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Bankruptcy is an Option for Retirees

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You Can Enjoy the Retirement You’ve Dreamed About

The U.S. and global economies constantly fluctuate, because what goes up must come down, and vice versa. The reasons for recessions vary, but the results are the same in that people suffer regardless of the causes.The Great Recession a decade ago, which caused over eight million people to lose their jobs, resulted in a huge number of business and personal bankruptcies. The current looming recession will probably not be nearly as severe, but the results will still be painful for those personally affected.

Baby Boomers All Grown Up

 

Recent articles suggest the people who will be most negatively affected by the next recession will be the elderly and those heading into retirement. That will be a lot of people, because 10,000+ people retire daily these days, which is twice as many as 20 years ago. That rate will peak at 12K per day in about a decade, when all baby boomers will have reached age 65.
Baby boomers have high debt compared to the previous generation. Late boomers have higher debt than middle boomers, who have higher debt than early boomers. This pattern is contributing to a situation in which many elderly adults will be forced to rely on food stamps and low-income subsidies to make ends meet.
Another inevitable result is that many seniors and retirees will turn to bankruptcy as a last-ditch effort at financial survival.

Times Have Changed

In 1991, two percent of U.S. bankruptcy filings were by people over 65. By 2016, that rate was 12%, while the population growth of that group only grew 2.3%, from 17% to 19.3% – a 9.7% imbalance.
The decline in corporate worker pension plans leaves retirees with less fixed income and higher health care costs to cover. Those costs are continually rising at over 10% annually. This is a recipe for serious financial issues for a large segment of society who are entering a more-vulnerable time of life.
The recipe includes ingredients that include a rise in healthcare costs from 5% of U.S. GDP in 1960 to 18% in 2017, with cost increases expected by about 1% annually in the next decade. Income for retirees could also be negatively impacted by 401(k) retirement plans that fluctuate with the stock market.
If a person’s health is, or becomes, a major issue, which is somewhat inevitable as we age, disability payments may help cover the ever-rising cost of living for those eligible. Otherwise, seniors will need to budget for medical costs not paid for by Medicare, supplemental drug coverage, or secondary insurance policies.
Many reasons exist to explain how we, as a progressive and prosperous nation, find ourselves in this position, but that is for historians and economists to ponder – and hopefully fix – for future generations.

Retirement Retired for Many

It’s too late to point fingers of blame. And it’s too late to find a quick fix for those hard-working Americans who are or will soon be “in retirement” without a sufficient retirement financial plan. The only apparent financial solution for individuals without any serious health issues is to continue working long past the official retirement age.
Many elderly individuals will never actually retire to the life of leisure they dreamed would be at the end of their career. They will still need to work, usually at low-wage jobs, to make ends meet.
If you’re retired or approaching retirement, and you’re still paying off a lot of debt — and adding monthly interest onto that debt — you need to think seriously about the long-term financially reality of your situation.
The burden of aging is bad enough. The additional burden of living on a fixed income sinking into a sea of debt is crushing. If you’ve started taking Social Security before age 70, you’ve taken another blow below the financial belt. If you can wait until 70, you will receive much more each year, so you should try to hold off until then if at all possible.
The current state of homelessness in America may just be the tip of the iceberg, if the nation does not find a solution to the situation a large portion of retirees face. The potential reality we may soon face as a nation is one in which a large portion of the baby boomer generation may be forced into bankruptcy as the only option to avoid a life of destitution.

An Option for Relief

Bankruptcy is usually an option of last resort. Careful consideration is warranted before you decide to file for bankruptcy. But after serious contemplation, you may not have any other viable options available to you.
The relief bankruptcy can offer is like having a mountain of weight lifted off your back. It can create the light at the end of the tunnel that leads you toward a future in which you can finally relax and enjoy the latter stages of your life.
Bankruptcy may be the only solution that allows you to enjoy retirement in a manner that at least somewhat resembles the dream you worked your whole life to achieve. Declaring bankruptcy is not a decision to be taken lightly, but it is a legal option built into our financial reason for a good reason.
Millions of people have taken advantage of the lifeboat that bankruptcy offers to those drowning in a sea of debt. It can help solve an otherwise unsolvable problem. If you head in that direction, you won’t be alone and you won’t have to face an uncertain future filled with financial fear.
To find out more about the possibility of a debt-free future, contact us to schedule a confidential conversation about your situation.

Reference Articles:

– Who Goes Bankrupt in America? Increasingly the Elderly
– What Happens to Your Retirement Plan Now That the Fed Lowered Interest Rates?
– Cutting Interest Rates Hurts Retirees the Most
– Why Are Americans Paying More for Healthcare?
– How Higher Interest Rates Impact Your 401(k)
– Americans are retiring at an increasing pace
– Baby boomers face more risks to their retirement than previous generations

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

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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 Filing Tax Returns Late and Unpaid Taxes Affect Your Bankruptcy Case

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Filing Tax Returns Late and Unpaid Taxes Affect Your Bankruptcy Case

A recurring theme bankruptcy lawyers deal with is tax returns not filed on-time. Determining tax liabilities in bankruptcy cases can be very complex. If a debtor pays back taxes through a bankruptcy plan, when the case is discharged the IRS can charge the debtor for the unpaid interest on those taxes. Even if you cannot pay your taxes, you should file your tax returns on or before the deadline, because filing just one day late can mean your tax debt will not be dischargeable through 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 focused on the affect filing tax returns late has on a bankruptcy case, along with the related topics of: non-priority taxes; the impact of the revisions to the bankruptcy code in October 2005; the position taken by the Indiana Department of Revenue; unpaid taxes as they relate to the priorities for allowed unsecured claims of governmental units; and a benefit of a Chapter 13 bankruptcy versus a Chapter 7 bankruptcy, for people who have tax problems.

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: What bankruptcy issues have you been dealing with lately?

Jess Smith III: One issue that keeps popping up concerns people who did not file their tax returns with the Internal Revenue Service (IRS) when they were due. As a result, the IRS is billing people who’ve received a bankruptcy discharge to collect the accrued interest on either priority taxes that were paid through their bankruptcy plan or non-priority taxes that are nondischargeable, that are due and payable despite the bankruptcy discharge because the debtor did not timely file the returns.

Q: What are the differences between priority taxes and non-priority taxes?

JS: Generally speaking, though there are exceptions to every rule, if you file a bankruptcy case, priority taxes are those taxes due and owing on any tax return that was required to be filed within the three years prior to the date the bankruptcy case is filed. As a general rule, the debtor must make provisions in his or her Chapter 13 Plan to pay those taxes in full to the taxing authorities.

