General Bankruptcy Issues: Nuts & Bolts
- Creditors: The Companies to which you owe money
- Affect of Filing Bankruptcy
- Discharge: What Debts are Discharged?
- Exemptions and Dischargeability
Unsecured Debt: You are not going to lose your shirt.
There are certain things that you cannot lose. The law lays
out those things that you may keep.
Secured Debt: As long as you can afford to continue paying
for them you will not lose your car or your house.
Automatic Stay: Once you have filed for Bankruptcy the
Creditors must stop calling, writing, suing, or any other action
against you in order to make you pay them.
Notification: The court will notify all the Creditors
that you have listed in your Bankruptcy Petition. This is why
you must list ALL of your Creditors. If in doubt put them on
- Affect of Filing Bankruptcy
Public Information: Bankruptcy Information is available
to the Public. It is, however, unusual for newspapers to list
Effect on Credit Rating: Chapter 7 Bankruptcy remains
on your Credit listing for 10 years; Chapter 13 Bankrutpcy remains
on your Credit listing for 7 years.
Effect on Credit: Filing Bankruptcy should not greatly
affect your ability to obtain Credit. Many Creditors will recognize
that after the Bankruptcy filing you will be able to add new
payments to your budget.
Definition: Discharge means that the Court has Eliminated
your obligation to pay for the Debt.
Secured Debt: Secured debt will NOT be
Discharged in a Chapter 7 Bankruptcy. In Chapter 13 Bankruptcy,
however, secured debt can be significantly reduced.
Priority Debt: Priority debt will NOT be
Unsecured Debt: All of your unsecured debt such as credit
card, personal loans etc will be eliminated.
- Exemptions and Dischargeability
- Taxes entitled to priority under Section 507(a). See Section
523 (a) (1) (A).
- A tax due upon filing a return, but the return is not filed.
Section 523(a) (1) (B) (i).
- A tax with respect to which a required return was filed
after the due date including extensions, but within two years
of the petition date. Section 523(a) (1) (B) (ii).
- Taxes with respect to which the debtor made a fraudulent
return or willfully attempted in any manner to evade or defeat
such tax. Section 523(a) (1) (C).
Priority taxes under Section 507 are always non-dischargeable,
so it is critical to determine when the time periods run for
taxes to fall under the priority umbrella. It is also important
to understand which non-priority taxes are also non-dischargeable
under Section 523(a).
Six types of taxes are entitled to priority under Section
507, the most common of which are income taxes which meet
one of four tests. First, if the last due date of the income
tax return, including extensions is within three years of
the petition date, the tax is priority. Second, taxes assessed
within 240 days of the petition date are priority taxes. Third,
the 240 day rule is suspended for the time any offer in compromise
is pending with respect to a tax assessment, plus 30 days,
so taxes due within the time an offer in compromise is pending
are priority. Fourth, taxes which are not assessed, but are
assessable after the commencement of a case are priority taxes
(such as when a notice of deficiency has been issued but the
90 day appeal period has not run).
The second type of priority taxes listed in Section 507(a)
(8) is property taxes assessed before the commencement of
the case and last payable without penalty after one year before
the petition date. Third are taxes which are required to be
withheld or collected and for the the debtor is liable in
some capacity (such as sales, payroll, and trust fund taxes).
The fourth type of priority taxes are employment taxes on
priority wage claims. Fifth, certain excise taxes due or occurring
within three years of the petition date. Finally, and sixth,
penalties for actual pecuniary loss are priority taxes.
Certain non-priority taxes are also non-dischargeable. These
taxes usually are non-dischargeable because the debtor has
engaged in bad behavior, such as not filing a tax return,
although the debtor is required to do so. If the debtor files
a tax return late, and the return is within two years of the
filing of the petition, the tax is non-dischargeable even
though it may not be a priority debt. Of course, as one would
expect, where a debtor files a fraudulent return, or willfully
attempts to evade or defeat a tax, the tax is non-dischargeable.
If there has not be a judicial determination of fraud prior
to the bankruptcy filing, the tax authority may be required
to litigate the fraud allegations in the Bankruptcy Court
to succeed in making these taxes non-dischargeable. However,
if there has been a Tax Court determination of fraud, the
debtor may be collaterally estopped regarding the non-dischargeability
of the debt. Grogan v. Garner, 498 U.S. 279, (1991).
