Tom Scott Law Indy

Bankruptcy Attorneys in Indianapolis Since 1980

Credit Score

Holiday Season and End of Year Preparations if You Have Financial Problems

by

Holiday Season and End of Year Preparations if You Have Financial ProblemsThe holiday season is a time of celebration, but for many people it’s a time of year that brings added financial pressure while they struggle to keep up with payments on their existing debt. If you use credit cards to buy Christmas gifts, with the expectation of filing for bankruptcy to get rid of those holiday season debts, those purchases may lead to creditors to accuse you of fraud and those debts could be declared nondischargeable. In that situation, the timing of a bankruptcy filing needs to be carefully considered.
We recently discussed several aspects of bankruptcy with Christopher Holmes and Jess M. Smith, III, partners at Tom Scott & Associates, P.C. The discussion focused on how buying gifts with credit cards and other expenses during the holiday season can contribute to financial problems after the New Year begins. Other topics covered in the conversation include the impact of previous tax liabilities on a bankruptcy filing; federal tax refunds in relation to Indiana law and the IRS Code; the tax filing status of married couples who are separated and have children; and how filing for unemployment benefits or your immigration status might effect your bankruptcy filing.

The simplified explanations in this conversation cannot be taken as legal advise, because every situation is different and complicated. Each case is very fact-sensitive and there is no one-size-fits-all explanation of how a tax liability relates to a specific bankruptcy case.
Q: As the end of the year approaches, what advice can you offer to someone who is struggling financially and researching the possibility of declaring bankruptcy?
CH: Typically, we have a lot of clients who come to see us after Christmas and after they have incurred too much debt purchasing gifts for family members and friends. As a result, when those bills come due in January, February, and March, our clients come to the realization that those accumulated bills are unmanageable and those clients seek our assistance in alleviating the financial problems caused by their inadvertent overspending.
Also, we have had a few clients who have used their credit cards for the purchase of Christmas gifts with the expectation of filing bankruptcy to get rid of those debts. In such cases, the creditors may scrutinize the use – or in their opinion misuse – of credit cards right before the filing of a bankruptcy. As a result, those creditors can use a provision in the bankruptcy code that provides that debts of a certain amount incurred in a certain period of time shortly before the filing of a bankruptcy case are presumed to be a fraudulent and, as a further result, nondischargeable. In those rare cases, we must advise our clients accordingly and we must be more careful regarding the timing of the filing of those cases.
Q: In other words, if you know you’re in financial trouble, it’s not a good idea to think you can “go out with a bang” with one last buying binge right before declaring bankruptcy, because that might be declared a fraudulent act. Don’t make matters worse just because it’s the holiday season.
CH: Yes. Section 523 of the U.S. Bankruptcy Code which is entitled “Exceptions to Discharge” and which sets forth the different kinds of debts that are NOT dischargeable in a bankruptcy includes a section that pertains to consumer debts of a certain amount for luxury goods or services that are incurred within 90 days of when a bankruptcy case is filed, as well as cash advances of a certain amount that are incurred within 70 days of when a bankruptcy case is filed, are presumed to be nondischargeable.
Although the presumptive periods are 90 days and 70 days respectively, creditors will often look for suspicious usage in the 3 to 12 months before a bankruptcy case is filed in order to determine whether a compelling allegation can be made that a reasonable debtor must have known or should have known when they incurred those debts that those debts would never be repaid. If so, then the creditor can assert that those debts were incurred under false pretenses and, as a result, they are not dischargeable.
Q: Are there any end-of-year financial loose ends you can tie up to prepare for a bankruptcy filing after the first of the new year? What should someone take care of first to make filing for bankruptcy as smooth and easy a process as possible?
CH: First and foremost, we meet with some people who have significant income tax liabilities for prior tax years. Although we ask all of our clients about income tax liabilities, we need to know about taxes owed not only for prior tax years, but we need to be aware of income taxes that might be due and owing for the current tax year for which the tax returns are due in the next calendar year. If so, then we must defer the filing of their bankruptcy case until after January 1, so the taxes can be included in the Chapter 13 plan and then paid back without penalty or interest; otherwise, they are deemed to be a post-filing debt that is not included in their Chapter 13 Plan.
JS: I have a similar situation now with a Chapter 26 (i.e., back-to-back filings of two Chapter 13 bankruptcy cases), in which a debtor is coming out of Chapter 13 and he has just paid a bunch of taxes, but still owes much more. We’re also going to delay filing for bankruptcy until 2019, so we can include his 2018 taxes in the plan.
Q: Should someone in a deep financial hole start the process of contacting a bankruptcy attorney as soon as possible, even if they might not file a case until next year?
CH: We’ve learned that some people have never filed some of their tax returns, and those unfiled tax returns must be filed before we file their bankruptcy case. And we will urge those individuals to prepare and file those unfiled tax returns as soon as possible, so we know if income taxes are owed, how much is owed, and for which tax years they are owed, in order to properly advise them regarding whether a Chapter 7 or a Chapter 13 case is more appropriate to resolve their income tax problems. Also, the U.S. Bankruptcy Code includes a provision that requires that all unfiled income tax returns must be filed and copies provided to the Trustee; otherwise, the bankruptcy case can be dismissed.
Q: So, the first tip is you shouldn’t make your debt worse by spending a lot of money on holiday gifts. The second tip is to get your tax filing situation as clean as possible before filing for bankruptcy. Should the approaching end of the year be considered with regard to the sale of real estate or other assets?
CH: Yes, we always look at client’s income tax returns from prior tax years. Not only do we want to know if income taxes are owed, but we need to know if a client is expecting to receive a significant tax refund back from the IRS and/or from the State of Indiana because tax refunds are deemed to be an asset of their so-called bankruptcy estate.
If we file a Chapter 7 bankruptcy case before the debtor receives and spends the tax refund, it’s likely, if the refunds total more than a $1,000, the Chapter 7 trustee assigned to the case will intercept – or take – the refunds and use the proceeds to pay as much as possible to the creditors who file claims for their fair share thereof. Accordingly, we advise people to refrain from filing their bankruptcy case until after they’ve prepared and filed their tax returns, and then they’ve received and spent their tax refunds in an appropriate way. As a result, they don’t run the risk of the trustee taking the money and giving it to their creditors.
By the way, in many situations, most of the refund is the result of the Earned Income Tax Credit (EITC). The good news: Indiana law includes a provision whereby the portion of the refund that results from the EITC is exempt – or off limits – from being taken by the trustee for the benefit of the creditors.
Also, we deal with many clients who have filed their tax returns improperly. For example, married taxpayers can file their income tax returns jointly, or as a married person filing separate from their spouse, or as a married person who files separately if they qualify as “Head of Household.” Unfortunately, we’ve seen many cases in which one of the married couple files as “Head of Household” without being qualified by law to do so, in order to receive a tax refund that is more than they would be entitled if they filed as “Married Filing Jointly” or “Married Filing Separately.”
The Internal Revenue Code has a provision that requires a taxpayer to be legally separated from their spouse for the last six months of a tax year before the taxpayer can claim “Head of Household” status, so we always ask our clients, “Were you living together at any time between July 1 and December 31?” If so, they’re ineligible for “Head of Household” status and the extra tax refund to which those taxpayers might be entitled.
As a consequence, we have people in Chapter 13 cases who get these bigger tax refunds who realize they have filed improperly – and the trustees also look at tax returns – and know they’ve received a refund to which they are not entitled, so they are forced to file amended tax returns with the correct status – “Married Filing Jointly” or “Married Filing Separately.”
Invariably, the refund to which they were legally entitled is less than what they received, and then they must repay the excess refund to which they weren’t entitled, and the Chapter 13 Plan must provide for the repayment of that ill-gotten excess tax refund money.
JS: I’ve just worked with a couple who were clever enough to say they were separated during the last six months of the year, but they both claimed the same child as a dependent on their tax returns. The husband claimed his tax status as “Married Filing Separately,” but the wife claimed “Head of Household,” so we had to have the husband amend his return to remove the child as a dependent for that tax year.
A few years ago I had a client who improperly claimed unemployment benefits, so he had to list the Indiana Department of Workforce Development as a creditor when he filed for bankruptcy. Depending on whether the amount of benefits the agency was paying was significant or not, it may object to discharge on grounds of fraud and have the debt declared nondischargeable.
I had that same type of situation with a different client about a month ago. This client was actually arrested, because a felony criminal charge of fraud had been filed. I know of two other attorneys with clients who have been arrested for the same type of fraud.
CH: I had a case recently in which the Indiana Department of Workforce Development filed its complaint to determine the dischargability of unemployment compensation paid to my client because my client received benefits to which she was not entitled because she received them despite being employed at the time those benefits were received. As a result, it was certain the Judge of the U.S. Bankruptcy Court would determine that those benefits were obtained as the result of my client’s fraudulent conduct and those benefits would be determined to be nondischargeable. As a result, I told my client, “You might as well agree it is a nondischargeable debt,” that passes through bankruptcy and must be repaid to avoid the additional time, effort and expense of fighting a losing battle.
Q: So the bottom line is that declaring bankruptcy does not allow a client to discharge an overpayments of unemployment compensation received due to the fraudulent conduct of the client.
CH: That is correct. We tell people, “If you’ve received benefits to which you weren’t entitled, because you were otherwise employed, the amount of those benefits becomes nondischargeable debt and it must be repaid.”
This type of situation reminds me that from time to time people who are in the country illegally come into our office to file for bankruptcy. Often times they have a fake Social Security number. We have to forewarn them, they do not have to be a citizen to file for bankruptcy in the U.S. but there is the possibility, if the bankruptcy trustee’s office researches their Social Security number and some other person’s name is listed, that will throw up a red flag. I don’t think people here illegally have to worry about the United States Trustee’s office giving that information to the Immigration authorities, and then being deported. But, I think they might be foolish to file for bankruptcy and run the risk of that situation being revealed, which might result in their deportation.
Q: As an attorney, do you have an attorney-client privilege relationship with your clients that legally prevents you from revealing a client’s criminal or immigration status?
CH: Yes.
Q: So, anyone consulting with you can reveal to you, without fear, any information that might impact their decision to file for bankruptcy, because you’re not allowed to repeat that information to anybody?
JS: But if they file for bankruptcy, we have to disclose it. There is no attorney-client privilege in bankruptcy.
Q: Okay. But, if you advise someone to not file for bankruptcy, you’re not going to then turn around and tell some legal agency about that person’s criminal or immigration status. When people come to your office for a free consultation, can they openly discuss their legal situation without having to worry about their personal information leaving your office?
CH: That is correct.

