Bankruptcy can stop collection and eliminate tax debt in many situations. For more details on tax discharge see the article I wrote about Bankruptcy Tax Discharge on my personal site. While bankruptcy can be a very useful tool in dealing with the Internal Revenue Service and state collectors, it will not solve all problems.  In many cases, a tax debt that would qualify for bankruptcy discharge is rendered non-dischargeable when the taxpayer fails to file a tax return and the IRS or state collection authority uses their statutory authority to assess.  Some types of tax, such as employment tax, are not subject to discharge.  Fortunately, there are other ways to stop or manage collection problems.

Some types of tax can not be discharged and can be collected by the IRS after the bankruptcy case is closed.  Bankruptcy may not be available or appropriate for some delinquent taxpayers.

The IRS allows properly authorized professionals to represent taxpayers and help them get relief from enforced collection such as bank account and wage levies.  Attorneys, CPAs, and Enrolled Agents are given special permission to represent taxpayers, can establish online electronic access to IRS taxpayer records, and can negotiate a resolution for a taxpayer with IRS collections.  Tax professionals can also be authorized to represent taxpayers before most state tax enforcement agencies.  Authorization is done with a power a power of attorney form 2848 for the IRS and similar documentation for state tax collectors.

While individual taxpayers can call the IRS directly and may be able to handle a tax problem themselves, tax practitioners are given access to a special telephone number to call the IRS and are assigned to specially trained personnel to help solve tax collection problems.  In addition, the tax professional usually has experience in calculating payment agreements and is familiar with the regulations governing the tax collection process.  If the collection officer oversteps or makes unreasonable demands, it is often difficult for an unassisted taxpayer to remedy the situation.

Bankruptcy is not always the best way to get rid of federal tax debt.  Given enough time, the tax may just go away.  The IRS is given 10 years from the date the tax is assessed to collect in most cases by 26 USC §6502, a section of the Internal Revenue Code. The date after which the tax can no longer be collected is called the “Collection Statute Expiration Date” or “CSED” for short in IRS lingo.

However, there are many things that can give the IRS more time to collect the tax. Under most circumstances, when the IRS collection officers are prevented from taking action to collect an overdue tax, the collection time is extended by the amount of time they can’t collect plus some extra time to restart their collection work.

Federal law prevents the IRS from using its powers to forcibly collect unpaid tax when an Offer in Compromise is pending and for an additional 30 days after the offer has been rejected if it was unsuccessful. Likewise, if a taxpayer has appealed a decision by the IRS to collect the tax by levy or siezure, the time that is taken to review the appeal, plus 30 days is added to the collection period and the CSED is extended. Both of these extension rules are contained in 26 USC §6331.

Additional provisions for extending the collection period are contained in 26 USC §6503. This section of the Internal Revenue Code provides for extension when the assets of a taxpayer are in the custody or under the control of any court, and for 6 months after they are released. The collection period also is extended for the period of time when a taxpayer is outside of the United States continuously for six months or more.

One common way the IRS collection period is extended and the CSED is delayed is by the filing of a bankruptcy court proceeding. Because federal law prohibits collection of a pre-bankruptcy tax while the case is being processed, 26 USC §6503(h) allows the IRS tax collectors additional time equal to the amount of time the case was open plus an additional 6 months for collection after the case is closed or the stay is released.

Unless it has a secured claim, the IRS is no longer able to collect tax after bankruptcy if the tax was discharged. To learn more about what types of tax debts are discharged in a bankruptcy, read: What About The IRS? and Use Bankruptcy To Solve Tax Problems. Both of these articles and many more can be found on the Bankruptcy Law Network.

Credit card debt is frequently discharged in bankruptcy.  Taxes can be paid with a credit card.  State and Federal governments accept and even encourage such payment.  However, a credit card debt incurred to pay tax is probably not dischargeable.  There are at least two important reasons why credit card convenience may result in non-dischargeable debt.

In the first place, it could be and often is considered fraud to incur a credit card debt with the intent to bankrupt the debt.  Many courts have ruled that 11 USC §523(a)(2), an exception to the discharge for money obtained by false pretenses or fraud, applies to credit card purchases made without the intent to repay them.  Important information can be found in an article by my colleague, Atlanta Bankruptcy Attorney Jonathan Ginsberg, called Recent Credit Card Use and Filing for Bankruptcy – What are some Guidelines?

Even with the intent to repay a credit card debt when the charge was made, the debt may be exempt from discharge when it was incurred to pay a tax.  Two new laws were added by Congress in 2005 to protect credit card companies in just this situation.  When used to pay a tax that is otherwise non-dischargeable, 11 USC §523(a)(14) and 11 USC 523(a)(14A) protect the creditor from discharge of the debt in bankruptcy.