For example, if priority taxes are owed, the debtor must pay the IRS and/or the Indiana Department of Revenue (IDR) the amounts due through their plan. But, on those priority taxes, if that tax return was filed within two years of the date the bankruptcy case was filed – whether or not it was due and even if you filed it timely – the IRS will assess interest on those taxes throughout the three to five year period of the plan. As a result, debtors can pay the amount the IRS claims is owed, but the debtor will be receiving a tax bill after the bankruptcy is discharged for the unpaid interest.

(NOTE: That is the part of the fallout from the significant revisions to the bankruptcy code in October of 2005, which the IRS was not enforcing until some favorable rulings were issued in some other Circuits within the last few years. Now they’re starting to whack debtors and intercept their refunds after discharge.)

I had a case in which the debtor worked out an agreement with the IRS. The bankruptcy was discharged after five years. Then recently the IRS came after the debtor for accrued interest on taxes from the two years before the bankruptcy was filed, because the debtor had timely filed those returns within two years of the filing of their bankruptcy case.

Moreover, the debtor had been curing a massive amount of pre-bankruptcy mortgage arrears, so the taxes weren’t, as a matter of law, paid until the fifth year of the plan; therefore, the IRS kept charging the debtor whatever statutory interest rates they could and then came after the debtor when his bankruptcy was discharged. Based upon decisions from other Circuits, the IRS action is lawful.

The IRS filed a Proof of Claim for whatever taxes were due, including accrued interest and penalties, up to the point of the bankruptcy. Even if the Trustee paid the claim as filed, the IRS still charges interest on the balance during the time the debtor is in bankruptcy. Then the IRS collects the unpaid interest after the bankruptcy has been discharged.

CH: Prior to the changes in the Bankruptcy Code in October of 2005, any taxes that were due for the three years before the filing of the bankruptcy could be paid through the plan, without penalty and interest. Once the underlying tax had been paid in full, upon discharge there were no penalties and no interest to worry about. Also, all unsecured taxes that were more than three years old when the bankruptcy case was filed were discharged whether those returns were filed in a timely manner or within two years of the filing of the bankruptcy case (or even if the returns were filed AFTER the bankruptcy case had been filed).

JS: Fortunately, the Indiana Department of Revenue is not taking a similar position.

Q: In situations in which this applies, are you anticipating those accrued interest payments coming down the pike and accounting for them in the payment plan?

JS: We can’t, because debtors can’t offer interest on those taxes unless they pay every other creditor in full. It’s difficult to get around

CH: Sometimes, in certain cases, we’ll offer some interest through the plan, to try to mitigate the bill for the accrued interest on those taxes that the debtor might receive after discharge.

Q: So, you try to pay off some of that interest that you know is coming?

JS: If we know and we can get the trustee to agree to it, but there are only certain circumstances in which the trustee will consent to that.

CH: Before the revision of the bankruptcy code in October 2005, one of the primary benefits of a Chapter 13 bankruptcy case was that we could tell people who owed taxes that at the end of the case, when they received their discharge, they were done. They had paid all of the taxes they had to pay and the taxes that weren’t paid through the plan would be wiped out in their entirety.

Since the new tax-related provisions came into effect in 2005, even if a debtor pays the underlying taxes through the plan, the interest on those taxes is still due. Accordingly, we need to refrain from filing some bankruptcy cases for at least two years and a day after a debtor has filed tax returns late, to account for that rule.

Q: What happens if a debtor filed a tax return on time, but did not pay the tax liability due until they started paying the IRS through their bankruptcy plan? Can the IRS still charge interest in that circumstance?

CH: If the tax return was submitted to the IRS within two years of the filing of the bankruptcy case, then the IRS is taking the position that the interest becomes nondischargeable and has to be paid after the case is over.

In conclusion, debtors with unpaid taxes often have complicated situations that require the expertise we have accumulated after handling hundreds of cases over the past 20 years to know how and when to file such cases at the appropriate time.

JS: There are no guarantees, because every case is different and the IRS rules for Processing Chapter 13 Bankruptcy Cases are complex, which is why you need to discuss your situation with an experienced attorney.

There are some rulings from other circuits that state even if you file the return more than two years before the petition date, but you filed it one day late, it’s never dischargeable. That’s a very harsh decision from one district. The issue has not come up in the 7th Circuit, so I don’t think the IRS is being aggressive enforcing it in this circuit.

CH: The tax code section that outlines the priorities for allowed unsecured claims of governmental units—U.S. Code Title 11, Chapter 5, Sub-chapter I, Section 507(8)(A)—gets deep into the weeds.

CH: Also, any tax liability incurred after the date a bankruptcy case is filed is deemed to be a post-filing debt that is not included in the bankruptcy case; however, it is possible, with the IRS’s permission, to add post-filing tax liabilities to the plan. In other words, we can modify or amend the plan to add money to the money that is already in the plan to pay those post-filing taxes.

Recently, I received a call from a client who complained that the IRS had taken her post-filing tax refund and applied that money to a post-petition tax liability we had added to her plan. Given this was a clear violation of the law, I contacted the IRS and I demanded the return of the debtor’s post-filing tax refund. Once the IRS realized it had taken that post-filing refund to apply to a tax that was being paid through the debtor’s plan, it promptly admitted its mistake and sent the ill-gotten refund to the debtor.

Q: Is the Proof of Claim that the IRS files any different than the Proof of Claim that any other creditors would file?

CH: It’s on the same form, but the IRS breaks down its claims into different categories, such as secured non-priority taxes, unsecured non-priority taxes, and unsecured priority taxes.

Q: What would be some examples of non-priority taxes?

JS: Taxes that are more than three years old when the bankruptcy case is filed, that arise out of tax returns that were filed in a timely manner, and the taxing authority has never recorded a notice of a tax lien.

Q: Is the circumstance of filing the taxes compared to paying the taxes a determining factor as to whether or not it becomes a priority or non-priority tax claim by the IRS? For example, let’s say someone reading this article is in financial trouble and foresees an approaching need to file for bankruptcy in the future. That person hasn’t filed tax returns for the past 10 years, so he files those tax returns, but does not pay the taxes due for those previous 10 years. Then, more than two years after the day all of those delinquent tax returns were filed with the IRS, that person files for bankruptcy in Indianapolis. Would those unpaid taxes be considered by the IRS to be priority or non-priority tax claims?