How Bankruptcy Affects Student Loan Debt and Car Loan Interest Rates

by

How Bankruptcy Affects Car Loan Interest Rates

As a result of the recent rise of the prime rate, vehicle loans included in Chapter 13 bankruptcy plans can have a higher interest rate than in the past few years. Despite the resurgent economy, single mothers are still vulnerable to financial difficulties. Student loans cannot be eliminated by filing for bankruptcy, but one of several strategies can be used in conjunction with a Chapter 13 plan to pay them back.

We recently discussed several aspects of bankruptcy with Christopher Holmes and Jess M. Smith, III, partners at Tom Scott & Associates, P.C. The discussion covered several topics, including: how the recent rise of the prime rate has affected bankruptcy cases; which group of people are currently at risk of financial hardship; how student loan debt is treated in a Chapter 13 bankruptcy case; misconceptions about bankruptcy; and the ability of the Indiana Department of Revenue to implement an administrative garnishment.

Q: How has the recent rise of the prime rate affected bankruptcy cases?

Jess Smith, III: It has affected the interest rate on cars. There was a case years ago, which originated out of Kokomo, Indiana, that involved the interest rate a non-mortgage secured creditor would get on an asset being paid through a Chapter 13 bankruptcy plan. The local court came up with a ruling that was basically sanctioned by the U.S. Supreme Court in 2004 (Till v. SCS Credit Corp.), which stated the creditor would receive the prime interest rate plus a risk factor of 1% to 3%.

If the creditors become astute to the recent rise of the prime rate, it could affect bankruptcy plan agreements. Many of the car loans we see in bankruptcy cases may have had an interest rate of 19% to 23% when the contract was signed. The Till case that was decided by the Supreme Court involved a loan for a used pick-up truck that had a 21% interest rate.

For the past couple of years, I’ve been offering secured creditors or lenders 4.5% interest on their car notes. However, I recently saw a local case being handled by another attorney in which the creditor objected to a similar rate offered in the proposed plan for the debtor. The creditor demanded a 5.75% interest rate and the trustee seemed to think that rate was appropriate, based on the higher prime rate now in place.

Q: The economy has rebounded since the recession of a few years ago, which has caused a decrease in the number of bankruptcy filings. Is there still a particular group of people who are currently at risk of financial hardship and in need of relief through the bankruptcy court?

Chris Holmes: Unfortunately, single mothers who must raise one or more kids without receiving child support payments. If they are sued and are facing the garnishment of 25% of their take-home pay, then they’re unable to pay their rent or their car note, so they really have no choice but to file for relief through the bankruptcy court, to prevent the garnishment of their wages and to wipe the slate clean.

Q: When people come to see you for a free consultation, is there a common misconception about filing for bankruptcy, the benefits of bankruptcy protection, or the types of services you can provide?

CH: Sometimes people think they can’t get rid of a certain debt after they’ve been sued and there’s a judgment—or if a garnishment has already been implemented. They feel like it’s too late and they can’t stop those actions. But you can.

Q: Are there any types of debts that filing for bankruptcy won’t discharge?

CH: The big one is student loans. Occasionally we speak with people who have up to $100,000 worth of student loan debt. I recently spoke with someone who said they saw on the Internet that student loans are now going to be dischargeable, but that’s not true.

JS: I’ve spoken with other attorneys who also stated they’ve had people counting on that.

Q: If a student loan debt is not dischargeable, can it be rolled into a Chapter 13 bankruptcy plan?

JS: Yes.

CH: Let’s say a debtor can’t afford to make any payments. A student loan lender is the only lender that can leapfrog a legal process and go directly to a payroll department to garnish wages.

