Tax Refunds and Chapter 7 Bankruptcy

When you file Chapter 7 bankruptcy, a Trustee is appointed to your case. The Trustee’s job is to look for assets. One asset a lot of clients or their attorneys overlook is a tax refund.

A tax refund is money that you overpay to the government through the previous year. Taxes are taken out of your pay each pay period and sent to the government to cover your tax debt at the end of the year. When the amount that accumulates is more than what you owe for the year, you receive a refund of what you overpaid. This refund will be taken from you by the Trustee unless you can exempt the money or prove that it is not an asset of the bankruptcy estate.

Any money that you pay to the government before filing the Chapter 7 bankruptcy case is an asset of the bankruptcy estate. Any money you pay after you file is not. Example: On July 31, 2011 you file for Chapter 7 bankruptcy protection. This is day 182 of a 365 day year. Any money paid up to this point is an asset of the estate and can be taken by the trustee unless it can be exempt with a State or Federal exemption. (Please see the Exemptions blog for a detailed explanation of this subject.)

On April 15, 2012, you will file your taxes and provide the Trustee with a copy of the return. The Trustee will see that you received a refund. Let’s say it was $4,000.00. The Trustee will then ask for the portion that was earned prior to filing. To determine this amount the Trustee or your attorney will divide the $4,000.00 tax refund by 365 days and then multiply this number by the number of days accumulated prior to filing. $4,000.00 / 365 = $10.95 x 182 days = $1,992.90 is an asset and will be taken from you.

Strategically, people who get larger refunds will file in the first quarter of each year to deter the Chapter 7 Trustee from going after the tax refund. The amount of the refund that would be an asset of the estate is so small that it may deter the Trustee from going after it as they would have to hold the case open for an entire year and produce paperwork for very a small amount of money. Generally, Trustees will not go after a tax refund if you file a Chapter 7 bankruptcy case prior to August or September.

Earned Income Credit is not a part of the tax refund that can be taken. It is automatically protected if it has not been received or comingled with other money.

Some people that receive large tax refunds will try and file at the beginning of the new year right after they have just received their large tax refund. When this happens the Chapter 7 Trustee will require proof of where the money went. Proof will be and explanation with receipts. If the money was spent on frivolous things that are not necessary for your household or you can’t provide prove where it went, the Chapter 7 Trustee will object to your case.

If you’re considering filing Chapter 7 bankruptcy, it is important that you get legal advice from an experienced bankruptcy attorney so that you will be aware of how and when you file affects your tax refund.

The Means Test, formally called the Statement of Current Monthly Income and Calculation of Commitment Period and Disposable Income, has two main purposes:

1)      To determine one’s eligibility to file Chapter 7  Bankruptcy. And if one is not eligible;

2)      To determine the amount of money paid to your general unsecured debts in a Chapter 13 bankruptcy. (Unsecured debts are debts owed to creditors that don’t have liens or security interest in property, personal or real property. A few examples of unsecured debts are medical bills, credit cards, signature loans, deficiencies on foreclosed homes or repossessed vehicles, pay day loans, etc.)

The means test compares a household’s income and expenses to that of a household of the same size in the same state and also takes into consideration local cost of living.

First, you have to define a household.  A household is everyone who lives with the person or persons who are filing Chapter 7 or 13 Bankruptcy. Generally, this is everyone that is a dependent or spouse of the filing party. In some cases a dependent can be an adult.

Next, you have to determine all income coming in from all sources to the household, and all necessary deductions from this income such as taxes and benefits.

Then, you have to define expenses. The test uses IRS standard expenses for what is considered necessary for the household to keep a roof over their head, vehicles to get members of the household to and from work, food, utilities, etc. Since not all households are exactly the same and fit these standards, the Bankruptcy Court allows additional or increased expenses as long as they are necessary for the health and welfare of the household.

If there is nothing left after the expenses are subtracted from the income, then the person filing is typically eligible for Chapter 7 bankruptcy.

 If there is a certain percentage of money left over after subtracting the expenses from the income, then the person has to file a Chapter 13 and pay this amount back to their creditors.