CH: We would hope the answer is that those delinquent taxes would then be become dischargeable. But, recent rulings seem to indicate that if you don’t file a tax return when it’s due, you’re going to be penalized forever and those taxes may be nondischargeable.

JS: There is a decision from one Circuit that says if you file one day late, you never discharge that debt. That’s a bit of an extreme position, but there is one Circuit–not the 7th Circuit–that reached that decision.

Q: So the bottom line is, regardless of your financial situation, file your taxes by April 15 every year. Is it safe to say that advice might save you from a lot of trouble down the road?

JS: Yes. Even if you cannot pay your taxes, you should file your tax returns on or before the deadline. The other issue is that we’re often contacted by people who will file a return on time, but they forget to report some income (e.g., IRA withdrawals, part-time jobs, Form 1099 income, etc.). After the debtor receives their refund check, the IRS notices the unreported income, the IRS assesses the unpaid tax thereon, and the IRS will send a billing to the debtor demanding payment of the taxes due on that unreported income.

CH: One of the benefits of a Chapter 13 bankruptcy versus a Chapter 7 bankruptcy, for people who we know have tax problems, is that in the Chapter 7 bankruptcy, neither the IRS nor the IDR are required to come forward and assert anything. Neither the IRS nor the IDR must file a Proof of Claim that would enlighten the debtor regarding what taxes are owed, what category the taxes fall into, whether there are any tax liens, or any indication which taxes must be paid and which are dischargeable.

JS: As a result, the debtor must live with that uncertainty until after they are discharged, and then they must wait in suspense to see if the IRS and/or the IDR will resume collection efforts.

CH: Accordingly, I will tell a client that one of the benefits of a Chapter 13 case is that if we are so uncertain about the tax liabilities, both the IRS and the IDR are required by law to come forward and file a Proof of Claim that breaks down the taxes into these different categories; therefore, the debtor has much more certainty about the full extent of their tax problems. Also, we can determine whether a Chapter 13 bankruptcy case might be a more effective way to handle those taxes. In other words, the debtor will not need to deal directly with the taxing authorities if they file a Chapter 13 case because the taxing authorities are compelled by Chapter 13 of the U.S. Bankruptcy Code to accept payment of those taxes through the U.S. Bankruptcy Court. Meanwhile, the taxing authorities can’t contact the debtors, nor can they garnish wages, levy bank accounts, take tax refunds, or impose tax liens upon the debtor while under the protection of the U.S. Bankruptcy Court.

Also, I’ve had such cases filed under Chapter 13 in order to force the IRS and the IDR to prove the nature and extent of the taxes owed, only to be pleasantly surprised that the tax liabilities were not as bad as we feared. As a result,, the debtor and I determined he didn’t need a Chapter 13 case, and then the case was converted to Chapter 7 case. As a further result, the debtor’s case ended in a matter of months rather a matter of years.

Q: When you convert from the Chapter 13 to the Chapter 7, what are the other consequences, in terms of assets?

CH: Before deciding to convert any Chapter 13 case to a Chapter 7 case, we must determine if they are eligible to convert the case and there would be no significant negative consequences if the case is converted. First, we must determine if the debtor makes too much money to file under Chapter 7. Second, we must determine if the debtor has any property that could be confiscated by the Chapter 7 Trustee for the benefit of the creditors. In other words, does the debtor possess any asset that the debtor can’t protect or exempt according to Indiana law. Third, we must determine if converting the case creates a risk that the debtor may lose a house or a car based upon how it had been treated by their Chapter 13 Plan. Lastly, we need to determine if the debtor will reap one of the big benefits of converting a case: Did the debtor incur any dischargeable debts after filing the Chapter 13 case, but prior to converting to a Chapter 7 case, that can be added to, and discharged by, the converted Chapter 7 case.

We’ve talked about how we put people into a Chapter 13 plan just in case they have non-reimbursed or uninsured medical bills after the date of filing, to protect themselves during the three-to-five-year time-frame they’re in a Chapter 13 (Bankruptcy Strategy for Client with Chronic Medical Condition and No Health Insurance). If two years down the road the debtor goes into the hospital, without insurance, and incurs an exorbitant amount of uninsured medical bills, we can then convert the Chapter 13 into a Chapter 7 and add those debts to the list of debts to be discharged. If at any point within that time-frame the debtor incurs a tremendous amount of debt for any reason, and that debt is dischargeable and unmanageable, that would sometimes be a justification for converting from a Chapter 13 to a Chapter 7, to add those post-filing, pre-conversion debts.

Q: Is that type of conversion occurring frequently or infrequently?

CH: I frequently have debtors who incur post-petition debt they can’t afford to pay back and have no good reason to remain in a Chapter 13. They convert to a Chapter 7, add the debts, and get them discharged along with the other previously listed debts.

Q: You mentioned a 240-day period of time during which the IRS can assess a tax debt. When does that 240-day period begin?

JS: That makes a tax liability a priority claim if the IRS does an assessment within 240 days of the petition date. It can be for a tax return that is more than three years old, if they somehow catch omitted income, do an assessment, and then someone files bankruptcy quickly. I had a case recently in which a debtor had a 2011 liability that was caught and assessed by the IRS in 2015, so I had to wait 240 days, until mid-2016, before I could to file the case, so that it was not a priority tax debt.

Q: The 240 days you had to wait seems like an arbitrary period of time.

CH: It can also be 240 days plus 30 days in some cases or 240 days plus 90 days in other cases.

JS: Determining tax liabilities in bankruptcy cases can be very complex.

CH: Sometimes we’ll refer people to a lawyer who specializes in tax law. He’ll do whatever he needs to do outside of the bankruptcy court to buy enough time for some of these taxes, which would otherwise be nondischargeable, to become dischargeable beyond a certain date. Then he’ll refer the clients back to us to file a bankruptcy case for them.

JS: He gets the tax returns filed prior to them being assessed; he gets them into an installment agreement for a while; he tells them to honor the installment agreement for a number of months; and then he tells them that if they want to default to consult with a bankruptcy attorney to file for Chapter 13 or Chapter 7. But you have to at least play the game long enough and pay some of those taxes.

CH: Debtors will file the returns and then wait at least two years and a day to come see us. Then, they’ll have waited long enough for the taxes to become dischargeable. There are some people who’ve filed their tax returns on time, but still owe a bunch of money for some tax years in the past three years. If they filed for bankruptcy in 2017, they’d have to pay that tax back in full.

