as described by the bankruptcy court. Their adult daughter has required their ongoing support for medical problems and addiction recovery since 2009. The debtors began having serious issues with the Internal Revenue Service (IRS) in 2007, when it assessed deficiencies for the previous two tax years. Those debts have reportedly continued to accrue.

When the debtors filed their Chapter 7 petition in March 2014, they identified almost $426,000 in debts. Debts owed to the IRS included over $102,000 in priority debt and $81,000 in non-priority debt. The IRS filed a proof of claim for more than $204,000 in taxes, interest, and penalties. They also identified tax debts owed to the states of California and Alaska. The $35,000 in personal property identified in their schedules is all exempt or subject to liens.

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By BenFrantzDale (Own work) [GFDL (http://www.gnu.org/copyleft/fdl.html), CC-BY-SA-3.0 (http://creativecommons.org/licenses/by-sa/3.0/) or CC BY-SA 2.5-2.0-1.0 (http://creativecommons.org/licenses/by-sa/2.5-2.0-1.0)], via Wikimedia CommonsA bankruptcy court recently ruled on a seeming conflict between two sections of the Bankruptcy Code dealing with proofs of claim (POCs) for tax debts. In re DeVries, No. 13-bk-41591, mem. dec. (Bankr. D. Id., Apr. 28, 2015). The Chapter 13 trustee objected to a POC filed by the debtors on behalf of the Internal Revenue Service (IRS) for their 2013 federal income tax. The court ruled that only a creditor may file a POC for tax debts incurred after the date the debtors file their petition, drawing on multiple precedent cases to determine precisely when tax debt is “incurred.”

The debtors filed a Chapter 13 petition in December 2013, and the court set a deadline in June 2014 for creditors, including the IRS, to file POCs. The IRS timely filed POCs for tax debts from 2011 and 2012. The debtors filed their 2013 federal income tax return in April 2014, which showed that they owed $1,021 to the IRS. The bankruptcy court confirmed the debtors’ Chapter 13 plan that May. The plan included full payment of all allowed tax claims.

The IRS did not file a POC for the 2013 tax debt by the June 2014 deadline. The debtors therefore filed a POC on behalf of the IRS the following month. The Bankruptcy Code generally allows a debtor to file a POC for a creditor if the creditor misses the filing deadline. 11 U.S.C. § 501(c), Fed. R. Bankr. P. 3004. The trustee objected to the debtors’ POC, however, arguing that only creditors may file “for taxes that become payable to a governmental unit while the case is pending.” 11 U.S.C. § 1305(a)(1).

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By Chuck Kennedy [Public domain], via Wikimedia CommonsCongress passed the Affordable Care Act (ACA), also known as “Obamacare,” in 2010, but some of its more controversial provisions did not take full effect until last year. The requirement that individuals and families either have qualifying health insurance coverage or pay a penalty, formally known as the “Individual Shared Responsibility Payment” (ISRP), became effective on January 1, 2014. The penalty does not become fully effective, however, until 2016. This provision has proven controversial for a variety of reasons. Our goal here is not to delve into the politics, but rather to explore what is required of people who are in serious financial distress. Federal regulations allow multiple exemptions from the insurance requirement and the ISRP, including a hardship that prevents a person from obtaining qualifying insurance. The government has interpreted this to include filing for bankruptcy in the previous six months.

The ACA made a number of changes to the U.S. health care system. The most significant changes affect the health insurance business, which along with Medicare and Medicaid provides most of the financing of health care in this country. People without insurance coverage or access to government assistance often find themselves unable to afford medical care, and medical bills are often a factor in bankruptcy cases. Whether the ACA addresses this issue adequately or appropriately has been a subject of much contention, but it seems clear at this point that it has made a difference for many people.