This is a very basic description of a means test. Every household’s test is different and other factors have to be evaluated in each case.  People often call that tried to do their own means test and tell me they can or can’t file a Chapter 7 and it’s the opposite. So, please, to find out more about a means test and how it applies to your specific situation, please call and schedule a free consultation with our office. With our experience, we can tell you if you qualify for a Chapter 7, or if you need to file a Chapter 13 bankruptcy, approximately what your monthly plan payment would be.   We will complete your means test, even if it’s complicated, for free, so that you can know your options.

You may have to pay income taxes after Foreclosure takes place if you don’t file Chapter 7 or Chapter 13 Bankruptcy before the foreclosure sale. Once a house is foreclosed the lender will likely claim the lose on their taxes. This means you will get a 1099 for the difference between what the house sold for and what was owed to the lender or lenders. You can prevent this by filing chapter 7 or chapter 13 bankruptcy before the foreclosure sale takes place.

 The Home Affordable Modification Program (HAMP) launched in early 2009 boasted potential mortgage assistance for 3 to 4 million homeowners. It is estimated that only 816,000 homeowners have received a permanent modification from this program as of the end of September 2011 according to the program’s web site.  Critics of the program blame this failure on the lenders’ slow response to implementing HAMP modifications combined with the fact that many lenders would rather put a homeowner in one of their in-house, more profitable, loan modification programs. 

Many homeowners that have come to me after trying to work with their lenders on a HAMP mortgage modification tell me it’s  has been frustrating and time-consuming, navigating through a sea of paperwork, and playing an endless game of phone tag. Some have ended up in a worse situation than when they began.

But recently, bankruptcy attorneys in the Middle District of Florida Bankruptcy received some positive news for those interested in a HAMP mortgage modification. Our Judges have implemented a system to try and speed up the process and remove the unnecessary anxiety that has accompanied homeowners in their attempt to navigate through the loan modification process. Homeowners that file for Chapter 13 bankruptcy protection can now file a motion in Federal Court under the bankruptcy that forces the mortgage company into a mortgage mediation. This process causes the mortgage company to either accept or deny a loan modification under the terms of the HAMP program. 

With the thousands of loan modification requests pouring into a mortgage companies loss mitigation departments your file has or will likely get passed over several times before it is reviewed a chance to actually review it.  Loan modification through the Chapter 13 bankruptcy is not only a way to get the mortgage company to pay attention to your mortgage modification, this puts you in the front of the line and forces the mortgage company to make an actual decision about modifying your loan. 

Please schedule an appointment with me via the telephone or in-office and I can give you a lot more details on the Chapter 13 Bankruptcy Loan Modification process and HAMP program.

Total Available Credit

Up to 30% of your credit (FICO) score is determined by how much you owe creditors. The ratio of this debt to your credit limit affects your score. Asking your credit card company for a credit line increase will help this ratio. But beware this request could trigger an inquiry on your credit (hard inquiry) which will negatively affect your credit score. Filing chapter 7 bankruptcy or chapter 13 bankruptcy will eliminated the debt entirely and forces the creditors to report $0.00 dollars owed but also will reduce your available borrowing amount to $0.00 when the account is closed. However, you will get tons of credit applications in the mail after filing bankruptcy. Getting a new credit card after filing bankruptcy will bring your borrowing amount back up, but you need to pay this card off every month. This in turn will bring your credit score back up after filing bankruptcy.

Type of Loan

Up to 10% of your FICO score is made up by the type of loans on your credit report. Unsecured loans such as revolving credit card loans have greater liability than installment loans. To raise your credit score you should try and pay off credit cards by taking out a signature loan (installment loan) through your bank. Pay off the higher interest rate cards first. Again if you can’t get an installment loan to pay off the high interest rate credit cards because your credit score is to low filing for chapter 7 bankruptcy or chapter 13 bankruptcy can eliminated these debts entirely. This will allow you to start fresh and repair your credit by getting a new credit card and paying it off each month.