For example, if someone filed their tax return on time for tax year 2016–before April 18, 2017–and then they found out they owe the IRS $10,000 for that 2016 return, if they file a Chapter 13 or Chapter 7 in 2017, that tax has to be paid back in full, maybe with interest added on. But if they wait long enough–in this example until after April 19, 2020, which is more than three years from the date the 2016 tax was due–that 2016 tax then becomes dischargeable, unless in the intervening three years a tax lien was imposed upon them or some other reassessment took place.

Q: So, as a rule of thumb, as we discussed, file your taxes on time. A second rule of thumb: pay, if you owe taxes. A third rule of thumb: if you haven’t followed either of those two rules, it’s best to establish a relationship with the IRS, perhaps with the assistance of a tax attorney, to start paying your overdue tax liability prior to filing for bankruptcy. Then make sure, in consultation with your bankruptcy attorney, that you file for bankruptcy at the right time as determined by all of the other circumstances related to your specific case.

CH: Absolutely correct. Between the tax lawyer and the bankruptcy lawyer, hopefully you can discern the appropriate time to file the bankruptcy to get the biggest relief afforded by the U.S. Bankruptcy Code. However, we have to advise clients, “Based on what we know, this is what we think we can accomplish. But if the IRS knows something we don’t know, you assume the risk there might be some nondischargeable interest or other problems that could crop up.”

Q: Do you try to place clients into Chapter 13 and then use a conversion to a Chapter 7 as a last resort? Or do you evaluate each case without assuming anything?

JS: Each case depends upon what the debtor’s roles are and their income. Some people have tax issues that they’ll probably need to deal with.

Q: So another rule of thumb would be that if you’re in financial straits, because you have unsecured credit card debt and a tax bill due, pay the taxes and worry about the credit card debt later on.

CH: If you have a debt that won’t go away versus a debt that will go away, obviously you want the benefit of paying the tax or student loan or other debts that won’t be dischargeable, such as child support.

How Bankruptcy Affects Student Loan Debt and Car Loan Interest Rates

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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 and Personal Injury Claims / Modifying a Chapter 13 Plan / Joint and Several Liability

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Bankruptcy and Personal Injury Claims

If you have a pending personal injury claim when you file for Chapter 7 bankruptcy, you relinquish to your trustee all control of the settlement of the case, but you retain some control with a Chapter 13 bankruptcy. In rare Chapter 13 cases, the cram-down method of reducing debt for an automobile can be used to reduce the first mortgage payments on a house.

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 a debtor’s pending personal injury claim affects a bankruptcy case; how the cram-down method of debt reduction can be used for a mortgage in rare instances; the willingness of bankruptcy trustees to modify a Chapter 13 payment plan; how the Rash decision affects a debtor’s ability to surrender a car in the middle of a Chapter 13 plan; and the circumstances during a bankruptcy in which divorced spouses can both be held jointly and severally liable for debt incurred during their marriage.

Q: How does a debtor’s pending personal injury claim affect a bankruptcy case?

Jess Smith, III: If a debtor files for a Chapter 7 bankruptcy, he or she loses all rights and control over that personal injury action. The Chapter 7 Trustee has complete authority to prosecute it, settle it, or abandon it. Also, the Chapter 7 Trustee will, in all likelihood, take all of the net proceeds and distribute them amongst those creditors who file a claim against the Debtor. In other words, none of the net proceeds will be turned over to the Debtor unless those net proceeds exceed the total amount of the claims filed against the Debtor.

With a Chapter 13 filing, the debtor maintains some control over the personal injury claim regarding settling it or taking it to trial. If money is paid to the debtor as a result of a trial or settlement, then there is a negotiation between the debtor and the trustee as to how much goes to the debtor’s creditors and how much the debtor is allowed to keep for his efforts to acquire that money. That is why sometimes a debtor will choose to file a Chapter 13 bankruptcy versus a Chapter 7.

Typically, a Chapter 13 trustee will allow a debtor to keep one-third (1/3) of the net proceeds, with the remaining two-thirds (2/3) of the net proceeds going to the creditors.

Q: Have you recently handled any bankruptcies that included a personal injury claim settlement?

JS: Yes. In a current Chapter 13 case, the trustee is allowing the debtor to keep 50% of the net proceeds, because his bankruptcy plan is paying all of his creditors in full; therefore, I was able to acquire a little extra money for my client.

Q: If there is an existing Chapter 13 plan in place, which pays back all of the debt to the creditors, and all of the creditors had already agreed to that plan, why does the trustee want 50% of that personal injury claim?

JS: Because it gives the creditors some money right away, in the event the plan fails down the road. For some unforeseen reason, the debtor might run out of money and won’t be able to pay the creditors according to the plan. The trustee has a duty to at least get some of that personal injury money and disperse it now, as opposed to waiting on the debtor’s good promise and good intentions to pay it.

Q: If the debtor maintains the payment schedule, does that shorten the length of the plan?

JS: Yes, in a full-repayment plan it will shorten the length of the bankruptcy. If the debtor is not in a 100% repayment plan, the money received from the personal injury claim, usually two-thirds (2/3) of the net amount, is extra money for the creditors of the debtor.

Q: What are some of the more common circumstances you encounter in which a debtor does not meet the original payment schedule obligation of the plan to pay back creditors?

JS: Job loss or significant decrease in income after approval of the plan. Also, the divorce or separation of joint debtors can cause a plan to fail. Also, any other significant change in circumstances that causes an interruption in income.

Q: If that occurs, what happens to the filing of the bankruptcy?

JS: The case is dismissed, the Chapter 13 case is converted to a Chapter 7 case, or the Chapter 13 plan is modified and the plan payments are changed to redress the problems caused by a change in disposable monthly income.

Q: Let’s expand upon those options. If a debtor is not able to meet the obligations of a bankruptcy plan, why would that case be dismissed?

JS: Because the creditors are not receiving what they are entitled to receive.

Q: If the bankruptcy case is dismissed, what happens to the debts?

JS: It is as if the bankruptcy proceeding never happened and the creditors can resume their non-bankruptcy actions to try to collect on the debts.

Chris Holmes: It usually is a situation in which the debtor is unable to make their bankruptcy plan payments and they are not eligible for a conversion to a Chapter 7 case. As a result, the case is dismissed and their creditors are free to resume their efforts to collect on the debts. The primary reason a debtor would not be eligible to convert a Chapter 13 to Chapter 7 would be if they filed the Chapter 13 within eight (8) years of the filing of a prior Chapter 7 case. As a result, the only option is to allow the case to be dismissed and the debtor may be able to refile under Chapter 7 if it has been more than eight years since the filing of the previous Chapter 7 case.