The “individual mandate,” which requires people to obtain health insurance or pay the ISRP, has been one of the most controversial features of the ACA. The idea behind the individual mandate is that everyone who can afford health insurance should buy a minimal amount of coverage to ensure that enough money is available in the system to cover everyone’s health care costs. If healthy people waited until they were sick or injured to pay for insurance, the theory goes, costs would go up for everyone. This has reportedly happened in states that required insurers to cover pre-existing conditions but did not require people to have insurance.
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Microsome at the German language Wikipedia [GFDL (http://www.gnu.org/copyleft/fdl.html) or CC-BY-SA-3.0 (http://creativecommons.org/licenses/by-sa/3.0/)], via Wikimedia CommonsAn extravagant lifestyle was not enough to overcome the presumption that debts incurred prior to filing for bankruptcy, including tax debts, are dischargeable, according to the Ninth Circuit. Hawkins v. Franchise Tax Bd. of California, No. 11-16276, slip op. (9th Cir., Sept. 15, 2014). The court considered whether the debtor’s tax debt was not subject to discharge under the exception for “willful[] attempt[s]…to evade such tax.” 11 U.S.C. § 523(a)(1)(C). After noting that the question of the mental state required to prove a “willful attempt to evade tax” was a matter of first impression, it held that the statute requires proof that a debtor specifically intended to evade tax liability. The debtor’s spending prior to filing bankruptcy, while “lavish,” was not out of the ordinary for him, and the tax debt was therefore dischargeable in bankruptcy.

The debtor made a substantial amount of money in the technology industry. He was an early employee of Apple, which he left to found the software and video game company Electronic Arts (EA). In 1990, he left EA to run a newly-created EA subsidiary called 3DO, which was entering into the video game and console market. By 1996, his net worth was around $100 million. He sold much of his EA stock and invested in 3DO. The Ninth Circuit’s opinion describes a series of accounting techniques using offshore corporations in order to claim losses on the sales of EA stock.

3DO filed for Chapter 11 bankruptcy in 2003 and later converted the case to a Chapter 7 liquidation. The debtor never received any substantial payouts from the liquidation of the business. The IRS began challenging his tax shelters in the late 1990s, and in 2005 it and the California Franchise Tax Board (FTB) assessed a total balance of over $36 million in unpaid taxes, penalties, and interest. The debtor sold some real property and applied all of the proceeds to the IRS balance in 2006, and the FTB also seized some financial accounts. In September 2006, the debtor and his wife filed for bankruptcy. The IRS and FTB filed proofs of claim for $19 million and $10.4 million, respectively. Continue reading

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geralt [Public domain, CC0 1.0 (https://creativecommons.org/publicdomain/zero/1.0/deed.en)], via PixabayFederal bankruptcy law allows debtors to discharge tax penalties if they meet certain criteria. The Internal Revenue Service (IRS) may penalize individual taxpayers for failing to file a tax return by the April 15 due date, 26 U.S.C. § 6651(a)(1). These penalties are dischargeable in bankruptcy if the “transaction or event” that resulted in the penalty happened at least three years before the filing date. 11 U.S.C. § 523(a)(7)(B). A California bankruptcy court recently considered when the “transaction or event” leading to penalties for a late-filed tax return actually occurred. The court agreed with the debtor’s argument, which placed the event more than three years before the filing date. In re Wilson, No. 12-11995, Adv. No. 14-1106, memorandum (Bankr. N.D. Cal., Feb. 25, 2015). The federal government is appealing the decision.

Individual and family federal income tax returns for a particular tax year are due on or before April 15 of the following year, but a taxpayer may obtain an extension of the due date to October 15. The debtor in the present case obtained this extension for tax year 2008, but he did not file the return until 2011. The IRS imposed penalties under § 6651(a)(1). The debtor filed for Chapter 7 bankruptcy in July 2012. The assets recovered by the trustee were sufficient to pay the debtor’s 2008 tax but not the penalties. The debtor then claimed that the penalties were subject to discharge.

In a motion for summary judgment, the debtor argued that the event leading to the imposition of penalties by the IRS occurred on April 15, 2009, the due date for his 2008 tax return. Since this date was more than three years before he filed for bankruptcy, he claimed, the penalties were dischargeable under § 523(a)(7)(B). The federal government argued, however, that since the debtor had obtained an extension, the penalties were not imposed until October 15, 2009, less than three years before the bankruptcy filing date. The court, somewhat incredulously, noted that this was a matter of first impression in the Ninth Circuit.