JS: The Indiana Department of Revenue can also do that, but obviously they’re not a lender. They can do what’s called an administrative garnishment and get 15% of your salary without a court order.

CH: Right. But a regular creditor must (1) file a lawsuit; obtain a judgment; (2) file a Motion for Proceedings Supplemental to Judgment; (3) have the court conduct a hearing; (4) determine if there is gainful employment; and (5) serve the employer with a Final Order in Garnishment. If your net pay is more than $217.50 per week, the creditor can garnish your wages. However, the maximum garnishment is 25% of your net income, which is your gross income minus taxes.

JS: I currently have a client in a Chapter 13 bankruptcy plan who makes about $80,000 a year, but who owes about $70,000 in student loans. The student loan lender was garnishing about 15% of his salary. We included the student loan debt in the plan to stop the garnishment, so he could take care of paying for his car and taxes, while keeping that loan on hold.

Q: When the Chapter 13 bankruptcy is filed, is that student loan debt treated like any other type of debt?

CH: Yes and no. Yes, it can receive a pro rata distribution along with the other general unsecured creditors. No, in that the amount that remains unpaid upon the conclusion of the case will not be discharged. Accordingly, I forewarn debtors that the total amount the student loan lender receives through the plan may not exceed the interest that’s accumulating while the case is pending. As a result, the total owed on the student loan may actually be bigger than when the debtor filed for bankruptcy because of the additional interest that accrued. However, it is often a cost worth bearing so the debtor need not make unaffordable monthly payments directly to the lender for the 3 to 5 years they are under the protection of the court.

JS: It’s just a temporary band-aid, not a cure for student loan debt.

CH: But that band-aid allows a debtor to resolve other debts and then, after the Chapter 13 plan is successfully completed, the debtor can focus his or her attention on paying back the student loan.

Q: If, during the bankruptcy plan, the debtor is in a position to pay back additional money on the student loan, is that possible?

JS: Generally, in this district, if you want to propose to make your regular payments on the student loan directly to the lender, you can propose to do that.

Q: Can a debtor make additional payments to a student loan lender, on top of the monthly payments included in the plan, or is the debtor’s choice one or the other?

CH: It’s either the regular monthly amount paid directly to the lender or the amount paid through the plan.

Q: Is that situation similar to a car loan, in that you might advise a debtor to pay off the car loan outside of the plan, if the debtor can afford to do that?

CH: If a debtor can afford the original monthly payment to the student loan lender outside of the plan, it’s preferable to pay that directly to the lender, rather than having that money paid through the plan for the benefit of all of the creditors. As a result, the debtor gets more “bang for the buck” by having that payment go toward eliminating the student loan instead of distributing that amount amongst all creditors in the plan.

Q: What would happen if a debtor decided to try and pay off the student loan outside of the bankruptcy plan, but for some reason is not able to keep up with the full monthly payments? If the debtor only pays a portion of the monthly payment, or none of it, can the student loan lender then go back to the debtor’s employer to begin wage garnishment?

JS: The lender can’t go back to the employer, but a long time ago I did see a case in which the debtor was going to pay $350 a month directly to a student loan lender. A couple of years into the plan, the debtor stopped paying the lender. The student loan provider then moved to dismiss the debtor’s case for being in default of the bankruptcy plan.

I’ve seen a case in which the lender notified the trustee about missed student loan payments. The trustee demanded that if the debtor stopped direct payments for the student loan, then the amount due to the lender would be added to the monthly bankruptcy plan payment. Remember, a plan payment is based on projected income minus projected expenses. Therefore, if the debtor is not paying the amount due to the lender each month, then the debtor’s monthly living expenses are that much less, which means there is that much more to add to the Chapter 13 Plan payment.

Q: So, if a debtor falls into that type of situation, the trustee won’t adjust the plan so the debtor can pay only a portion of the monthly loan payment?

JS: Correct, but I did have a previous case in which the debtor was actually a married couple with two incomes and two student loans. When the plan began, one spouse was under-employed, so we parked the student loans in the plan along with all of the couple’s other debts. Two years into the plan, the under-employed spouse obtained a new job with a much higher salary. Instead of giving all of those additional earnings to the trustee, we amended the plan to start directly paying back the student loans, directly to the lenders, outside of the bankruptcy plan.

Q: And the trustee agreed to that amended plan?

JS: Yes. Every case is different.

CH: Here is another misconception about bankruptcy. I’ve spoken with a debtor who wanted to include a student loan in the bankruptcy plan, to hold off the lender for the duration of the plan. The debtor assumed the student loan would not bear interest while the plan was in place, which is not true. The automatic stay does not prevent interest from accumulating on the student loan.

JS: Whatever interest is allowable in the loan contract continues to accumulate on top of the loan amount during the three to five years of the bankruptcy.

Q: Here in Indiana, would the closing of ITT Technical Institute in September 2016 be an example of when a closed school discharge could be used to eliminate a student loan debt?

CH: Yes. If some of your money went to ITT and your circumstance meets the criteria established by the U.S. Department of Education, you can contact the lender and initiate an administrative procedure to apply a closed school discharge to that student loan debt.

Q: What would be an example of an undue hardship that could cause a student loan to be discharged?

JS: It’s a very high level of hardship. You basically need to show the court that you’re going to perpetually live below poverty level.

CH: Someone who is disabled or who is on Social Security, who has only enough money to pay their necessities, and who has no money left over for the benefit of a student loan lender.

JS: And no reasonable expectation of any of those circumstances changing. There has been litigation in other districts—in which people have made good faith efforts to pay back the student loan and they demonstrated what they could afford to pay—where some courts have discharged part of the debt. In our district, there has not been much reported litigation like that. It’s expensive to undertake that type of litigation.

Bankruptcy Can Affect a Divorce Settlement / Advantages, Disadvantages, and Misunderstandings of Bankruptcy

by

Bankruptcy Can Affect a Divorce Settlement

You can use a Chapter 13 plan to catch up on child support arrearage or spousal maintenance support (alimony) arrearage. If you have received a Chapter 7 bankruptcy discharge, you may still be obligated to relinquish to the bankruptcy trustee assets you receive in the future, such as your next tax refund check, a pending inheritance, or the eventual settlement from a pending personal injury case.

We recently discussed several aspects of bankruptcy with Christopher Holmes and Jess M. Smith, III, partners at Tom Scott & Associates, P.C. The discussion covered several topics, including property settlement in a divorce; alimony and child support payments; the different eligibility requirements for filing a Chapter 13 bankruptcy compared to filing a Chapter 7 bankruptcy; surrendering exempt assets to protect non-exempt assets; and misunderstandings about being sued and garnishment in relation to bankruptcy.

 

Q: How can filing for bankruptcy affect a divorce settlement?

Chris Holmes: Recently I had a client who, in his Decree of Dissolution of Marriage, was ordered to pay his ex-wife $900 per month for 10 years. He provided me with a copy of his settlement agreement, so I could look for language that indicated whether or not that monthly payment was in the nature of property settlement or if it was in the nature of alimony or maintenance.