In a Chapter 13 case, the "super discharge" under
Section 1328(a) can discharge more taxes than possible under
Chapter 7. A Section 1328(a) discharge occurs when a debtor
successfully completes his or her payments under the confirmed
Chapter 13 plan. If a debtor can not complete the plan, but
is nonetheless deserving of a "hardship" discharge
based upon his or her efforts in the case, the discharge enters
under Section 1328(b). A Section 1328(b) discharge is the
same as a discharge under Section 727 in a Chapter 7 case.
Taxes which are priority debt must be paid in full during
the course of the Chapter 13 case. However, for unsecured
priority taxes, while the principal tax and interest up to
the date of filing must be paid as a priority debt, any penalties
on that debt are paid as general unsecured debt (just like
credit cards). Since penalties can significantly increase
the amount of pre-petition taxes facing a debtor, an analysis
of the amount of penalties associated with tax debt is essential
in determining whether a feasible Chapter 13 plan can be constructed
to pay the priority portion of the taxes in full.
In addition, if the tax authority fails to timely file a proof
of claim, the tax debt can be discharged in full without any
payment of the taxes (whether they are priority or not). Unfortunately
for debtors, both the IRS and MRS are very attentive to the
deadlines for filing claims in recent years.
Chapter 13 can assist a debtor to strip down a tax lien to
the value of the property upon which the lien attachs. Once
the taxes are no longer secured, it is still necessary to
determine whether the taxes are priority or general unsecured
claims in order to properly categorize them for payment under
Most interestingly, in Chapter 13, a debtor is only required
to pay income taxes and interest in full if they are less
than three years old. If income taxes are older than three
years and are unfiled as of the petition date, they are still
dischargeable in Chapter 13 when the tax returns are filed
post petition. In that circumstance, the income taxes are
paid as general unsecured claims.
STRATEGIES FOR LITIGATING TAX ISSUES
The basic tool used in litigating tax issues is contained
in Section 505(a) (1). That section permits the Bankruptcy
Court to determine the amount or legality of any tax, a fine
or penalty relating to a tax, or any addition to tax, whether
or not previously assessed, whether or not paid, and whether
or not contested before and adjudicated by a judicial or administrative
tribunal of competent jurisdiction. If, however, there was
a judicial or administrative tribunal adjudication of a tax,
fine, penalty, or addition to a tax, before the commencement
of the bankruptcy case, the Bankruptcy Court may not determine
these issues again under Section 505(a)(1). See Section 505(a)
The procedural vehicle to bring a Section 505 issue before
the Court depends upon the relief sought by the debtor. If
the debtor is seeking a determination of tax liability, that
can be accomplished by an objection to the claim of the tax
authority or by an independent motion to determine tax liability.
Under either scenario, the Court will probably permit each
party to engage in discovery similar to an adversary proceeding
in an effort to fully air the underpinnings of the taxes assessed
and the debtor's assertions that the taxes are not owed.
If the goal is a determination of the dischargeability of
certain taxes, a complaint must be filed pursuant to Rule
7001(6). The full panoply of discovery devices is available
to the parties through this form of litigation.
The burden of proof is upon the taxpayer that the tax authority's
assessment is incorrect. See Raleigh v. Illinois Department
of Revenue, 120 S. Ct. 1951 (2000). The official determinations
of the IRS are entitled to a presumption of correctness. Delaney
v. C.I.R., 99 F. 3d 20 (1st Cir. 1996); United States v. Kantaratos,
36 B.R. 928 (D. Me. 1984). But see 26 U.S.C. Section 7491,
in which the taxpayer may have simply a burden of production
while the IRS may have the ultimate burden of proof in certain
circumstances (i.e. for tax periods after July 1998 where
the taxpayer has maintained tax records and has cooperated
with the IRS in providing documents as well as compliance
with other requirements to substantiate the taxpayer's position).
In instances where the issue is whether the debtor is a "responsible
person" by the tax authority for the payment of what
was once called the "100% penalty" for corporate
trust fund taxes (940, 941, or sales taxes), the First Circuit
has simplified the test for determining who is a responsible
person. 26 U.S.C. Section 6672 imposes trust fund tax liability
upon a person, who willfully fails to collect, account for
and pay for such tax if that person is "responsible"
for the collecting, accounting, and paying of the taxes. In
Vinick v. U.S., 205 F. 3d 1 (1st Cir. 2000), a.k.a. Vinick
II, the First Circuit narrowed the scope of activities a person
can engage in to be found a "responsible" person,
by first acknowledging that there have been seven criteria
generally followed by most Courts in making this determination:
- is the taxpayer an officer or member of the board of directors;
- does the taxpayer owns shares or possess an entrepreneurial stake in the company;
- is the taxpayer active in the management of the day-to-day
affairs of the company;
- does the taxpayer have the ability to hire and fire employees;
- does the taxpayer make decisions regarding which, when
and in what order outstanding debts or taxes will be paid;
- does the taxpayer exercise control over daily bank accounts and disbursement records; and
- does the taxpayer have check signing authority?