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Joseph Mischyshyn [CC BY-SA 2.0 (http://creativecommons.org/licenses/by-sa/2.0)], via Wikimedia CommonsA California bankruptcy court ruled that sales tax obligations owed by a debtor in connection with a convenience store she owned were subject to discharge in the debtor’s Chapter 7 bankruptcy case. In re Athar, No. 1:11-bk-23947, Adv. No. 1:12-ap-01038, memorandum (Bankr. C.D. Cal., Feb. 27, 2014). The debtor argued that she should not be held personally liable for the sales tax, claiming that she was not a “partner” in the business. The State Board of Equalization (BOE), which administers and collects various types of state taxes, disagreed and claimed that the tax debt was excepted from discharge. The court held that the debtor was a partner under California law but also ruled that the sales tax debt was not excepted from discharge.

A business venture by two or more people with no formal legal entity, such as a corporation, is usually considered a “general partnership.” Unlike a corporation, owners in a general partnership, known as “partners,” are personally liable for business debts. The debtor and her father signed a BOE application for a permit to operate a convenience store in July 2001. They also filed a Fictitious Business Name Statement in Los Angeles County that month. They did not, according to the court, form a business entity, such as a corporation, to operate the store. They obtained a beer and wine license in August 2001 that named the debtor as the primary owner of the store.

The BOE issued a notice to the debtor in 2009 stating the store owed more than $86,000 in sales tax. The debtor’s father passed away in June 2011. She formally closed the BOE permit in March 2012, stating that the store’s effective closing date was June 30, 2011. In December 2011, the debtor filed for personal Chapter 7 bankruptcy.

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Swedish Transport Agency (Transportstyrelsen), uploaded by Fry1989 [Public domain], via Wikimedia CommonsCalifornia law allows for license suspension, including both driver’s licenses and professional licenses, for nonpayment of certain debts or other obligations. In some cases, a Chapter 7 or Chapter 13 bankruptcy can help an individual get his or her license reinstated by enabling him or her to catch up on payments more quickly or efficiently. Not all of these debts and obligations are subject to discharge in Chapter 7 or Chapter 13. Personal bankruptcy can still be a useful tool, however, for people whose financial difficulties leads to license suspension, which often leads to even more financial difficulties.

First, a bit of reassurance. Generally, only state agencies and courts have the authority to suspend a license for unpaid debts. Debt collectors, who might be collecting for private debt like unpaid credit cards, do not have any such authority. License suspension is only possible where state law has specifically authorized it. Under California law, this includes unpaid judgments for automobile accidents, nonpayment of state tax, and nonpayment of child support. Bankruptcy itself is not grounds for license suspension, since the Bankruptcy Code prohibits discrimination on the basis of a bankruptcy filing. 11 U.S.C. § 525.

Unpaid Judgments and Penalties under the California Vehicle Code

California law allows the Department of Motor Vehicles (DMV) to suspend a driver’s license for failing to satisfy a judgment resulting from an automobile accident. The DMV will typically reinstate a license upon payment of the judgment amount, or release by the creditor. It should also reinstate a license upon receipt of an order from a bankruptcy judge discharging the judgment debt. Continue reading

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eFile989 [CC BY-SA 2.0 (https://creativecommons.org/licenses/by-sa/2.0/)], via FlickrContrary to what many people may believe, it is possible to wipe out tax debts in a Chapter 7 or Chapter 13 bankruptcy. Federal law sets several strict criteria that focus first on the government’s efforts to collect unpaid taxes, and then on the debtor’s adherence to tax regulations and procedures. This applies in both Chapter 7 and Chapter 13 bankruptcy cases. To be eligible for discharge, the tax debt must meet the following five criteria.