Under the new laws, use of a credit card to pay tax may make a tax that is dischargeable with the passage of time, into a debt that never becomes dischargeable.  While the bankruptcy code allows discharge of personal income tax after a waiting period, there is no such provision in the new law. This is yet another reason that payment of tax with a credit card may be a bad idea.  Personal income tax that is due for recent years is considered a priority and is not dischargeable under the bankruptcy code.  While the tax would become dischargeable in two or three years if not paid, the credit card debt used to pay it would not.

Despite state laws legalizing production of marijuana for medical use, it is not a legitimate revenue source to fund a Chapter 13 Plan.  Medical Marijuana laws have been enacted in sixteen states and the nation’s capital city, Washington, DC, as of September 2011.  An additional six states have pending legislation to legalize the use of Cannabis for the treatment of various medical maladies.  Oregon is one of the states that issues permits for possession and use of medical marijuana.  Individuals with certain medical conditions designated by the statute or approved by the Health Division of the Oregon Department of Human Resources may apply for and receive a state issued permit that offers protection from criminal prosecution under Oregon law for possession of small amounts of the drug. 

In an unpublished but widely cited opinion, Oregon Chief Bankruptcy Judge Frank R. Alley, III, ruled that a Chapter 13 plan based, in part on income from a medical marijuana growing operation, did not meet the requirements of 11 USC §1325(a)(3) and could not be confirmed.  A Chapter 13 plan, to be approved by the court, must have “been proposed in good faith and not by any means forbidden by law”.  Judge Alley explained that Oregon law only permitted reimbursement of medical marijuana growers for supplies and utilities.  Oregon law prohibits the receipt of compensation in excess of those limited reimbursements.  For this reason, receipts that exceed production costs would constitute illegal drug proceeds.

Federal law is unambiguous in its prohibition against the possession or sale of marijuana.  While the current Attorney General may have indicated that the federal government will not take action to disrupt use of medical marijuana in compliance with state law, the US Attorney for Oregon has stated a contrary position.  It is clear that deriving income from the production of marijuana remains illegal under Federal statutes currently in force.

There are, of course, practical concerns about an enterprise based on conduct prohibited by federal or state law.  The bankruptcy code actually requires a certain level of feasibility in that the court must find the debtor will be able to make all the payments proposed in the Chapter 13 plan.  A plan based on growing marijuana for a living, even in part, has an uncertain future. 

In addition to the concerns addressed by Judge Alley in the Oregon case, federal tax law calls into question the financial viability of marijuana growing operations.  Expenses associated with the production of medical marijuana may not be deductable for federal tax purpose.  Medical marijuana dispensory operations in California have been assessed with federal income tax liabilities after their deductions for the cost of producing and distributing medical marijuana have been disallowed.  It would be difficult indeed to generate an after tax profit with which to fund a Chapter 13 plan when ordinary business expenses are not allowed as a deduction against income.  This is particularly true in states with laws like the Oregon statute that only allows reimbursement for supplies and utilities.

The majority of Chapter 7 bankruptcies in most jurisdictions end up being no-asset cases. This means that all the debtor’s assets are exempt.  In such a case there are no assets for the trustee to administer and distribute to creditors.  An exempt asset is an asset that can be removed from a debtor’s estate under the law.

Most exemption laws limit the dollar value or quantity of an asset that is subject to exemption.  Debtors in bankruptcy estates with assets above the exemption limit often think that their assets cannot be protected.  This is not always the case. 

When someone is considering filing and has significant non-exempt assets, it is the perfect time to talk to an experienced bankruptcy lawyer about some pre-petition planning. I haven’t yet met a potential client that was eager to turn their assets over to the trustee. There are a lot of ways to protect assets that non-lawyers may not consider; exemption laws can be complicated but an experienced lawyer may be able to find a way to protect an otherwise vulnerable asset. Many people are tempted to simply hide their assets in bankruptcy, but doing so is a crime.

What happens when the debtor has too much money? It may sound odd to someone not experienced in bankruptcy, but it happens more often than you would think. Many states have wildcard exemptions that can be used for cash on hand. Some states have generous limits while others are very small. For example, the Oregon wildcard exemption, applicable to an asset not otherwise exempt, is only $400.  There are also exemptions that apply to certain types of accounts, for example IRA accounts are exempt up to $1,171,650 under 11 USC §522(n).

What you should do with any assets you can’t exempt is worth discussing with your attorney. There are different types of debt in bankruptcy, each treated a different way, some of which may be worth paying down before filing.  Expenses can be prepaid in some circumstances, but what is ok varies from jurisdiction to jurisdiction.