There was absolutely no language in the agreement that indicated it was in the nature of alimony or maintenance. The reason that’s significant is that anything that’s in the nature of alimony or maintenance is a nondischargeable debt, whether you file for a Chapter 7 or Chapter 13 bankruptcy. (Child support is another example of a nondischargeable debt.) In this particular case, the Judge awarded $900 per month to the ex-spouse as a way to equalize the respective value of their respective retirement accounts, because his was worth more than hers.

Because the obligation to the ex-wife appeared to be a property settlement, and because Chapter 13 of the bankruptcy code allows a debtor to discharge property settlement debts, I urged this particular client to file a Chapter 13 case, rather than a Chapter 7 case, so he could seek the discharge of this property settlement debt to his ex-wife. (NOTE: He would be required to pay back some of the property settlement through the plan; however, the portion of the property settlement not paid through the bankruptcy plan would be discharged (i.e., rendered null and void). As a result, he decided the benefits of a Chapter 13 case, because he still had over three years worth of payments to make to her, outweighed the additional costs of a Chapter 13 case.

Q: What are some of the other advantages and disadvantages of a Chapter 13 bankruptcy compared to a Chapter 7 bankruptcy? Are there certain circumstances in which you would always lean towards one or the other?

CH: Sometimes people must file Chapter 13 case because it has been less than eight (8) years since they filed a previous Chapter 7 case, which renders them ineligible to file another Chapter 7 until it has been more than eight (8) years since the date of filing the previous Chapter 7 case. In other words, if they desperately need debt relief during that eight-year time frame, they must file for relief under Chapter 13 of the U.S. Bankruptcy Code.

Q: Is there a similar ineligibility time frame for someone who has filed a Chapter 13 bankruptcy?

CH: You can file a Chapter 13 anytime, but a debt will not receive a discharge unless the new case is filed more than four (4) years after the filing of the previous Chapter 13 case. Also, some debtors are rendered ineligible for a Chapter 7 case because they earn too much money to qualify for a Chapter 7 case because of something called the Means Test. In other words, the computer program we use determines that a debtor has the ability to pay back a significant portion of their debt; therefore, they are not allowed to discharge certain debts in their entirety under Chapter 7 of the U.S. Bankruptcy Code. As a result, they must file a Chapter 13 case and pay back as much of their debt as they can afford during a five-year plan.

As we’ve discussed before, we file Chapter 13 cases for debtors who are behind in their house payments and are either threatened with foreclosure, or are in foreclosure, and they need more time to catch up on those overdue mortgage payments.

We also have some clients who have significant income tax problems that are not addressed as effectively by a Chapter 7 case because certain taxes can be paid back through a Chapter 13 Plan without penalties and without interest over a longer period of time.

Also, we have situations like in our recent conversation, in which the debtors are so far upside-down on a car loan (that is, the payoff on the loan exceeds the fair market value of the auto by a significant amount and/or the interest rate is significantly higher than the prime rate of interest plus 1 ½ %. Through a Chapter 13 plan, the debtor can effectively refinance, or “cram-down,” the higher payoff and reduce it to the fair-market value of the auto. As a result, the debtor pays only the fair market value of the auto, plus a lower rate of interest, which saves the debtor a lot of principal and interest.

Sometimes, people are just behind in their car payments and they are desperate to keep the vehicle. We can use a Chapter 13 plan to either catch them up on those payments or to pay the loan in full through the plan. As a result, the debtor is given more time to catch up on their car payments than the lender might otherwise demand.

Q: Going back to the issue of divorce, if alimony and child support are nondischargeable debts, would there be any advantage or disadvantage to someone in a divorce proceeding or having been divorced to lean toward either a Chapter 7 or a Chapter 13?

CH: Let’s say a debtor is behind in their spousal maintenance or child support payments. A debtor can use a Chapter 13 plan to resolve those problems as well. A debtor can use the plan to catch up on child spousal maintenance or child support arrearages. Sometimes, when the obligation is short-term and the payments are too great to be affordable, a debtor can put that obligation into a Chapter 13 plan to extend its payment over 60 months, which reduces the monthly amount to be paid on those obligations to an amount that is more affordable.

It should be noted, however, the bankruptcy code changed in October 2005, and we would need the cooperation of the state court or the child support recipient, because the automatic stay in a bankruptcy case no longer stops the collection of child support. Currently, only with the consent of the other party, can the debtor use a Chapter 13 plan to cure an overdue child support situation.

Q: Have you recently dealt with any unusual bankruptcy cases?

CH: A situation I hadn’t dealt with in many years in a Chapter 7 case arose in which the debtors had assets that were worth a significant amount more than what the law would allow them to protect or exempt. In other words, the debtor filed a Chapter 13 case to pay an amount to their creditors that exceeds the amount the creditors might have received in a Chapter 7 had the debtor’s nonexempt asset been taken and liquidated by a Chapter 7 Trustee for the benefit of the creditors had the debtor filed a Chapter 7 case.

In this case, however, the debtors did not have the disposable income to fund a Chapter 13 plan to pay any money to those creditors. In that case, the Chapter 7 Trustee was threatening to take and liquidate some real estate to get at the equity the debtors could not protect. Fortunately, the debtor owned some vehicles they could live without; therefore, the debtors offered those vehicles to the trustee for liquidation because the net result would be enough to satisfy the Trustee.

In exchange for surrendering assets they normally could protect through a Chapter 13 Plan—the vehicles—the debtors were able to convince the Trustee to abandon his interest in the real estate the debtors could not protect.

Q: So, they chose a Chapter 7 case rather than a Chapter 13 case because the debtors did not earn enough money?

CH: Yes. The debtors were not eligible for Chapter 13 case because they did not have regular, steady income above and beyond their regular living expenses to pay what needed to be paid through a Chapter 13 plan.

Q: What is the most misunderstood aspect of bankruptcy? In other words, what do a lot of people you initially meet with believe concerning bankruptcy about which you have to set the record straight for them?

CH: By the way, sometimes debtors assume that after they’ve been sued and a garnishment has been entered against them, that they can’t stop the garnishment. Fortunately, even if a garnishment order has been entered, as soon as we file the bankruptcy case we can stop and prevent any further garnishments. Also, I’ve met with debtors who believed that if they file a bankruptcy case that they must give everything they own to the bankruptcy court for liquidation and they’ll be left with nothing; however, Indiana law allows debtors to protect an ample amount of assets in order to get a truly fresh start.

Jess Smith, III: One thing some people don’t understand is why they have to turn over tax refunds.

Q: So, why do people who file for bankruptcy need to surrender their tax refunds?

JS: Because, when you file bankruptcy, the bankruptcy trustee takes control and possession of all of your assets until they are abandoned or are determined to be exempt. Certain portions of a tax refund may be exempt, but usually it is a non-exempt asset.

People don’t understand that even though a bankruptcy case is fully closed at the time of the discharge, the asset portion of the case remains open. That confuses a lot of people.

Q: So, after you receive the discharge document from the court, the case may not actually be finished?

JS: One of the roles of a Chapter 7 trustee is to determine if you qualify for a Chapter bankruptcy. A second role is to determine if the debtor has any non-exempt assets that can be liquidated for the benefit of creditors.

