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Forgive & Forget? Decoding Bankruptcy Debt Forgiveness Rules

Forgive & Forget? Decoding Bankruptcy Debt Forgiveness Rules

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A CPA deconstructs tax debt, consumer debt and more in this timely article. From Disclosures, January/February 2010, Virginia Society of CPAs, www.vscpa.com
A CPA deconstructs tax debt, consumer debt and more in this timely article. From Disclosures, January/February 2010, Virginia Society of CPAs, www.vscpa.com

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Published by: Jill Edmonds, Communications Director on Jan 19, 2010
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By Maxine Magri, CPA
• Disclosures •
Decoding bankruptcy debtforgiveness rules
he Bankruptcy Abuse Preventionand Consumer Protection Act o 2005, signed by President Bushon April 20, 2005, had two main objectives:reduce the number o debt categories thatcould be discharged and orce more debtorsto le Chapter 13 bankruptcy rather thanChapter 7.Chapter 7 is a liquidation in which a business goes
o business, while Chapter13 allows individuals in the United Statesto undergo a nancial reorganization su-pervised by a ederal bankruptcy court,requiring one monthly payment to a trusteewho distributes the same according to bankruptcy rules.Terms to become amiliar with in bankruptcy include nondischargeable debt(debt that cannot be eliminated through bankruptcy), dischargeable debt (debt thedebtor does not have to pay) and protectedassets. Protected assets can be excluded orexempted.Chapter 7 bankruptcy oers immediate,complete relie o many oppressive debts,and could eliminate unsecured debt, creditcards, payday loans and medical bills. Chap-ter 7 bankruptcy cannot be used by debtorswho earn more than the median incomein their states and who can repay at least$100 a month or ve years. Because thereis little or no nonexempt property in mostChapter 7 cases, there may be an actualliquidation o the debtor’s assets. Thesecases are called “no asset cases.” The debtorreceives a discharge just a ew months aterthe petition is led.Commercial enterprises that desireto continue operations will oten le or bankruptcy under Chapter 11, in which thedebtor can terminate burdensome contractsand leases, recover assets and change opera-tions in order to return to protability. Thedebtor generally goes through a period o consolidation and emerges with a reduceddebt loan and a reorganized business.
Tax debt
Is bankruptcy an option or the clientwho owes back taxes? For Chapter 13 bankruptcy, the debtor must have led alltaxes or the our-year period prior to lingthe bankruptcy petition.
There are ive rules that must all besatisfed to discharge income taxes in eitherChapter 7 or Chapter 13 bankruptcy. Therules apply to both ederal and state taxes,and the most common inraction
• Disclosures •
Chapter 7 bankruptcyoffers immediate,complete relief of manyoppressive debts, andcould eliminate un-secured debt, creditcards, payday loansand medical bills.
keeps an individual rom qualiying is theailure to le the tax return. The tax rulescan be ound in 11 USC Section 507 andSection 523. The ive items are as ol-lows:1. The most recent due date or lingthe return is more than three yearsold.2. The tax return was led more thantwo years ago.3. The assessment is more than 240days old.4. The tax return must not have beenraudulent.5. The taxpayer must not have beenguilty o a willul attempt to deeator evade the tax.The law specically states that back taxesrelated to noniled or late iled returnscannot be discharged. Nondischarge-able taxes include ederal, state and localtaxes that became due within three yearso ling or bankruptcy, and also includetrust und taxes. Additionally, trust undtaxes include employees’ withholding andemployers’ share o Social Security andMedicare taxes.The age o the debt does not matter.Nondischargeable debt includes loans thedebtor borrows to pay the nondischargeabletaxes, and penalties and interest associatedwith the taxes are nondischargeable. Al-though, in some cases, Chapter 13 penaltiesare dischargeable to the same extent as anygeneral unsecured debt.
Even though the taxes, interest andpenalties are discharged, the tax liabilityhas oten been secured with a led tax lien — and the basic rule is that a properly ledtax lien survives bankruptcy.
Individuals who obtain a discharge o debts in bankruptcy ater ve years willcontinue to owe taxes, interest and penal-ties that have not been ully paid. O course,they can try to obtain an oer in compro-mise to reduce the liability.So are there benets or taxpayers whoowe back taxes? The ling o bankruptcyprovides an automatic stay to prevent col-lection activities on the taxes prior to bank-ruptcy ling. Another pro-taxpayer benetis a single interest rate or the computationo interest on tax claims. Bankruptcy canalso stop oreclosure and repossession.
Consumer debt
Nondischargeable consumer debt in-cludes court-ordered alimony and childsupport, as well as any debt due to obtain-ing money, property or services by raudor alse pretenses.Credit card charges or oods and servic-es o more than $500 made within 90 dayso bankruptcy, and cash advances o morethan $750 within 70 days o bankruptcy, arenot dischargeable. Car loans are subject toull repayment.
What about possessions?
A new section, 522 ()(4), limits thenonpossessory, non-purchase money se-cured interest in household goods that can be avoided under section 521()(1)(B).The denition limits electronic equipmentto one radio, one TV, one VCR and onepersonal computer with related equipment.It excludes works o art not created by thedebtor (or a relative) and jewelry worthmore than $500 (except wedding rings).Section 523(a)(8) is amended to makestudent loans dischargeable, in the absenceo undue hardship, regardless i they arerom nongovernmental and prot-makingorganizations.In Virginia, bankruptcy law allows an in-dividual to keep clothes worth up to $1,000,household goods worth up to $5,000, carequity up to $2,000, and cash or debtor’schoice o valuables up to $5,000. Clothingand household goods can be valued at thritvalue. I the debtor has something o valueover $5,000, the courts will normally sellthe asset to pay o the debts.
Retirement andinsurance investments
Protected unds include traditionaland Roth IRAs (exempted or the rst $1million and indexed or infation). The ex-emption amount is unlimited or employeeretirement plans, SEPs and SIMPLE IRAs.But debtor beware! Employer retirementunds do not keep exempt status i they arerolled into an IRA. However, i IRAs arerolled into employer retirement unds, theexemption amount is unlimited.
• Disclosures •

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