Pre-petition bankruptcy planning is both an art and a science. Talk to an attorney. You may have more options than you think.

It is becoming more common for debtors to receive notification of a proof of claim in their bankruptcy from a party they have never even heard of, let alone dealt with. This often takes the form of a company claiming to have purchased credit card debt from the credit card company after the debtor filed for bankruptcy. In 2005, these companies accounted for $66 billion in credit card debt affecting over 8 million credit card users.

While it is not always important to a debtor whether or not a claim is paid, there are circumstances in which it can have a significant impact. A Chapter 13 plan can be extended or shortened by the number and dollar amount of claims filed. This can also be important in Chapter 11 and 12 cases.

Bankruptcy Rule 3001 governs what the bankruptcy proof of claim must include in order to be “adequate as it appears,” what courts will often call a prima facie showing. How courts interpret this rule varies greatly; in the case of assigned credit card debt, some courts require only an account statement from the original creditor, with no documentation of assignments, while others require a good deal of documentation. A small but growing number of courts will deny a proof of claim for failing to fully comply with every aspect of the rule (see In re Tran, 369 B.R. 312).

A creditor with a claim that has prima facie status will be paid by the trustee unless someone with an interest in the result presents evidence against the claim. If no evidence is introduced, the creditor’s claim will be allowed and paid. Consumer debtors are at a disadvantage here. They are being asked to prove a negative with little or no ability to produce this kind of evidence.  Consumers rarely keep extensive records of their family purchases.

Look over the proof of claim carefully! Creditors sometimes provide the evidence to defeat their claim within the claim itself. Creditors who buy debt do so in large transactions. Their paperwork gets sloppy. Numbers on one document may not match numbers on another. This kind of mistake isn’t enough to defeat the creditor’s claim on its own, but it is often enough to shift the burden of proof back onto the creditors.

What the creditor has to do from here is a matter of state law, but often the creditor is required to supply the documents proving the underlying assignment, something these kinds of creditors can rarely do. Many courts are becoming less sympathetic to assigned creditors when they that can’t document the assignments. As In re Shank (315 B.R. 799) states, “the fact that a party’s business practices make it difficult to produce evidence to prove its case does not permit courts to ignore evidentiary rules in deciding a disputed matter.”

Married couples can file a joint petition in bankruptcy for a single filing fee.  Consolidation of cases for married couples saves administrative cost, attorney fees, and can promote domestic harmony.  This benefit has, until recently, been denied by some courts for same sex married couples.  The United States Department of Justice has announced that it would stop opposing same-sex bankruptcies if the couple is legally married.  It is a branch of the Justice Department called the “US Trustee” that represents the administrative branch of government in all bankruptcy cases.

This change of policy comes as same-sex bankruptcies have been gaining traction in some districts.  It can be seen as another indication the Obama administration will no longer defend the Defense of Marriage Act (DOMA). But what does that mean for same-sex couples looking to petition for bankruptcy jointly?  A pre-DOMA bankruptcy case may be telling. In 1995, the Northern District of Georgia decided In re Allen, 186 B.R. 769. The Court in Allen sided against the same-sex couple on the grounds that they were trying to set a federal standard for “spouse” when Congress hadn’t intended there to be a federal standard, so the state definition is what controlled. In fact, the Court goes so far as to say “…if a state recognizes a legal marriage between a same sex couple, they would qualify for relief under § 302” of the Code.

With the Federal government no longer objecting, it appears as though married same-sex couples should be able to file for bankruptcy jointly in states that have allowed same-sex marriage. Under the Full Faith and Credit Clause of the Constitution, the same is likely true even in states that do not allow same sex marriage. The future of DOMA, however, is less certain. A spokesman for Speaker of the House John Boehner (R-Ohio) stated that “bankruptcy cases are unlikely to provide the path to the Supreme Court, where we imagine the question of constitutionality will ultimately be decided.”

DOMA isn’t dead yet. It has many ardent supporters in positions of power.  Others, equally ardent in their opposition, are attempting to overturn the law in Congress.  While the law may one day be repealed or ruled as unconstitutional by the Supreme Court, it remains the law; albeit one that the current administration has chosen not to enforce.  The opponents of same-sex marriage do not believe that bankruptcy court is an appropriate place to save DOMA. For now, file away, same-sex couples.

An illegal immigrant can file for bankruptcy in the United States.  There is no reference to a citizenship requirement in the Bankruptcy Law.  US Code §109 provides the requirements to be a “debtor.” The most common way to be eligible to be a debtor is to have a “domicile” in your state. A domicile “requires the physical presence of a person at the place of the domicile claimed, coupled with the intention of making it his present home.” Ellis v. Southeast Construction Co., Inc., 260 F.2d 280. The timing of where you use as a domicile can be tricky if you have not been domiciled in your state for two years.