So, when people receive their Chapter 7 discharge, they sometimes forget about their non-exempt assets, because they might not have received their tax refund at the time they filed their case, but they have accrued their rights to at least a portion of their tax refund. That portion is what becomes an asset.

People don’t understand that they have to trade that asset in exchange for their discharge. If they don’t cooperate with the asset portion of the case, then their discharge can be revoked.

Q: So, in other words, if a debtor receives a bankruptcy discharge notification in October of this year, the refundable portion of the income taxes they paid prior to the discharge date can be considered a non-exempt asset subject to be taken by the trustee, even though the debtor doesn’t receive their refund check until next year?

CH: Yes. The debtors still have the duty to cooperate and turn over that asset, even though the debtor has received a discharge. Let’s say, for example, a debtor filed a Chapter 7 case on October 12, 2016, which is day 286 out of the 366 days in this leap year. Let’s also assume that as of this date, the debtor might receive a 2016 tax refund, when they file during the next tax season, in 2017. In the eyes of the U.S. Bankruptcy Court, approximately 78% of their Federal and State tax refunds have accrued as of this date. As a result, a Chapter 7 Trustee will force the debtor to provide a copy of the tax returns, which will show the refunds for the year, and then the Trustee will determine that portion of the tax refunds, less the Earned Income Tax Credit, which is exempt, and can’t be taken; whereupon, the Trustee could take and then distribute to the creditors 78% of the non-exempt portion of the tax refunds.

Other similar types of assets a debtor might receive in the future, which the trustee could take, include an impending inheritance or the settlement from a pending personal injury case, if they stem from an event that happened prior to the bankruptcy petition date.

We’ve learned from experience that if the amount of that pending asset is less than $1000, then trustees would probably ignore it, because they would not be able to provide a meaningful distribution to the creditors.

JS: But that decision is up to each individual trustee. Trustees make a commission based on what they collect from debtors on behalf of creditors, so some trustees spend more time than others pursuing small assets.

Means Test Helps Determine Filing For Chapter 7 or Chapter 13 Bankruptcy

by

The bankruptcy means test was established by congress as a standard method of calculating the disposable monthly income of a debtor, to help determine the amount paid to the trustee of a Chapter 13 bankruptcy plan.

We recently discussed several aspects of bankruptcy with Christopher Holmes and Jess M. Smith, III, partners at Tom Scott & Associates, P.C. The discussion covered several topics, including the means test, the differences between Chapter 7 and Chapter 13, how divorce and child support can affect bankruptcy, and the discharge process. Below is Part 1 of 4 of the transcript of that conversation.

Q: In a Chapter 13 bankruptcy, how is a debtor’s monthly plan payment amount determined?

Chris Holmes: In a Chapter 13 bankruptcy case, the general rule would be that the debtor must pay to the Chapter 13 trustee all of their disposable monthly income. So, we craft their budget to show how much their projected monthly income will be—gross income minus taxes—and then we calculate what they pay for rent, utilities, food, clothing and all of their living expenses. So, income minus expenses, whatever that difference is, that’s the primary way of determining the monthly plan payment. The bankruptcy code says a debtor must turn over all of their disposable income to the Chapter 13 trustee for the benefit of their creditors. And then, as long as they’re not already paying off 100 cents on the dollar, that’s what they have to pay.

Q: How do factors such as everyday expenses figure into determining what a debtor’s disposable income ends up being?

CH: Whatever their real expenses are or there are some IRS standards that we use on occasion. Obviously, a family of eight has expenses that are greater than a family of three. Jess and I have been doing this for so long, we understand, after putting thousands of budgets together, how far you can push the envelope on a food budget, for example, for a family of four. We know that if we go beyond a certain amount—a sort of comfort zone—that the trustee gives us some pushback and says, “Wait a minute. $1200 a month for two people?” So, for example, they can’t be going out to St. Elmo’s Steakhouse every night for dinner. They have to be reasonable in their budget. We’ve learned over time what a reasonable budget is, based on the household size.

The general rule of whatever is left over goes to the trustee was thrown out the window in a recent case we handled, because the husband had a job and the wife was disabled. She received Social Security benefits. Their combined income, including those Social Security disability benefits, exceeded their living expenses by $660 per month. Before the bankruptcy code changed back in 2005, and really up until just recently, their plan payment would have been $660 a month. However, in this case, our associate attorney Andrew DeYoung said we are only going to offer $250 per month. The concern was that the trustee would ask, “What about the other $410?” However, Andrew understood that there is an area of the law developing where judges have decided that because Social Security benefits are exempt—off limits to creditors—and that they don’t count in the means test that determines household income.

Q: So, Andrew was subtracting the disability payments from the means test equation?

CH: The wife collected about $1600 a month in Social Security benefits. Andrew was just arguing that not all of the couple’s disposable income should be turned over to the trustee, because the disability benefits are intended to provide the wife with a safety net, in case her health deteriorates or an unexpected medical situation arises.

Q: In this case, had both the husband and wife declared bankruptcy?

CH: Yes, it was a joint case. When the trustee asked why I only offered a $250 monthly payment, I stated there is some existing case law that suggests creditors cannot claim bad faith or abuse when debtors do not turn over all of their disposal income, because some of it—not all of it; just the disability benefits—is exempt from creditors. The trustee stated she was also familiar with that case law, so she dropped that disability income from the plan and, to our clients’ pleasure, accepted the $250 per month offered. I asked her if any Indiana judges had ruled on this type of situation or if there are any related 7th Circuit Court of Appeals cases. She stated not to her knowledge. The precedent for this is from some other jurisdiction where crafty bankruptcy lawyers have made this argument and evidently those judges have agreed, so she’s basically taken a position that maybe it isn’t money that she can demand from the debtors.

Q: You mentioned a family of four, which obviously includes children, and a related comfort zone of credible monthly expenses. Is there any entertainment budget that you can justify as not part of that family’s disposable income?

CH: There’s two things. There’s the means test, which looks at average monthly income over the past six months before filing. There’s also certain IRS standards for housing and food and whatever. If I refer to the computer program we use, I can look at how much is deemed to be reasonable for a four-person household. So sometimes when my clients don’t do a really good job on their budget, I’ll go to the means test and use the IRS standards to fill in a blank. Also, if a debtor shows too much money left over, and I know they really don’t have it, I’m going to find some place to use up that money, so they’re not too rich for a Chapter 7 bankruptcy. There are standards for what you can put into the different slots within a monthly household budget.

Q: Where do you find the means test you mentioned?

CH: It’s something that congress established, but our computer program provides all of this information, which is periodically updated. In Indiana, there’s currently a medium income for a one-person household of $43,422.

Jess Smith, III: The medium income varies from state to state.

CH: That’s the starting point. So if I have a family of four and their household gross income per year was less than $74,584, they immediately pass this test. The test is designed to determine if someone has an ability to pay back a significant percentage of their debt through a Chapter 13 plan.

Q: What happens if they fail the test?

CH: They’re ineligible perhaps for a Chapter 7, so we tell them that if they want relief from the bankruptcy code, they’ve got to file a Chapter 13 and offer this disposable income to their creditors.

Q: What happens if that disposable income figure turns out to be zero or just a couple of dollars?