Q: In most cases, if you’ve never filed for a Chapter 7 bankruptcy and you’re having trouble meeting the obligations of a Chapter 13 plan, then that option to convert to a Chapter 7 still exists?

CH: Yes, provided the debtor qualifies for relief under Chapter 7 of the U.S. Bankruptcy Code, the debtor has no nonexempt assets that can be confiscated and liquidated by the Chapter 7 Trustee, and the debtor is prepared to deal with certain secured creditors or nondischargeable debts outside the U.S. Bankruptcy Court.

Q: Have you had any extraordinary situations arise that are resolved more effectively by a Chapter 13 case rather than a Chapter 7 case?

CH: Recently, I had a very rare situation in which a woman owned a home that is worth less than the balance due on her first mortgage and, as a result, her second mortgage was wholly unsecured. As a further result, Chapter 13 of the U.S. Bankruptcy Code allows us to, as we say, “strip off” or avoid a wholly-unsecured second mortgage because there is no equity in the home to which that second mortgage can effectively attach.

JS: In other words, the debtor can change a secured debt into an unsecured debt and, as a result, we can treat that debt just like we would treat credit card debt or a medical bill.

CH: What made this particular case extraordinary, however, was how we treated the partially secured first mortgage in the debtor’s Chapter 13 Plan. First, I asked the debtor: “Do you really want to pay off a mortgage that, with interest, totals more than twice the current value of the home?” Given her home is located in a neighborhood in which the value of homes is depressed, and her home is in a state of disrepair, we concluded that it was unlikely that the creditor would want to foreclose on its mortgage and take possession of a home that will be impossible to sell for more than what the debtor owes on the mortgage. Also, the home would be expensive to maintain until it is sold. As a result, the debtor offered to pay the holder of the first mortgage only the current value of the home, plus a reasonable rate of interest, through the plan, and treat the balance of the mortgage as an unsecured debt. (If you recall, we do something comparable with certain auto loans—what we refer to as a “cram-down.” When an auto loan is more than two-and-a-half years old and the payoff exceeds the retail value of the car, the debtor can force the creditor to accept only the retail value of the auto plus a reasonable rate of interest, and then treat the balance of loan and any unpaid interest as an unsecured debt to be discharged.)

Legally, we can’t force the creditor to accept a “cram-down” on residential real estate; however, the debtor decided to give it a chance in the hope that the creditor preferred to accept what she offered rather than assume the risk of a worse outcome if it took possession of the property…and the creditor accepted! And given the debtor’s plan payment is roughly equivalent to her first mortgage payment, she will be able to resolve all of her debts using the money the debtor would have otherwise used for only the first mortgage. And should she successfully complete her plan, the balance due and owing on her other debts will be discharged and the debtor will own her home free-and-clear.

Q: In regards to debtors who do not successfully complete their Chapter 13 plans, what circumstances do you encounter most frequently as the cause?

CH: The primary reasons why Chapter 13 Plans fail: The debtor fails to make regular monthly plan payments due to a reduction in income caused by a job loss, or the debtor must use the money earmarked for their plan payments to pay some unforeseen, extraordinary expense such as car repairs or uninsured medical bills that arise after the filing of the case.

Q: Are there situations in which you adjust the plan payment to make it easier for the debtor to continue to make their payments on time?

JS: Yes, sometimes. If the debtor’s disposable monthly income decreases, then we can reduce the monthly plan payments accordingly.

CH: Also, if the debtor fails to make a few plan payments, then we can ask the Judge to modify or amend the debtor’s plan. For example, if the plan life is shorter than 60 months, then we can extend the life of the plan by the number of months in which plan payments were missed, in order to make up for the shortfall.

Q: What would happen if the debtor’s plan is already set at 60 months?

JS: I’ve just been in communication with a debtor who has a motion to dismiss. Her current plan payment is $1000 per month and she is behind by two months. What we’ve agreed to do is tack on an additional $100 per month for the next 20 months to catch up on the total amount due. This will place her in kind of a probationary status. If she misses another payment, the trustee can then choose a quicker route to get the case dismissed.

Q: How willing are trustees to negotiate to modify plans?

JS: The longer you’ve been in the plan, and the trustee sees your making a sincere genuine effort, the more likely the trustee will be to work with you. For example, I have a married couple as a client and they have a plan that is supposed to be 60 months long. For most of the plan, the debtors were having a portion of the trustee payment deducted from their wages, but one them lost their job, so they fell slightly behind in their plan payments.

At the end of the 60 months, the trustee stated the payments were two months short of the total amount due and filed a motion to dismiss. I objected, because payments were still being made to the trustee. The hearing is now set in about month 63. As long as that money is still coming in, the trustee will agree to just continue the hearing on the motion to dismiss until all of the money due has been paid.

Q: Does the trustee need to go back to the creditors to get them to agree to the extended period of time it will take to fully pay the amount due?

JS: No, it’s within the trustee’s discretion. If a creditor wanted to show up at the hearing and voice their own displeasure, they could. But most of the time the unsecured creditors rely upon the trustee to have the more intimate knowledge of what’s going on with the case and the debtor’s situation.

Q: So in any circumstance where you try to go back and renegotiate the terms of the plan, is it strictly up to the trustee to accept the proposal?

CH: No, the creditors can object if the modification of the plan negatively impacts them. For example, if the debtor’s plan base (i.e., the total of all plan payments) is reduced and, as a result, the amount of money to be distributed amongst the creditors is decreased, then the creditors must be notified and given an opportunity to object if the creditor believes the modification will be unreasonable or unfair.

Q: Is it like you’re going back to the beginning of the bankruptcy filing process?

JS: Yes, if you’re reducing the plan base. There is some interesting case law out there, which fortunately doesn’t come up much in our district.

For example, let’s say a debtor had a $15,000 car that they were going to pay for through the plan. The debtor gets the benefit of driving the car while the trustee is giving the creditor who made the car loan a few dollars every month towards the car payment. Three years into the plan, the car breaks down and the debtor says, “I don’t want the car anymore. I’m going to change the plan, reduce the amount owed on the car by cutting it out of the plan, and have the lender come pick up this piece of junk.”