The First Circuit, in Vinick II, concluded that the last three
criteria were the most important. The Court reasoned that
the crucial inquiry is whether the person has the "effective
power" to pay taxes - that is, whether the person has
the actual authority or ability in view of his or her status
in the company, to pay the taxes owed. A careful examination
of the factual circumstances under which a debtor has been
assessed the "100% penalty" may result in sufficient
grounds to litigate the issue with the tax authority in the
Bankruptcy Court and eliminate the penalty or provide fertile
ground for a compromise with the tax authority.
IV. Bankruptcy and Divorce
There are many issues of law that can be explored in the intersection
between bankruptcy law and divorce law. The purpose of this
article is to summarize the state of the law regarding some
of the most prominent issues that appear in consumer cases.
- The effect of a divorce judgment on the division of marital
debt. There is a common misperception by individuals who are
getting divorced that if a divorce judgment requires one of
the two people to be responsible for various marital debts,
that the so-called responsible person is the only person obligated
on that debt. For example, if a divorce judgment requires
a husband to pay the Citibank Visa account, but if both husband
and wife signed for the Citibank account prior to the divorce
case, then both parties can be responsible for the account
notwithstanding any language in the divorce judgment to the
contrary. A divorce judgment does not require Citibank to
look only to the husband for payment of that account. Citibank
can look to either party for payment of the account. At best,
the wife may have the right to insist that the husband reimburse
her for any money that she pays to Citibank on the account.
A divorce judgment merely rules on the relationship between
the husband and the wife. A divorce decree can not bind Citibank
regarding from whom Citibank can collect money it is owed.
In short, it is a mistake to think that a divorce judgment
protects either a husband or a wife from creditors if the
husband or the wife signed personally on any of the premarital
- Alimony and support versus division of marital debt. The
Bankruptcy Code makes a distinction between how alimony and
support is addressed in bankruptcy versus simple division
of marital debt. Alimony and support are non-dischargeable
debts. The division of marital debt may be dischargeable in
Chapter 7 cases. Frequently it is difficult to determine whether
or not debt is alimony and support or whether it is simply
a division of marital debt. Several important bankruptcy decisions
that address these issues are In re Dressler, 194 B.R. 290
(Bankr. R.I. 1996); In re Warren, 160 B.R. 395 (Bankr. D.M.e.
1993); In re Marquis, 203 B.R. (Bankr. D.M.e. 1997). These
decisions help determine the circumstances under which obligations
under a divorce decree are either alimony and support or a
simple division of marital debt. When the issue is an award
of attorney's fees in a divorce judgment, the case of In re
Whitney, 265 B.R. 1 (Bankr. D.M.e. 2001) is worthwhile reading
to understand that an order to pay attorney's fees is usually
considered in the nature of alimony and support.
The 2005 Bankruptcy Reform altered the relationship between
debtors and their spouses in divorce. In Chapter 7, debtors
must pay, as a non-dischargeable claim, any debt associated
with a divorce judgment, whether it is in the nature of alimony
or support (now known as a "domestic support obligation")
or it is a property division. In Chapter 13, while domestic
support obligations are non-dischargeable, property divisions
are still dischargeable. Debtors with significant divorce
property divisions should seriously consider the benefits
of Chapter 13 to reduce his or her future financial obligations.
Should the non-filing spouse challenge the debtor spouse's
ability to discharge certain marital debt? Is that debt alimony
and support or division of marital debt? Would it be better
to make that challenge in the Bankruptcy Court or later challenge
the nature of the debt in Divorce Court (which has concurrent
jurisdiction to make that determination if is not made in
the Bankruptcy Court)? What is the cost associated with such
a challenge in the Bankruptcy Court?
If a challenge is made to the discharge or certain marital
debts, the burden of proof is on the party filing the complaint.