New Inquires

Recent credit applications comprise 10% of your FICO score. Known as Hard Inquiries any application you make for a new loan, credit card, even sports club membership may result in an inquiry that will remain on your credit report for two years. Protect your credit score by avoiding applications that required your social security number. Pulling your own credit report or score is a Soft Inquire that doesn’t affect your credit score.

Payment History

Payment history can make up 35% of your credit (FICO) score. Bring past-due accounts up to date and avoid missing payments in the future is the best way to improve your credit score. If your credit report is a land mind of negative 30, negative 60, negative 120 late payments then chapter 7 bankruptcy or chapter 13 bankruptcy will stop this reporting the day you file. This in turn will allow you to start over and create a new history on your credit report.

 Length of History

Credit history can make up 15% of your FICO score. Late payments, defaults and other negative information will report for seven years and will lower your credit score. Positive information over a two year period will raise the score.

Just remember filing for chapter 7 bankruptcy or chapter 13 bankruptcy is not the end of the world, it’s a new beginning. The negative history that you created will fall off your credit report after 7 years from the default. Filing chapter 7 bankruptcy or chapter 13 bankruptcy will stop the reporting the day you file. All you have to do then is create a new history and prove to everyone that pulls your credit in the future that you learned your lesson and you are on the right track. They will see the old history and see that you filed bankruptcy but they will also see then new improved history you created after filing. As long as you don’t make payments late and don’t default on your new creditors after filing bankruptcy your credit score will dramatically increase.

Also you can keep car loan and house loans out of the bankruptcy if they are in good standing and they will keep reporting positive to your credit after filing bankruptcy.

How can I stop my wages from being garnished?  To stop a potential or active garnishment , you must act fast. The faster the reponse, the less likely you are to lose your income and savings.

 If a creditor has threatened to garnish your pay or bank account, immediately taking action, such as quickly paying the balance of the account in full, settling the debt for a lump sum if the creditor is willing, or filing a Chapter 7 or Chapter 13 bankruptcy, may avoid garnishment all together. For those that cannot afford to pay the balance or settle the debt, bankruptcy is a welcome alternative. Filing a Chapter 7 not only stops the creditor from being able to garnish, but it may also relieves you of your obligation to pay all your debt. More importantly, you may avoid a judgment against you, something that is viewed negatively by potential employers and lenders when credit reports and background checks performed. 

If early action could not be taken, and a judgment has already been entered agasint you, the creditor may have also filed for a writ of garnishment. This “court order” is sent to your employer and/or bank, and, by law, must be implemented.  

Most of my clients are caught off guard when their pay is garnished for two reasons.  1) Some are not aware that the creditor’s collection efforts have progressed to a point where their wages can be garnished. There is often a lot of paperwork mailed during a lawsuit. Frankly speaking, if you are not familiar with these documents, it might not be clear how close you are to being garnished. 2) Secondly, many of my clients believe that their income or “head of household” status disqualifies them from garnishment; they ignore the warnings and do not comply with requests from the creditor for information proving their status.

 So who can be garnished? In Florida, the law states that only a Debtor that makes more than $750.00/week can be garnished. (That’s $750.00 after mandatory federal and state deductions.) If someone meets this criteria, up to 25% of their wages can be garnished. However, if the Debtor is head of household, meaning they can prove they provide more than 50% support to a child or other dependent, they cannot be garnished unless it is agreed to in writing. Depositions may be required or documents may need to be filed to prove head of household status. Surprisingly, separated and single moms do not always meet these requirements. (See Florida Statute below.) 

If your creditors are threatening to or have garnished your wages, and you are ready to gain control of your finances, filing a Chapter 7 bankruptcy will not only stop the garnishment, but may also relieve you of your obligation to pay your other debts. If you don’t qualify for Chapter 7 bankruptcy under the means test, you can file a Chapter 13 bankruptcy, and pay back your debt based on your disposable income NOT the debt amount. The sooner you file, the faster the wage or bank account garnishment can be stopped. Remember, any money taken prior to filing the Chapter 7 or Chapter 13 bankruptcy is gone and may not be returned if the creditor knows what they are doing. 