Most of the time, in this district, the creditor will not object. But there is case law in other circuits outside of Indiana, such as the Rash decision (In the Matter of Elray and Jean RASH; United States Court of Appeals, Fifth Circuit.; Decided: July 30, 1996), which deals with this type of situation. The Rash decision is a widely-followed decision that states if a bankruptcy case is approved and a secured creditor is to receive a specified amount for a car, the creditor can object to a plan modification that surrenders the car back to them, because the debtor is the person who drove the car into the ground, not the creditor.

Those are some issues in limited circumstances—where you try to give back a secured asset after it breaks—in which a creditor will sometimes object. And if the creditor would push it, they would probably win. At that point, the debtor would have to decide to either (A) give the creditor the money they’re entitled to and fix the asset, or (B) to convert to a Chapter 7 bankruptcy, if otherwise eligible, or (C) to let the case be dismissed and start all over. Those are all options, but fortunately we’re fairly lucky in this district that we don’t have a lot of secured creditors object when we try to surrender an asset after the plan has been approved.

CH: I can’t remember the last time a creditor objected to the surrender of a car midway through the plan.

JS: I’ve seen a few instances with certain lawyers based in Kentucky who cite the Rash decision.

CH: In our previous conversation we talked about a debtor who owed his ex-wife a property settlement debt based on their divorce agreement. Because the debtor filed a Chapter 13 bankruptcy, that property settlement debt was dischargeable; whereas, it would not have been dischargeable in a Chapter 7 case.

I had a similar situation recently in which our client told me she had a car loan from the marriage that both her ex-husband and she had co-signed. In the divorce decree, the judge ordered our client to pay that debt and to hold her ex-husband harmless (that is, to protect the ex-husband from any liability thereon).

As it turned out, our client couldn’t make the loan payments, the car was repossessed, and the car was sold for less than the unpaid principal balance on the loan. As a result, there is a deficiency balance—the unpaid portion of the debt—for which both her ex-husband and she are jointly and severally liable.

In a Chapter 7 bankruptcy, her obligation to hold him harmless is a nondischargeable debt. That means the ex-husband could ask the divorce court judge to hold our client in contempt for not holding him harmless, should that car creditor sue him for that deficiency balance. According to Chapter 13 of the U. S. Bankruptcy Code, our client can list her obligation to the ex-spouse—to hold him harmless on that debt—as a debt to be discharged, which is another compelling reason why some people opt for a Chapter 13 case rather than a Chapter 7 case. As a consequence, our client will be able to discharge her personal liability on this $12,000 deficiency balance, and her ex-husband will not be able to go to ask the divorce court judge to hold our client in contempt for not holding him harmless on the underlying debt.

Q: It sounds like the husband thought he was going to be protected, but ended up not being protected. Did he make some sort of a mistake in his negotiation of their divorce agreement?

CH: Sometimes divorce lawyers will insert language into a property settlement agreement that asserts that such obligations are in the nature of alimony or maintenance and, therefore, nondischargeable. Whether such a provision is enforceable is a matter for the Judge of the U.S. Bankruptcy Court to resolve.

Car Loan Payments in a Chapter 13 Bankruptcy

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If you will be filing for bankruptcy protection, you have a few options regarding the best way to pay off a car loan or to buy a new vehicle before or during the period of a Chapter 13 bankruptcy.

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Key Points of This Article:

  • If your vehicle loan is over two-and-a-half years old and the remaining loan balance is greater than the car or truck’s current value, Chapter 13 could provide an opportunity to lower the remaining loan amount and interest rate, and then pay the loan off as part of your approved bankruptcy plan monthly payment. The amount you ultimately pay for your vehicle could then be significantly less than your current total loan amount—and you would own the car or truck outright when the case is successfully discharged.
  • If your vehicle loan is less than two-and-a-half years old and the interest rate is already 5% or less, to keep the car or truck you would need to continue to pay off the loan on your vehicle outside of a bankruptcy plan.
  • A sudden need to acquire a new vehicle during an approved bankruptcy plan presents a potential need to submit a request to modify the plan. The trustee of the plan would need to approve that new additional debt as part of your monthly plan payments.
  • A bankruptcy plan trustee’s job is to retrieve money for creditors, so they may consider a monthly vehicle loan payment above a certain amount inappropriate as part of a Chapter 13 bankruptcy plan. If you file for bankruptcy, you may need to switch from an expensive luxury vehicle to a model with lower monthly payments.
  • In addition to your transportation costs, a Chapter 13 trustee will use established federal standards to determine what they consider as your reasonable monthly “cost of living” expenses, including housing, utilities, food, clothing, and out-of-pocket health care expenses.

We recently discussed some 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 affect of paying off a car loan during a Chapter 13 bankruptcy, buying a new vehicle before or during a bankruptcy, what is a “cram-down,” modifying a bankruptcy payment plan, and means testing. Below is the transcript of that conversation.

 