Assuming you’ve been living in your home state for a while, what other hurdles might an illegal immigrant face? You don’t need a Social Security card to file for bankruptcy, but if you don’t have one, you will need to provide an ITIN. An ITIN is an Individual Taxpayer Identification Number, which is often used by people who can’t obtain a Social Security Number but want to pay taxes to avoid problems with the IRS.

If you have been using a SSN that isn’t yours, don’t put it on your bankruptcy petition! Bankruptcy courts don’t like being lied to and will serve up jail time to those who attempt fraud. Not only can you get in legal trouble for false statements on your bankruptcy forms, but debts incurred using a SSN that wasn’t yours may not be dischargeable under the Bankruptcy Code.

In Oregon and in many other states, you will also need to be able to prove your identity at the 341 meeting, also known as the First Meeting of Creditors. You will need an ID document that proves your SSN or ITIN such as a SSN card or a pay stub, and a photo ID, such as a driver’s license or passport.

Of course, there is a long list of other things you will need for your bankruptcy, but those are requirements that all debtors must face, not just those without citizenship. Bankruptcy is a complicated process, but there are few additional barriers to non-citizens.

If you owe federal tax and fail to pay, the IRS has a federal tax lien on all of your assets. The lien can be a secret and exists even if the IRS has failed to file a Notice of Federal Tax Lien in the public records. This secret lien can take your retirement funds to pay a tax debt even after the tax has been discharged in bankruptcy.

Bankruptcy can discharge some types of tax liability. However, a properly recorded lien generally survives bankruptcy discharge. This is true for recorded tax liens as well as liens that are recorded voluntarily against property of the debtor in bankruptcy. The code specifically provides protection for assets of the bankruptcy estate that the debtor has claimed exempt unless the assets are encumbered by a properly recorded tax lien. However, to qualify for exemption, the property must have actually been part of the estate in the first place.

The US Supreme Court in the 1992 case of Patterson v. Shumate, 504 U.S. 573, decided that assets protected by The Employment Retirement Security Act (ERISA) are not automatically part of the bankruptcy estate and can be altogether excluded from the estate. This protects ERISA covered retirement funds from claims of trustees and creditors. Unfortunately, excluding the asset does not allow the bankruptcy court to remove a secret federal tax lien. In order to protect retirement funds from the IRS secret lien, they must first be included and then claimed as exempt.

The 9^th Circuit Court of Appeals in Raines v. Flinn, 428 F.3d 893 explains that exclusion of ERISA assets is optional and that they can be voluntarily included in the estate. Once the assets have been included in the estate, code section 11 USC §522 permits them to be exempted and freed from the IRS secret lien. This must be done clearly and specifically or the IRS will retain their lien and can take the funds covered by their lien as shown by the 2010 US Tax Court case of Wadleigh v. Commissioner, 134 T.C. No. 10. In the Wadleigh case, the tax court agreed that the IRS retained the power to seize retirement funds, even after discharge, if the funds were excluded from the estate rather than exempted under the code.

Image credit: Audric Leperdi/Flickr

It is generally unwise to break the rules and disobey a court order. This appears to be true for debtors in a Chapter 13 plan as well. In Standiferd v. United States Trustee the 10th Circuit Court of Appeals upheld denial of discharge for two debtors who failed to comply with the court order confirming their plan and later sought a Chapter 7 discharge. The Court of Appeals for the 10^th Circuit approved the use of Bankruptcy Code §727(a)(6)(A) by the bankruptcy court after the Standiferds refused to obey the confirmation order by failing to file monthly operating reports and copies of their tax returns with the trustee.

While the results appear harsh, the facts of the case show that the Standiferds nearly tripled their already considerable debt during the four years they operated an undisclosed business under the protection of their Chapter 13 plan. While debts mounted, profits from the business were used for home improvements. By failing to provide copies of tax returns to the trustee, the Standiferds were able to conceal the income from their business and make modest payments on their plan while feathering their nest. Converting a case to Chapter 7 is freely permitted and may be good strategy in some circumstances. If the conversion is made in good faith, debtors are allowed to keep assets they acquired during the Chapter 13 case and discharge new debts.

Like many things in life, good faith is the key to a successful conversion by Chapter 13 debtors. The reverse, evident in the Standiferd case, appears to include the failure to disclose income to the trustee and the debtors’ willful failure to comply with the terms of a confirmed plan.  Loss of the discharge is a significant penalty.  However, the Standiferds willfully failed to comply with a lawful order of the court and the result of that failure was the concealment of important information from the trustee.