Whether or not the debtor can afford to pay for the marital
debt or whether or not the burden is greater on the debtor
than the non-filing spouse to pay the support is determined
under the circumstances of the parties as of the time of the
trial of the Bankruptcy Court. It is important to note, that
whether or not the debt is dischargeable or nondischargeable
becomes a very fact intensive inquiry notwithstanding the
labels placed upon the nature of the debt by the Divorce Court.
See Werthen v. Werthen, (2002 Bankr. LEXIS 972).
- The Automatic Stay and pending divorce actions. If a bankruptcy
case is filed at the time that a divorce case is pending,
the Automatic Stay prevents the Divorce Court from continuing
to consider any divorce issues unless one of the parties to
the divorce gets permission from the Bankruptcy Court for
relief from the Automatic Stay. If the Bankruptcy Court grants
relief from the Automatic Stay, then the divorce can proceed.
Without such relief, the bankruptcy case must be stayed like
any other pending court action against the debtor. Although
parties to a divorce may forget that a pending divorce is
stopped in its tracks by a bankruptcy filing, divorce courts
are very sensitive to that event. Most divorce courts will
refuse to take any action on pending divorces since a divorce
court's orders or judgments could be void if they violate
the Automatic Stay.
- Davis v. Cox. The most influential recent decision by the
First Circuit Court of Appeals arising from the Maine Bankruptcy
Court regarding the intersection of bankruptcy and divorce
law is Davis v. Cox, 356 F. 3d 76 (1st Cir. 2004). This case
is found on the 1st Circuit's website and the underlying decision
from the U.S. Bankruptcy Court is located on the U.S. Bankruptcy
Court of Maine's website, both of which is linked to this
In essence, the Bankruptcy Court, in Cox, attempted to delineate
the role that bankruptcy plays on ongoing divorce actions
and the effect, if any, a bankruptcy has on the determination
of the parties' property rights and the division of debts.
Any person who is in the midst of a pending divorce action
and who may be obligated to pay significant marital debt while
losing significant property should consider the holding in
the Cox case to determine whether or not a bankruptcy filing
may be of assistance in evening the playing field between
the two divorcing parties. The Cox decision was upheld on
appeal to the Federal District Court for the District of Maine.
The First Circuit Court of Appeals overturned the decision
of the Bankruptcy Court. The Court of Appeals held a certain
property, which the Divorce Court had awarded to the non-debtor
spouse, was held in a constructive or resulting trust for
that spouse. The First Circuit's decision affords the Divorce
Court more authority to determine property interests of non-debtor
spouse. This case has been the subject of seminars between
bankruptcy and divorce attorneys and is likely to guide attorneys
in both areas of the law for years to come. If an individual
contemplating bankruptcy is in the situation outlined above,
he or she should make sure that their divorce counsel and
bankruptcy counsel work together closely to be sure to provide
the person filing bankruptcy the best counsel in both forms.
Only by both divorce and bankruptcy counsel working together
can a party be sure that the legal mine field described in
the Cox case can be successfully navigated.
V. IRA/Retirement Exemptions
Rousey v. Jacoway, U.S. Supreme Court.
Decision dated April 4, 2005
The Supreme Court determined that in individual’s IRA
was exempt under federal exemption laws when that individual
files bankruptcy. Before this decision, most courts had concluded
that IRAs were available to bankruptcy trustees and the proceeds
to those accounts distributed to creditors. This decision
represents a major victory for individuals filing bankruptcy,
and will help protect that very important asset for retirement
VI. Parochial School not Exempt
Watson v. Boyajian, First Circuit Court of Appeals
Decision dated March 25, 2005
The Watsons had minor children who attended a parochial school.
The Watsons filed a Chapter 13 case and proposed to continue
paying for parochial school for their children while also
proposing a Chapter 13 payment plan for their creditors. The
Chapter 13 Trustee objected to the Watsons’ Chapter
13 plan on the grounds that not all of the Watsons’
disposable income was to be paid into the payment plan.
The First Circuit Court of Appeals held that the Watsons’
payments for parochial school were not reasonably necessary
for their budget and that they should contribute those funds
into their payment plan for the benefit of creditors. The
result of this decision is that parents filing bankruptcy
will no longer be able to pay for their children to attend
parochial school, an expense previously considered reasonable
by many courts provided that the expense was not excessively
large on a monthly basis. This decision demonstrates the necessity
of careful preparation of a budget when parents file bankruptcy.
VII. Payment Demanded for a Vehicle in Bankruptcy
On September 1, 2006, the First Circuit Court of Appeals reversed
the Maine Bankruptcy Court decision in Pratt v. GMAC.