Q: Does the fact that a debtor who is planning on filing for bankruptcy protection is currently making car loan payments, but the loan will be paid off within a year or two, affect the plan you propose to the bankruptcy court?
Chris Holmes: When I meet with clients in that situation, in a Chapter 13 case where the plan life is anywhere from 3 to 5 years, we weigh the pros and the cons of them either paying for the car directly outside the bankruptcy court versus throwing it into the plan and paying for it over the life of the plan. What we’ll look at is how old is the vehicle loan. If a car loan is more than two-and-a-half years old on the day of filing, and if the payoff on that loan exceeds the fair-market value of the vehicle by a significant amount, then we do this thing we call a “cram-down.” We take the higher payoff and reduce it—cram it down—to what the vehicle is worth. The debtor pays that amount, saving all of that extra principal. Often times, these loans have a very high rate of interest, so we can effectively cram that interest rate down, within the plan, from the high rate to the prime rate plus 1.5%.
As an example, if someone owes $20,000 on a car only worth $15,000, and that loan is supposed to be paid at 21% interest, what we say to the car creditor is that we’re only going to pay the value, $15,000, at perhaps 5% interest through the plan, saving the extra principal and extra interest on that loan. That’s a clear win for the debtor.
If the car loan is less than two-and-a-half years old. we can’t cram the payoff down in value. In that situation, the only thing we can do is reduce the interest rate, so a debtor would payoff the loan through the plan at perhaps 5% interest, to save a considerable amount of interest.
If the loan is less than two-and-a-half years old and the interest rate is already 5% or less, there’s no real advantage to paying it off through the plan, so then we would make arrangements for that debtor to continue to pay on that vehicle outside of the bankruptcy court.
If the bankruptcy plan life is 60 months, but the car loan is going to be paid off in, for example, 36 months, that scenario creates a potential problem. Previously, we would tell the trustee that, when the car was paid in full, the car loan payment would be used to purchase a replacement for that car or maybe a second car for the debtors. The trustees used to accept that at face value, but evidently they have recently learned of too many circumstances, after the car loan was paid in full, in which debtors weren’t using that monthly car payment for the purchase of a replacement or second vehicle. Now trustees don’t trust debtors anymore, so we’re compelled to sign agreements whereby the monthly bankruptcy plan payments increase, for the remaining months of the plan, by the amount that was being paid monthly for the car loan.
In those types of cases, we will go back to the bankruptcy court and ask the judge to allow the debtor to renege on that pledge when the debtor presents to the judge a tentative car loan for a replacement or needed second vehicle. We have the burden to go back into court to request permission to modify the plan back to what we intended, so we can use that extra money for the purchase of another vehicle.
Q: What happens to an individual who has (1) already filed bankruptcy, (2) set-up a plan, (3) their income is such that they are just able to take care of their current bills and monthly payment to the trustee, (4) they haven’t had a car payment during the plan, and then (5) all of a sudden their car breaks down beyond repair and they need to buy a replacement vehicle? Can you modify their bankruptcy plan mid-stream to account for their need to take on a new monthly car payment they did not have before the plan started?
CH: That creates another dilemma, because when we filed the case we submitted a budget that showed all of the debtor’s different monthly living expenses. If the debtor doesn’t have any money allocated for a regular monthly car payment at the start of the plan, the trustee will not approve a loan for that car unless we amend their budget to show the debtor now has the money available for the vehicle loan payment.
What we might have to do is go through the other budgetary items to determine if possibly the debtor is no longer paying so much for child care or perhaps their rent went down. We try to find cuts in their budget. Sometimes, if we don’t find cuts in their monthly budget that equal the amount of the proposed monthly vehicle loan payment, we’ll look at their paycheck to see if they’ve received a cost-of-living adjustment or maybe the withholding for medical insurance has gone down a little bit.
Between a little more disposable monthly income and a few less monthly expenses we night find the extra income needed to pay for the car loan. We’ll then put that amount in an amended budget, submit that to the court along with a copy to the trustee. Then, when the debtor goes to the trustee for permission to the car, the trustee can look at the amended schedule, see that the necessary funds are available each month to pay for the vehicle, and approve the loan.
Q: Would it be in the best interest of someone who was planning on filing for bankruptcy to buy a new car or reliable used car before filing.
Jess Smith III: The bankruptcy code states that we cannot counsel a client to incur new debt on the eve of bankruptcy.
Q: What period of time constitutes “the eve of bankruptcy?” In other words, how much time does someone need to wait between buying a new vehicle and filing for bankruptcy?
CH: I don’t advise clients about that type of activity. What I tell people is that I’ll put $350 in the monthly budget, even though they’re not currently spending that for a car loan, but that they’ll have to go out immediately after filing the case and start shopping around for a vehicle. If the trustee doesn’t receive that request he or she is going to want that $350 each month to give to the creditors.
JS: I told a client to dump his big fancy truck and its $750-a-month payment, which the trustee would think is excessive, and to go get a $350-per-month replacement. The trustee is now demanding proof of that $350 monthly payment, otherwise he is going to want that money for the creditors. We recently met with the creditors, who asked if my client had bought the replacement truck yet. The client said, “No, I need to save my previous monthly payments to accumulate enough money for a down-payment on a replacement.” The creditors stated that unless he does that by the claim bar date, they’re going to ask for that money to go into the plan.
CH: The trustee’s job is to squeeze as much money out of a debtor as possible for the benefit of the creditors.  That’s why they look at projected income and projected expenses. Sometimes they will scrutinize the budget and find there’s some “fat” in it. Maybe we put too much money in there for food or clothes or some other expense—and the trustee will say that’s excessive. We then have to reduce that number to free up some money for the plan payment, which will increase by the amount of “fat” we cut out.
Q: Is there a schedule or chart published by the State of Indiana that shows the average household expenses for a single person, a married couple, and families of different sizes?
JS: There are federal standards (Dept. of Justice Means Testing) that are loosely based on if the IRS is considering going into an installment arrangement with you to pay federal taxes. The IRS publishes amounts they consider to be reasonable for the cost of housing, utilities, transportation, food, clothing, and out-of-pocket health care expenses. The trustees have adopted those figures, but on occasion they’ll take a harder line on a case-by-case basis.
CH: The computer program we use to determine a client’s budget has those regular monthly living expenses built right into it.
Q: Is the IRS standard different for each state?
JS: There are housing allowances listed for each county in every state. For median incomes, the allowances are listed state-by-state, and there are national allowances for food, clothing, transportation, etc.

 

Common Reasons People File for Bankruptcy

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Uninsured medical bills resulting in lawsuits and threats of legal action or garnishment are common reasons for bankruptcy these days. Divorce is also a reason for many bankruptcies—a high percentage of the people who file for bankruptcy protection are single mothers. In a Chapter 13 bankruptcy, a conduit case refers to making mortgage payments through the trustee.

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 being "judgment proof," protecting your house from liquidation in a bankruptcy, home equity exemptions, some benefits of filing a Chapter 13 “100% plan,” common reasons people file for bankruptcy, a deficiency balance on a debt, an example of how an ex-spouse can impact a bankruptcy, and conduit mortgage payments. Below is Part 2 of 2 of the transcript of that conversation.

Q: With the economy turning around and the rate of bankruptcies dropping, what are the most common reasons people file for bankruptcy these days? Why are people getting into financial trouble?

Chris Holmes: It’s still uninsured medical bills resulting in lawsuits and threats of legal action or garnishment. The biggest percentage of people I see these days are single mothers on a limited income with children to support. They’re on a razor-thin budget and threatened with garnishment, while they’re barely getting by on 100% of their take-home pay, They can’t afford to lose 25% of their take-home pay through a garnishment, so they come in and seek protection from creditors through the bankruptcy court.

Q: Is credit card debt what’s causing their problems?

CH: I would say uninsured medical issues or an old cell phone bill or maybe a car got repossessed and there is a deficiency balance that the creditor is suing them for. Maybe the economy is better in the sense that the unemployment rate is relatively low, but all the jobs people are getting are such low-paying jobs that they aren’t being paid a living wage to really make ends meet. Then they’re on that razor-thin line with a budget that is just barely enough to survive on. If something unexpected happens there’s a threat of garnishment. If they let the garnishment happen, maybe they’ll be evicted or lose their car and can’t get to work. They’re just desperate to file bankruptcy.