CH: They really wouldn’t flunk the means test in that case. There’s an algorithm in the computer program that looks at what’s left over at the end of the month and what their debt is, and it figures out if you have an ability to pay back a certain percentage of that debt. The program indicates whether they’ve flunked or passed the test; it shows if you’re eligible for a Chapter 7. Sometime you can get around that, because we’re looking at income over the past six months. If the debtor has just lost a job and no longer has that income, we can override the test in a way, or at least show this special circumstance—they’re now destitute and don’t have any money—they’re not required to pay back some of this debt when clearly they don’t have an ability to do that.

Q: So that inability to pay back the debt determines whether you file for Chapter 7 or Chapter 13?

CH: Right. Most people will file for Chapter 7, wipe the slate clean, not make any monthly payments, and be done in three to four months. In Chapter 13, it’s three to five years where they’re making this monthly payment to a Chapter 13 trustee who then divvies up the money amongst the creditors in a certain way. Some people do Chapter 13 because they need it to save a house, to pay taxes, or do some other creative things, but there’s a small percentage of people who are required to file Chapter 13 because they are too rich to just wipe the slate clean. It’s not fair; it’s consider an abuse of the bankruptcy code for somebody who makes $100,000 to just get rid of all their debt.

Q: So that medium income is the number that determines whether you makes too much money?

CH: Right. It’s a starting point. If they’re below that number, they pass automatically. If they’re above that number, then we have to do this more-comprehensive test that looks at not just gross income, but where all of that money goes. Taxes, insurance, rent, food, utilities, car payments, student loans—all of those things. Then, after you plug in all of these numbers, the program shows a green happy face if you pass or a yellow unhappy face if you fail.

Bankruptcy Means Test

There’s a case we filed in which we received the green happy face. We filled in the debtor’s average monthly income and then on the next page it totals it up to $62,580. The median income for a family of this size is $62,431. So, because their combined income was a little bit above the median income, I had to go through the program and fill in additional fields, for example car payments and mortgage payments. There are certain standards, for example for a two-person household with two cars it’s $424 per month for gas, oil, and routine maintenance on a vehicle. At the very bottom of this test, in this particular case, we come up with this number for Disposable Monthly Income, which we call “DMI” and here it’s “minus $371.” So, clearly in this case they don’t have any money left over. That’s why the program gives us the green happy face, because it concluded that even though their income is above median income, because of all of their expenses, there is no money left over for the creditors. So they qualify for Chapter 7. Now if this had been a yellow unhappy face, and the DMI had been a significant positive number, then we would have to say to the debtor that the case would get thrown out or threatened with dismissal, so we just know that we have to file as a Chapter 13. Then they’re in this plan for 60 months, five years, to pay back as much of their debt as possible.

JS: And there are certain things that are not deductible on a Chapter 7 means test that are deductible on a Chapter 13 means test.

Q: Such as?

JS: Such as retirement account contributions or 401(k) loan repayments. Going back to the Social Security issue, the code says that, if you have a habit of making retirement contributions, you’re supposed to be able to continue those under this means test. Then you put your budget together going forward. Our associate Andrew DeYoung had a case where he tried to schedule the ongoing contributions, because she had done them within the six months. But he received a creditor objection and Judge Graham said, “I’m not going to allow you to keep socking away this kind of money while paying very little on your debt.

CH: Even though they’re in a Chapter 13, they get credit for it.

JS: Correct. She had a very low Disposable Monthly Income number under the means test, but when it came before the judge, the judge said this doesn’t pass the smell test. If the client were to appeal, maybe the client would have won, but the client didn’t have the resources to appeal.

Q: Was it because the IRA contribution was too high?

JS: It was substantial. Plus, evidence came out that the debtor worked for a university. If she contributed some phenomenal amount of money, her employer would match it with about 20% of the contribution. So this woman was trying to put away $9000 to $10,000 a year, hoping to get another $3000 to $4000 match. It was not the trustee who objected, it was an individual creditor who had loaned the debtor money and who spent enormous resources objecting to the proposed plan. I don’t know that every judge would have sided with the creditor, but this particular one did.

Q: So the judge threw out the IRA contribution entirely or forced her to lower the payment?

JS: She was in a Chapter 13, so the plan Andrew offered met the means test. But the creditor started objecting with old law—pre-2005 case law—and Andrew and I did not believe the creditor could win because it was such old case law.

CH: But it was an extraordinary amount of her income that she was contributing.

JS: Yes, it was about 15%, so a substantial portion of her income was being deferred.

CH: I’ve told people that if their contribution is 4%, or 6%, or even 8%, that no one is going to squawk. But if it’s 10% or more, that’s probably where it wouldn’t pass the smell test.

JS: In this case, the debtor was trying to only pay about $7000 on over $100,000 debt, so the judge said, “You’re not going to walk out of here with a fat 401(k).”

CH: This case illustrates the situation where you go to law school and think the law is black and white. You’re going to learn how to solve problems and there are definite rules. But the law is actually shades of gray. It’s almost never black and white. One judge might say, “That seems reasonable,” and another judge might say “It’s unreasonable.” It’s unpredictable, especially in state court law, where you go to one county and have one judge rule one way, then you go to another county, with the exact same facts, and another judge might rule a different way. Clients always ask, “Can you predict the results?” But that’s next to impossible, because you just don’t know how that judge on that day is going to interpret those facts in light of the law. Sometimes I’ve had judges where it was not what they knew that I was afraid of, it was what they knew that just wasn’t so. They thought that they knew the law, but they didn’t and they interpreted the law improperly. But you can’t go to the judge and imply they’re wrong. The only way you can do that is to appeal and most people we represent don’t have the financial ability or resources to appeal a decision, because that’s really expensive and time-consuming. The case mentioned earlier is a good example of the gray shades of the law and it’s fluidity, because by offering a plan with only a $250 monthly payment, instead of $660 a month, Andrew saved our client $24,600 over the life of the five-year plan.

Part 2 of Conversation: Differences Between Chapter 7 Bankruptcy and Chapter 13 Bankruptcy

Part 3 of Conversation: Divorce and Child Support Can Impact a Bankruptcy

Part 4 of Conversation: Being Discharged From Bankruptcy

Differences Between Chapter 7 Bankruptcy and Chapter 13 Bankruptcy

by

The primary difference between a Chapter 7 bankruptcy and a Chapter 13 bankruptcy is that a Chapter 7 bankruptcy can eliminate debt in a period of three to four months compared to the three to five years it takes to complete a Chapter 13 plan. Under certain circumstances, a Chapter 13 bankruptcy can be converted into a Chapter 7 bankruptcy.

We recently discussed several aspects of bankruptcy with Christopher Holmes and Jess M. Smith, III, partners at Tom Scott & Associates, P.C. The discussion covered several topics, including the means test, the differences between Chapter 7 and Chapter 13, how divorce and child support can affect bankruptcy, and the discharge process. Below is Part 2 of 4 of the transcript of that conversation.

Q: For a debtor, in terms of moving forward with your life after you declare bankruptcy, what are the differences between between Chapter 7 versus Chapter 13? How does that affect your credit score or your standing in the financial world?