This is one of the most significant decisions in consumer
bankruptcy in recent years, and represents a recognition by
the First Circuit that creditors have been engaging in inappropriate
behavior in attempting to collect money.
In April 2005, the Maine Bankruptcy Court ruled that GMAC
was within its rights to refuse to release its lien on a worthless
motor vehicle after the owner of the car filed bankruptcy,
received his bankruptcy discharge, and the owner surrendered
the car to GMAC. GMAC refused to accept the surrender and
insisted upon the owner paying GMAC all the money owed on
the car in exchange for the lien release. Without the lien
release, the owner could not junk the vehicle or otherwise
dispose of it. The Bankruptcy Court held that GMAC was only
protecting its lien rights, and that GMAC did not violate
the discharge injunction.
This author argued the case before the First Circuit. The
First Circuit's reversal of the Bankruptcy Court decision
was stunning in its sweeping conclusions that a debtor has
the absolute right to surrender a vehicle in this circumstance,
and that the creditor must accept the vehicle. Before this
decision by the First Circuit, both GMAC and Ford Motor Credit
had attempted to collect on discharged debts by refusing to
issue lien releases not only in Maine, but across the country
according to members of NACBA (National Association of Consumer
Bankruptcy Attorneys). In addition, the First Circuit held
that GMAC's behvior objectively violated the discharge injunction,
causing GMAC to be liable to the debtor for actual and consequential
Pratt v. GMAC, Maine Bankruptcy Court
Decision dated April 15, 2005
The Maine Bankruptcy court recently ruled that the General
Motors Acceptance Corporation (GMAC) was entitled to insist
upon payment of its lien in a motor vehicle which a debtor
attempted to surrender to GMAC and which GMAC refused to accept.
The import of this decision could adversely affect any debtor’s
ability to surrender a motor vehicle to a car lender in bankruptcy
and avoid paying for the vehicle. The decision is currently
on appeal to either the Bankruptcy Appellate Panel or the
U.S. District Court.
Return to Top
VIII. Income-Based Repayment Program for Federal Student Loans
Long Awaited Help for Federal Student
For federal student loan borrowers, repaying loans has become
more and more difficult with the increased costs of post-secondary
education and the down-turn in the economy. Student loan debt
is almost never dischargeable in bankruptcy, although there
is a very narrow exception for undue hardship 11 U.S.C. §523(a)
(8). The effect has been that many borrowers fall into default.
The effects of default are serious including wage garnishment
and income tax refund withholding by the IRS. Many students
who are entering the workforce are unable to afford their
student loan obligations even though they very much want to
repay the educational debts.
As of July 1, 2009, student loan debtors may now opt for the
Income-Based Repayment Program (IBR). IBR differs from income
sensitive repayment programs in that it caps a debtor's monthly
repayment at 15% of disposable income. Other programs offer
graduated payments that do not take into consideration a person's
ability to pay or a debtor's income availability. Upon 25
years of IBR payments, the remaining balance is forgiven.
The new IBR programs are a breath of fresh air for federal
student loan borrowers. Some borrowers in the program may
have monthly payment requirements of as low as zero since
the payment plans are based on disposable income. These programs
have strict guidelines for the determination of income.
Pros of the Income-Based Repayment
Students struggling to make payments may now qualify for much
lower monthly payments.
Students who are successful in the program may enjoy significant
forgiveness of the balances of federal student loans at the
end of a 25 year period.
Payment plans are based on individual income as opposed to
a percentage of the loan balance and term of repayment.
Cons of the Income-Based Repayment
Currently, loan balances forgiven at the end of the 25 year
period are subject to taxation but legislation in Congress
may remedy this problem.
Payment plans are calculated based on loan balances when the
student entered repayment as opposed to the current balance
on loans; this is problematic for student borrowers whose
loan balances have increased over time due to the accrual
of interest. However, the Department of Education has agreed
to fix this issue but the changes will not go into effect
until July, 2010.
Do I Qualify For IBR?
Student borrowers may access IBR calculators by going to their
respective student loan lender websites. A borrower must not
be in default of their loan obligations. Loans must be federal
in nature - private loans are not eligible for IBR. Students
must certify their income on an annual basis for continued
participation in IBR.
Helpful IBR Links:
If you are current on your loan obligations but are looking for more affordable ways of keeping your payments current, you should contact your student loan lender and inquire about IBR.
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