Bankruptcy falls under U.S.C. Title 11. This can sometimes cause confusion as there is a bankruptcy Chapter 11 as well. We are going to deal with the two chapters that are most prevalent in our jobs as tax professionals, Chapter 7 and Chapter 13.

Chapter 7 Bankruptcy

Chapter 7 is better known as a “liquidation” bankruptcy. This is because the things included in the bankruptcy are liquidated (or sold) to pay off the debt and all other debts included in the bankruptcy are eliminated.

Most Chapter 7 cases are “no asset/no equity” cases. Meaning that the filer has no assets or equity in any property so nothing is lost but all debts are eliminated.

Eligible taxes, credit cards, medical bills, and other debts can be eliminated in this type of bankruptcy. There are some debts that are not dischargeable in this type of bankruptcy such as child support and student loans.

The fee, as of 06/01/14, to file a Chapter 7 bankruptcy is $350 and this chapter may only be filed once every 8 years.

Time lines:

Most Chapter 7 filings take approximately 4-6 months to be completed. This includes the petition being filed (See Appendix), the meeting of the creditors, and the open objection period after the meeting.

The filing of a Chapter 7 petition also imposes an automatic stay on all collection activity against the taxpayer, including the filing of a lien or levy. The stay is in place until after the case is closed and the discharge is issued.

If there is an IRS levy or seizure in place or pending, the filing of the petition will cause the immediate release of the levy or seizure. However, the filing of bankruptcy does not release a lien already in place. If the property with the lien is included in the bankruptcy then the IRS will usually release the lien after the discharge as they have no further equity eligible for the lien in the property.

If the lien is against an exempt asset, such as a retirement account, the IRS can and will pursue the lien. This will remain attached until the taxpayer can access the funds or the CSED runs out unless the debt is settled prior to that time. (I.R.M. 5.11.6.2)

The IRS rarely pursues relief from a stay for bankruptcy, however, this does not apply to criminal proceedings, the continuation of audit procedures, the issuance of the Statutory Notice of Deficiency (though it does stay the tax Court response and proceeding SOLs), the demand for tax returns to be filed and the assessment of taxes. (Bankruptcy Code Section 362(b)(9))

Qualifications:

Chapter 7 cases are for taxpayers (Individuals or businesses) who can’t afford to repay their debts. When a reasonable budget is established, the filers net cash flow should be very close to $0. If there is cash flow in the budget to make repayments the filer should consider a Chapter 13 instead.

The is no minimum or maximum dollar amount owed to qualify for a Chapter 7 filing. In most cases the filer will be required to meet with a certified credit counselor before or during the filing process.

Property:

Property that is secured by a debt and has no equity will not be lost to the filer in a Chapter 7 as long as they are current on payments. This usually applies to secured debts like real property or vehicles. The bankruptcy agreement “sets the clock back” between the debtor and the creditor to prior to the bankruptcy and is called a Reaffirmation.

The bankruptcy laws are not designed for the debtor to come out of a Chapter 7 homeless, with no transportation and no belongings. Federal and state laws provide for exemptions to the application of collections by creditors and trustees after the discharge of a bankruptcy.

You should always be cognizant of which laws help the debtor the most when assisting with a bankruptcy decision. Compare the federal laws and the state laws to see where the debtor gets the bigger exemption.

Example: In the federal exemptions for a single person you may claim as exempt property up to $22,975 for a homestead, $3,675 for a vehicle, and $12,250 for clothing, appliances, furnishings and household goods. Also exempt are tax exempt retirement accounts in total and IRAs up to $1.24m., SS/VA/Unemployment benefits, Alimony/Child Support, and a “wild card” allowance of up to $1,225.

In the Massachusetts, the homestead is up to $500K if properly registered as a homestead, up to $7,500 for a vehicle, up to $15,000 for household furnishings, a monthly allowance for food, fuel, utilities and rent (if no homestead), and bank deposits of up to $2500. Also exempt are all the income and pension items mentioned above and a $1,000 “wild card”.

In Louisiana, my home state, the homestead exemption is $25,000, up to $7500 for a vehicle, unlimited for household goods, clothing, furnishing and appliances, up to $5000 for jewelry, and the same as federal for income items. There is no “wild card” amount.

Looking at the three of these, right off hand, I would say Massachusetts is the best place to declare bankruptcy of the two offered with Louisiana running second. The federal limitations are very restrictive but there are some states that are even more so.

At this time there are only 20 states that allow the debtor the choice of the state exemptions or the federal. As you can probably guess, the ones that aren’t given a choice have the more restrictive state laws. Massachusetts residents and most of your surrounding states have a choice, Louisiana residents do not.

Chapter 7 works best in a “No Asset/No Equity” situation. This means that the debtor has no assets that are not subject to the exemptions above and the property he does have has little or no equity in it after the loans have been deducted. For example, in Massachusetts you have a homestead worth $750,000 with a loan of $240,000. After deducting the loan and the exemption there is only $10,000 in equity left and that will be eaten up by the costs of the sale, so the trustee will “abandon” the property back to the debtor. Again, this is only if the debtor is current with his house payments.

In a case where the debtor has assets or equity that is not exempt, they have some choices, which will be governed by the court. They can either negotiate a value of the asset after the exemptions and loan amount and then pay the court that amount, allowing them to keep the asset; or they lose the asset to the court who liquidates it and takes the proceeds to pay off creditors in order of precedence. The IRS usually stands first in that line.

In our next session, Chapter 13

In accordance with Circular 230 Disclosure