If you want to talk further about getting out of debt or your specific case, email or call me.  

Florida Exemption of wages from garnishment.— Statute 222.11

222.11 Exemption of wages from garnishment.—

(1) As used in this section, the term:

(a) “Earnings” includes compensation paid or payable, in money of a sum certain, for personal services or labor whether denominated as wages, salary, commission, or bonus.

(b) “Disposable earnings” means that part of the earnings of any head of family remaining after the deduction from those earnings of any amounts required by law to be withheld.

(c) “Head of family” includes any natural person who is providing more than one-half of the support for a child or other dependent.

(2)(a) All of the disposable earnings of a head of family whose disposable

earnings are less than or equal to $750 a week are exempt from attachment or garnishment.

(b) Disposable earnings of a head of a family, which are greater than $750 a week, may not be attached or garnished unless such person has agreed otherwise in writing.

Welcome to the new Keith D. Collier, Bankruptcy Attorney website. Come back often for industry news, information and helpful tips.

Is it best to file a chapter 7 bankruptcy to surrender my house before or after the foreclosure?

It’s best to file the chapter 7 before the foreclosure to prevent receiving a 1099 for the deficiency amount after the sale. The IRS will try and tax a person for the difference in what the mortgage company was owed at the time of the foreclosure and the amount the property was sold for at the foreclosure sale. Example: If you owe $300,000.00 on house and it sells at the foreclosure sale for $175,000.0, the mortgage company will send a 1099 to you and the IRS for the difference, $125,000.00. This could be added to your gross income in the year the property was foreclosed and cause a tax liability. Most tax liabilities are non-dischargeable in bankruptcy. So we recommend filing before the sale and preferable before the get a judgment against you. There are some tax provisions that may prevent the 1099 income from being taxed in some cases. Please consult a tax attorney for this type of advice.

How often can you file Bankruptcy?

Chapter 7 –> Chapter 7 or Chapter 11? You can file chapter 7 or file a chapter 11 and get a discharge is a chapter 11 only after 8 years from the date of filing a chapter 7. Filing not discharge.

Chapter 7 –> Chapter 13? You can file chapter 13 any time after filing chapter 7, but you can’t get a discharge in the chapter 13 unless the chapter 13 is filed 4 years after the filing of the chapter 7.

Chapter 13 –> Chapter 7? You can file chapter 7 after 6 years from discharge of the chapter 13 or anytime after the discharge of the chapter 13 if your chapter 13 paid 100% to unsecured creditors.

Chapter 13 –> Chapter 13? You can file chapter 13 anytime after discharge or dismissal of the prior chapter 13. However, if a discharge was received in the prior case and that case was filed less than 2 years ago, you cannot receive a discharge in the subsequent case but you are protected by the automatic stay. If the prior chapter 13 was dismissed, you can still re-file anytime but there are some rules that need to be addressed regarding the automatic stay. Please see an attorney. If you have had a case pending in the last year, then the automatic stay is only in place for 30 days and a motion to continue the automatic stay must be filed to extend it beyond that 30 days.  If you have had more than one case pending in the last year, then the automatic stay is not in place and a motion to impose the automatic stay must be filed and a hearing must take place within 30 days of filing the case or you are not protected. You can argue that if the case gets confirmed the automatic stay is reactivated.  See an attorney.

Stripping Second and Third Mortgages!!!

Chapter 13 Bankruptcy will allow a Debtor to strip a subordinate mortgage if the value of the house is less than the superior mortgage.  This means subordinate mortgages don’t have to be paid and no longer have a lien against your home.  Example:  Present Value of House $150,000.00, First Mortgage amount of $160,000.00 and a Second Mortgage amount of $75,000.00. This is a perfect example of a over encumbered house that would be eligible for a lien strip in a chapter 13 bankruptcy. Lien Strips can only be done in chapter 13 cases not chapter 7.

What happens to the Second and Third Mortgage after they have been Stripped?

They become unsecured debt along with all of your other credit cards, medical bills, repossession etc. These debts are only paid if you can afford to pay them. In most cases they get paid very little but it depends on your income level.