Jess Smith, III: In the short-term, a Chapter 7 is probably more advantageous, because when you’re in a Chapter 13 there’s always the risk that you won’t complete the plan and you’ll become eligible to convert it to a Chapter 7. Therefore, you can add debt to your bankruptcy that accrue from the time you file your Chapter 13 to when you convert to your Chapter 7. That makes lenders nervous about extending credit to you while the Chapter 13 is open, because they could take a hit.

Chris Holmes: I always tell people you’re in a case for three to four months under Chapter 7. Your done and you can do whatever you want. In a Chapter 13, you can’t borrow money without permission of the trustee or the judge. As Jess pointed out, debts that are incurred after the filing of the case, if they change their mind and switch to a Chapter 7, they can be thrown into the mix for discharge.

Q: So what would be the circumstance in which someone could switch from a Chapter 13 to a Chapter 7?

JS: A loss of income is the primary one.

CH: People start out and maybe they’re too rich. they make $100,000 a year and can pay back some of the debt. Then their job goes overseas and they’re making $10 an hour; income plummets; no money left over for the creditors; case is no longer feasible. And so we switch to a Chapter 7, dispense with the monthly payments, and just wipe out the rest of the debt.

JS: Another reason someone might want to start as a Chapter 13 and contemplate having the option of a Chapter 7 later is that you have people with substantial medical issues. Perhaps they have a few creditors coming after them now, where they need that protection. But they don’t want to file Chapter 7 now, because they know they’ve got medical issues within the next eight years that are going to crop up. Some of them will go into a Chapter 13, to establish a payment plan with those existing creditors, knowing that if a medical calamity happens before the Chapter 13 is done they can convert to a Chapter 7 and add those debts.

CH: It’s kind of a way to insure against uninsured events over this three- to five-year period, so if something terrible happens—they run up $50,000 of uninsured medical debt and they can’t afford to pay it—the law says we can switch from a Chapter 13 to a Chapter 7 and move those debts. Generally speaking, when you file the case, you’re going to list the debts prior to that date. In a Chapter 13 or a 7, you can’t add debts thereafter. Unless you switch it from a Chapter 13 to a Chapter 7, so that deadline before which debts can be added moves up to the date of conversion to a Chapter 7. So, all of those debts incurred in-between, that otherwise a debtor would have been stuck with, are added to the list.

Q: It seems as if wiping out debts completely under Chapter 7 is a more drastic financial transaction. Does that affect your credit score more negatively than filing a Chapter 13?

CH: You would think that someone filing under Chapter 13 who is paying back some of the debt would get some kind of credit for that. But my understanding is that a bankruptcy is a bankruptcy is a bankruptcy to most creditors, whether it’s a Chapter 13 or a Chapter 7. People don’t get credit, in a sense, for paying back some of their debt through a Chapter 13 plan.

JS: Not until the Chapter 13 discharge, but while you’re in it you get no positive benefit from it.

CH: No one is going to pat you on the back and say, “You’re paying back some of your debt, here I’ll give you more money.”

JS: At the end, if it shows you paid your mortgage on time and you paid your car off in full, you’ll get credit for those things. But your not going to get a boost for running into a Chapter 13 as opposed to a Chapter 7. Not in the short-term, no.

Q: But in the long-term?

JS: Potentially, yes.

CH: I tell people that supposedly debts stay on your credit reports seven to 10 years.

JS: Usually from petition date.

CH: So being in a Chapter 13 for three to five years, as opposed to a Chapter 7 for three to four months, won’t stay on your record any longer.

JS: A Chapter 13 will actually come off the credit report sooner. A Chapter 7 will be up there for up to 10 years; a Chapter 13 for about seven years.

Q: So an advantage to completing a Chapter 13, in the long-term, is that it will help you establish better credit sooner?

JS: Potentially. But in the short-term it’s the same.

CH: People always ask, “What’s a bankruptcy going to do to my credit rating?” Well, if you’ve got $50,000 of credit card debt, $30,000 of medical bills, and people are suing and garnishing and hounding you, your credit worthiness is already shot. In a weird sort of way, when you get a discharge in bankruptcy, you wipe that slate clean. You can’t file another bankruptcy for eight years, but if you have decent income and no debt, I would imagine that one’s credit worthiness is going to be enhanced by wiping the slate clean. We have debtors who tell us that just weeks later they start getting inundated with car loan applications, even though they’re in a bankruptcy. I assume that’s because the creditors are sophisticated enough to know they can’t file another bankruptcy and they can’t add any post-filing debt to the bankruptcy. So, any car loan after the filing can’t be added; they can’t file another Chapter 7 for eight years, and they’ve got decent income and they know all of this debt is going to be wiped out, a new loan can’t be discharged. I assume that’s why they are aggressively marketing to those people.

Q: So, you can’t file another Chapter 7 for eight years after having filed a Chapter 7?

CH: Date of filing plus eight years.

Q: How about if you file for Chapter 13, then complete that 60-month plan and the bankruptcy is discharged?

JS: If you file a Chapter 13 first and complete it, you can file a Chapter 7 six years after your Chapter 13 filing date, under certain circumstances. If you file a Chapter 7 first and then you file a Chapter 13, it has to be four years after your Chapter 7 filing to be eligible for a discharge. We have people who file them so close together they’re not eligible for any discharges. They complete an umbrella, so they can get their things sorted out. With an umbrella, the creditors are told to stay, while the debtor makes some sort of a payment plan. We have people complete those payment plans and then they still have to deal with the debt, because it wasn’t discharged. But, in the interim, that period of the five-year window, they’re able to live their lives and try to get their affairs in order.

CH: Or we put them in one of these bankruptcies just long enough until finally it’s been long enough to file a bankruptcy from which they can get a discharge. So, we let the case be dismissed and then re-file when it’s been long enough.

JS: I just placed someone into a Chapter 13 where basically the primary purpose was that her main debt was student loans. She made about $70,000 salary and, based on her household size, she could file a Chapter 7. But the student loan creditor said, “You owe us over $100,000, so we’re going to administratively garnish 15% of your wages. And she said, “No you’re not. I’m going to file a Chapter 13 and I’m going to pay you $500 a month for the next five years, so I can get my kids out of the house.” Otherwise she knew that 15% was going to have her end up being evicted, because it was too much of her income.

CH: Another reason we do Chapter 13 filings is because student loans are nondischargeable. If, for example, the debtor has other problems and the student loans is just too burdensome, we put them in a Chapter 13, so they can keep the student loan creditor at bay for five years. Meanwhile they can resolve some other cash issues or save their house or do whatever they need to do. But then, of course, because it’s nondischargeable, down the road that student loan is still there. Chances are that what was paid to the student loan through the five year plan won’t cover the interest that accumulates, so that student loan is probably going to be bigger. But at least they can get rid of all their other financial problems and then they can focus on the student loan at the end of five years. Hopefully at that time the money that was in the plan to solve other problems will be there to solve the student loan five years down the road.

JS: We refer to that as a Chapter 26. That’s when you get through your first Chapter 13 and shed everything but the student loan, and then if you’ve got all of the kids out of the house, maybe you’re in another Chapter 13 where your student loan is your only creditor and you try to knock it out during the second five-year plan.