Q: So it’s mostly people in a single-income-with-kids situation?

CH: It seems that way in many cases. Of course, divorce is always a big reason that people file for bankruptcy. People go their separate ways and somebody has been ordered to pay certain marital debt, but they can’t afford to do that, so they have to seek refuge in the bankruptcy court. Job loss is still a big cause of financial problems. I’m sure there are going to be some bankruptcies on the horizon when all of those Carrier employees get laid off.

Q: Have you seen any unusual circumstances in recent cases?

Jess Smith, III: I have a nasty hearing coming up soon. A woman received an offer to sell real estate. She had a divorce decree in which she owned the real estate only in her name and only her name was on the mortgage. But the divorce decree stated that if she were to sell the house, she would keep the first $60,000 and anything over and above that first $60,000 would be split between her and the ex-husband. In the interim, she filed for bankruptcy because she had other debt. He hasn’t paid child support to her in months. The house goes into foreclosure. I hire a Realtor and get permission to sell it—and we get an offer. By the way, we listed the ex-husband as a creditor in the bankruptcy, which basically states, “Speak up or forever hold your peace.” He never filed a claim. Instead, he hired a couple of lawyers and eventually his objection to the bankruptcy plan is overruled. He said, “If we get anything over and above $60,000, you can have that,” knowing that we’re not going to get there. So we had an offer to buy the house. The debtor would get to keep her exemption of $17,600 and as things stand there is presently around $15,000 that would go to the creditors who filed a claim. We had a motion out to approve the sale, but the ex-husband has objected to the sale—even though his name is not on the mortgage and he didn’t file a claim. I have to go before the judge next week.

CH: And the sale will not bear proceeds big enough for him to even get a half.

JS: Right. His objection is, “You should list the house for more money," even though there is a foreclosure pending and he is not current with his child support. I don’t know what kind of patience the judge will have for this gentleman, but I’ve got to bring the debtor into court and also have the Realtor state there will need to be $10,000 thrown into the house, to deal with radon and other things, and that this is the best offer we’re going to get. In the meantime, the foreclosure is actively proceeding to Sheriff’s sale.

CH: So, the payoff on the mortgage is constantly getting bigger.

JS: If we wait, it’s going to take money out of the hands of the other creditors who filed claims.

Q: Have you thought about throwing some his way to make his objection go away?

JS: Our client is an attorney, so when the case originally started we contemplated amending the divorce decree to bump up his position; to give him $5000 or $10,000, but her ex-husband wanted nothing of it. So, he started first with attorney John W. I call John, whom he never paid to file an appearance, but we had discussions and I said, “We’ll move you up the ladder and give you a secured position and give you some money. It wouldn’t be a lot, but it would be something as opposed to nothing.” He never paid John W. a retainer. Then, after we filed our second plan, the ex-husband hired attorney Jim Y. and after a couple of hearings I amended the plan and said, “We’ll give you one-half of anything over $60,000.” He didn’t pay Jim Y., but now on the day of the objection on the motion to sell, he paid attorney Eric R. some money and Eric filed an objection and handed off the files to attorney Keith G. So now I’m dealing with Keith. Then, my client, who is mad as heck, sent me an email saying that her ex-husband was at the house having someone service the air conditioner—and he doesn’t even own the house or have his name on the mortgage or deed. And she still lives there.

Q: He’s paying someone to service the air conditioner at her house?

JS: Yes. And then he asked, through Keith G., for permission to show the house to other people—despite the fact that I have a Realtor with an exclusive listing and a sale pending.

CH: So, he seems to think that she accepted a low-ball offer to move the property and deny him his fair share of the net proceeds.

JS: Yet, he hasn’t paid child support for seven months.

Q: What is the assessed value of the property compared to the sale price? Is it in the ballpark?

JS: The price offered is about $30,000 less than the assessed value, but here’s where it starts to get tricky: When the case started, they had a rental property. In addition, she fell behind in the mortgage payments on their house, because the husband moved out. I explained to her that if she didn’t get current on the mortgage payments for the house, it would have to be a conduit case. In the interim, the rental property went into foreclosure and a judgment lien was placed on that. So, we had to value the rental property low to get the lien avoided—and we got that lien avoided. But now the sale price is higher than what I initially scheduled the value of the property for, which is neither here nor there because the judgment lien holder from the rental property had their opportunity to object and they disclaimed any interest in the real estate and the foreclosure.

Q: You used the phrase “conduit.” Can you explain what that is in relation to a mortgage and bankruptcy?

JS: Conduit means if you file a Chapter 13 and you want to keep your house, and you’re behind on the mortgage payments when you file the case, the ongoing future mortgage payments get made through the trustee, who then disperses it to the mortgage company. Not only the ongoing payments, but the pre-filing arrearage also goes through the trustee.

CH: In the past, you would just cure the arrearage on the mortgage in the plan, then people would resume their regular mortgage payments outside of the plan, directly to the creditor, starting the month after the date of filing. But now the judges have decided that if the debtor is more than one month behind, then they have to make those regular monthly mortgage payments through the Chapter 13 trustee, which debtors and debtors’ counsel don’t really like.

JS: The reason for that is because for years we used to have arguments with the mortgage company about ongoing mortgage payments and whether they were made on time or not. Huge amounts of time were spent accounting and keeping track of payments. I guess the theory is that if the debtor is more than one month behind then they were going to miss some payments along the way.

CH: At the end of the old plan, invariably the mortgage companies would say, “You didn’t pay every single penny and you’re not current on the mortgage.” Now there is either a hearing or the trustee files a notice stating that a debtor is current, which gives the mortgage company an opportunity to say, “Yes, they’re current,” or “No, they’re not current.” The judge would then decide whether or not they really are behind, based on all of those payments that should have been made through the plan.

JS: Typically, the trustee, as the neutral party, has a record of dispersing three to five years of payments to the mortgage company.

CH: With variable interest rates, or the changes in taxes and escrow, those mortgage payments are fluctuating. Every six months, or 12 months, debtors receive an escrow analysis stating that the property owner’s taxes went up, so the mortgage company would have to bump up the mortgage payments a little bit to make up for that additional that would have to be paid in taxes. Or the homeowner’s insurance rate goes up and the mortgage company would have to escrow a little bit more for that increased insurance premium. We don’t see variable or adjustable interest rates much anymore.

Part 1 of Conversation: Protecting Your House From Liquidation in a Bankruptcy

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

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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