1. The Tax Due Date Must Be More Than Three Years Before the Bankruptcy Filing Date.

Tax debt is considered non-dischargeable priority debt, unless the debtor files for bankruptcy more than three years after the tax comes due. 11 U.S.C. §§ 507(a)(8)(A)(i), 523(a)(1)(A). This three-year period is known as a “lookback period,” which is similar to a statute of limitations. As the Supreme Court noted in Lozano v. Montoya Alvarez, 134 S.Ct. 1224, 1234 (2014), if the government “‘sleeps on its rights’ by failing to prosecute those claims within three years, however, those mechanisms for enforcing claims against bankrupt taxpayers are eliminated.”

2. The Tax Assessment Must Be at Least 240 Days Old.

The lookback period for tax debt has a second component. Tax debt is only dischargeable in bankruptcy cases filed more than 240 days after the government makes a tax assessment. 11 U.S.C. §§ 523(a)(1)(A), 507(a)(8)(A)(ii). The bankruptcy laws enacted in 2005 closed a loophole that had allowed debtors to take advantage of the automatic stay in a bankruptcy case to stop collection action by the IRS. Holland v. Florida, 130 S.Ct. 2549, 2570 n. 3 (2010), citing Young v. United States, 535 U.S. 43, 50-51 (2002). Continue reading

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By Joshua Doubek (Own work) [CC-BY-SA-3.0 (http://creativecommons.org/licenses/by-sa/3.0)], via Wikimedia CommonsA Chapter 13 debtor argued that a bankruptcy court should rule that part of an Internal Revenue Service (IRS) tax lien was void. The lien was only secured debt, he claimed, up to the value of his personal property, and he asked the court to avoid the unsecured amount of the lien. The bankruptcy court ruled that federal bankruptcy law does not allow “lien stripping” in the manner requested by the debtor, and the appellate court affirmed. In re Ryan, 725 F.3d 623 (7th Cir. 2013).

The debtor reportedly failed to pay federal income tax from 2006 through 2010, and the arrearage amount totaled nearly $137,000. The IRS recorded a notice of federal tax lien against the debtor’s property in January 2011. In August 2011, the debtor filed a Chapter 13 bankruptcy petition claiming $1,625 worth of personal property. He stated that he had lost his residence due to delinquent property taxes, and that he had no vehicle or financial accounts. He filed an adversary proceeding admitting to the tax debt and asking the court to rule on the value of the tax lien.

Because the debtor only owned $1,625 in personal property, he argued that the value of the IRS’s secured claim was limited to that amount, with the remainder of the lien being unsecured debt. 11 U.S.C. § 506(a). The IRS did not dispute this point. The debtor then argued that the amount of the tax lien that exceeded the value of his personal property was void under § 506(d). This section states that a lien is void if it “secures a claim against the debtor that is not an allowed claim,” with some exceptions. Continue reading

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By Bongochico (Own work) [CC-BY-SA-3.0 (http://creativecommons.org/licenses/by-sa/3.0)], via Wikimedia CommonsAaron Carter, who achieved fame as a singer in the late 1990s and early 2000s, filed for Chapter 7 bankruptcy in Florida in October 2013. In his petition, he lists assets of just over $8,000 and debts of more than $2 million. More than half of the debts, including a seven-figure amount owed to the Internal Revenue Service, date back to when Carter, now twenty-five years old, was a minor. Much of his fame and fortune accrued before his eighteenth birthday, but he is liable for tax on that income regardless of age.

Carter’s music career began before he was even a teenager. His older brother, Nick Carter, was a member of the popular “boy band” the Backstreet Boys. Carter opened shows for the group and toured on his own. He acted in movies and on stage, and his family was featured on a reality television show several years ago. He is currently touring in support of a comeback, but the performances are reportedly not bringing in enough money to pay his debts.

The majority of his outstanding debts were incurred when he was a minor, and his relationships with the people managing his career did not always turn out well. He filed for legal emancipation from his mother, who was also his manager, in 2003, claiming that she was working him too hard and mismanaging his income. He was also managed by Lou Pearlman, who created and managed numerous “boy bands.” Pearlman is currently serving a sentence in federal prison for fraud, and has been the subject of multiple lawsuits by former clients, including two lawsuits filed by Carter in 2002 and 2007. Continue reading