Q: So, regardless of whether you file Chapter 7 or Chapter 13, student loans are not dischargeable?

JS: Correct. By and large, with rare exceptions.

Q: And that’s the same for federal taxes?

CH: Well, no. Taxes are a little different, although that gets complicated, too. But, generally speaking, if the taxes are less than three years old, you’ve got to pay them back. Taxes more than three years old may be dischargeable, but then you have to worry about whether there is a federal tax lien. Some of the tax might have to be paid back. I’m about to file a case for a debtor who had some taxes owed for 2012. The clock didn’t start ticking until April 15, 2013, because taxes are always due by April 15 the following year. So, I said to her, “Look, you’ve got all of these taxes owed for 2012; we don’t have to file your bankruptcy sooner than later. Let’s wait until after April 15, 2016, so they’ll be more than three years old and then maybe those 2012 taxes will be treated just like a credit card or medical bill, and be totally wiped out.” The threat was that in the interim, unbeknownst to me, the IRS filed a tax lien, which would make some of the tax payable. The hope is that the tax is going to fall off as a dischargeable debt.

Part 1 of Conversation: Means Test Helps Determine Filing For Chapter 7 or Chapter 13 Bankruptcy

Part 3 of Conversation: Divorce and Child Support Can Impact a Bankruptcy

Part 4 of Conversation: Being Discharged From Bankruptcy

$20,000 Contempt Penalty Because Mother Hurt Father’s Credit Should Be Dischargeable In Bankruptcy

by

*Disclosure required by 11 U.S.C. § 528(a)(3): We, the law office of Tom Scott & Associates, P.C., are a debt relief agency. We help people file for bankruptcy relief under the Bankruptcy Code.
Q: A state court judge orders the mother to pay the father $20,000.00 following a contempt hearing as a penalty for actual costs of petitioner’s attorney fee. The award is a contempt penalty following the Judge’s determination that the mother has not been paying student loans in a timely manner thus harming the father’s credit and that the mother has not complied with a parenting time order. Is that penalty dischargeable in Bankruptcy?
A: Bankruptcy Code Section 523 provides a list of debts that are not dischargeable in bankruptcy. Specifically 523(a)(7) states: A bankruptcy discharge “does not discharge an individual debtor from any debt – … (7) to the extent that such debt is for a fine, penalty, or forfeiture payable to and for the benefit of a governmental unit, and is not compensation for actual pecuniary loss…”
Under section 523(a)(7), civil contempt sanctions are generally non-dischargeable where, they are imposed to uphold the dignity and authority of the court. For example see U.S. Sprint Communications Co. v. Buscher, 89 B.R. 154, 156 (D.Kan.1988); PRP Wine Int’l, Inc. v. Allison (In re Allison), 176 B.R. 60, 63-64 (Bankr.S.D.Fla.1994). In these cases, the dischargeability of a prior fine was at issue in a subsequent bankruptcy.
A “debtor seeking to discharge a pre-petition sanction faces an uphill battle. While he has the ability under Bankruptcy Rule 4007 to seek a determination of the dischargeability of the sanction in that subsequent proceeding, the bankruptcy court will evaluate and adjudicate the prior debt’s dischargeability guided at least in part by § 523(a)(7). It is for this reason that a representative of a corporate debtor, like Mr. Hansbrough, is not free flatly to ignore the bankruptcy court’s orders, absorb any sanction the court can muster, and then simply file a personal bankruptcy petition before a different court and obtain a discharge as a matter of course.” In Re Hercules Enterprises, Inc., d/b/a JP’s Health Club, Debtor. James Hansbrough, Appellant, v. David Birdsell, Chapter 7 Trustee of Hercules Enterprises, Inc.’s Bankruptcy Estate, Appellee, 387 F.3d 1024 (9th Cir, 2004).
Accordingly, my reading of the Bankruptcy Code is that Section 523(a)(7) creates a two prong test to determine whether a civil contempt action is dischargeable in bankruptcy:
1) The debt cannot be discharged if the penalty is payable to and for the benefit of a governmental unit; AND
2) The debt cannot be discharged if the penalty is not compensation for actual pecuniary loss [a “pecuniary loss” is defined as “a loss that can be evaluated in money terms” (Black’s Law Dictionary)].

If mother files a Chapter 7 bankruptcy and receives a discharge, even if the current $20,000.00 penalty is dischargeable, the underlying order to remain current on student loans is not dischargeable. The mother should file a Chapter 13 bankruptcy to attempt a discharge of both the civil contempt penalty as well as the property settlement order.

In the facts presented, the state court order was that the money be paid directly to the father and not payable to or for the benefit of the any governmental unit. Therefore, the first prong is not met and the debt can be discharged in bankruptcy. The second prong is that the debt cannot be discharged if the debt is not compensation for actual pecuniary loss. Conversely then, the debt is dischargeable in bankruptcy if the penalty is for actual pecuniary loss. In this case, the court order does specifically state that penalty is for actual compensation so it should be dischargeable in bankruptcy.
More importantly, however, is that the divorce decree directed the mother to remain current on student loans and hold the father harmless as a co-debtor. Through issuance of this divorce decree order, the state court has created another potential debt for the mother; that is, the father can collect money for damages if the mother does not remain current on student loans. This potential debt to father will remain in effect until either the student loan is timely paid or the divorce decree order is discharged. A Chapter 7 bankruptcy will NOT discharge any debt to a former spouse that was incurred by the debtor in the course of a divorce. Therefore, if mother files a Chapter 7 bankruptcy and receives a discharge, even if the current $20,000.00 penalty is dischargeable, the underlying order to remain current on student loans is not dischargeable. Accordingly, if the mother ever falls behind on student loans in the future, the father could simply seek another post-discharge contempt order and the mother would have to appear again before an already unhappy judge. Therefore, I would recommend that the mother file a Chapter 13 bankruptcy to attempt a discharge of both the civil contempt penalty as well as the property settlement order.

What happens if I do not declare bankruptcy?

by

Our office often works with creditors to try and negotiate a lower settlement on claims and has reached great success. Our office oftentimes has a greater success in non-bankruptcy workouts because the threat of bankruptcy is always on the creditors mind when we negotiate.
Creditors know that our office has filed thousands of bankruptcies and that if they do not settle then there is a good chance that they will get nothing (or much less than we have offered).
In order to have a successful non-bankruptcy workout, we like to see a limited number of creditors (as any single non-cooperative creditor may ruin the whole deal for everyone) and a source of funds (such as borrowing from a friend or taking a hardship loan from retirement).
We recently had a client settle on four claims for less than $17,000 when he owed over $70,000. He did not want to file and was able to borrow from a retirement account. Our fees for saving him $50,000 was less than $2,000.

How will bankruptcy affect my credit score?

by

Naturally, filing for bankruptcy will negatively impact your credit score. The severity or long-term influence on your credit score will vary in each case, but after you file for bankruptcy you can begin right away to slowly rebuild it.
If you are reading this answer, you might want to discuss your situation with a bankruptcy attorney soon. For immediate assistance, please contact us.