No aspect of tax law is simple or easy.  This is true in the bankruptcy context too.  The dischargeability of IRS liabilities in bankruptcy is a minefield.  The subject of discharging taxes in bankruptcy is so complicated and dangerous, it is the subject of entire treatises.  We can’t tackle the totality of the subject in this blog post, but we can summarize three basic rules.  These three rules, if couched as questions and answered in the affirmative, often times reflect that an income tax liability is dischargeable in a Chapter 7 or Chapter 13.

First, you must ask whether a tax return was filed. If a return was not filed, then the tax liability will not be discharged. If a return was filed, then proceed to the second question.

Second, you must ask whether the tax liability was assessed more than 240 days prior to filing the petition in bankruptcy.  The assessment date is the subject of a great deal of discussion and legal analysis. In order to come to some conclusion on your own, consider the date that you filed the return or the date an audit was completed as the assessment date.  While this may not result in a date that is certain to be correct, it will allow you to get a general idea of its dischargeability.  Your legal counsel will be able to identify the exact date of the assessment.

Third, you must ask whether the tax liability was last due, including extensions, three years or more prior to filing the petition in bankruptcy. In the absence of an extension, your income tax was last due on April 15.  For purposes of illustration, assume an individual filed bankruptcy on January 1, 2012 owing income taxes for 2007 and 2008.  The 2007 taxes would have been last due on April 15, 2008.  That is more than three years from the date the bankruptcy was filed.  Accordingly, the income tax might be dischargeable.  Conversely, the 2008 taxes would have been last due on April 15, 2009.  That is less than three years from the date the bankruptcy was filed.  As a result, the income tax will not be dischargeable.

Bankruptcy can help those with income tax problems.  To see if it can help you, contact an attorney experienced in dealing with tax issues in bankruptcy.

There are two separate mechanisms through which a debtor in bankruptcy may recover prepetition wage garnishments.  The first of these is 11 U.S.C.  § 547.  Section 547 is known as the preference section.  In summary, it allows a chapter 7 trustee to recover amounts paid to a creditor, including a judgment creditor who garnished the debtor’s wages, within 90 days of the bankruptcy filing.  If the trustee elects not to pursue a preference action against a judgment creditor who garnished wages of the debtor, the debtor himself may choose to pursue a preference action against the creditor.  (See 11 U.S.C.  § 522(h) providing the debtor certain powers of a trustee).  However, there is one very important limitation on a debtor’s ability to utilize Section 547 to recover prepetition wage garnishments. This limitation appears in Section 547(c)(8).  Subsection (c)(8) provides generally that a trustee may not pursue a preference if the amount paid to the creditor within 90 days is less than $600.00.  Accordingly, if the prepetition wage garnishment is less than $600, then the debtor will not be able to use Section 547 to recover petition wage garnishments. (See In re Leuders, 2009 WL 1564115 for details in the application of Section 547 in Nebraska).

In instances where Section 547 is not useful in recovering prepetition wage garnishments, consider 11 U.S.C. § 522.  Section 522 allows the debtor to avoid a creditor’s lien to the extent that the lien impairs an exemption.  In other words, a debtor can assert, via Section 522, that the wages garnished were exempt and that the garnishment constituted a lien against the wages; in this instance, the lien impairs the debtor’s exemption and the garnished funds should be returned to the debtor.  To the extent that this sounds like a stretch, keep in mind that there is precedent in support of this proposition.  In fact, the Debtor in In re Yetter, 112 B.R. 301 (S.D. Iowa 1990) used this same theory to recover funds from a judgment creditor.

Finally, there are circumstances where a debtor may employ both Section 547 and Section 522.  It seems that these two sections could, at least in theory, be stacked in order to maximize the amount that a debtor could recover from a judgment creditor who has garnished wages prepetition.

First, we start with Section 522(o)(4) of the Bankruptcy Code.  Section 522(o)(4) provides, in pertinent part, as follows: “the value of an interest in real property that the debtor claims as a homestead shall be reduced to the extent that such value is attributable to any portion of any property that the debtor disposed of in the 10 year period ending on the date of the filing of the petition with the intent to hinder, delay, or defraud a creditor and that the debtor could not exempt if on such date the debtor had held the property so disposed of.” In short, this section prevents a debtor from selling property, receiving cash from the sale, and then using the cash to build equity in a home that is then claimed as exempt under state or federal homestead laws.  In other words, this section of the Bankruptcy Code disallows, or discounts, a debtor’s homestead exemption for the purpose of determining what assets are available for liquidation.

Second, we consider Section 522(f)(1)(A) of the Bankruptcy Code. Section 522(f)(1)(A) provides: “the debtor may avoid the fixing of a lien on an interest of the debtor in property to the extent that such lien impairs an exemption to which the debtor would have been entitled if such lien is a judicial lien.”  In summary, this section allows the debtor to strip or remove a lien arising by a judgment if the lien impairs a debtor’s exemption.

Next, consider the following fact pattern.  Assume a debtor files bankruptcy owing a creditor.  The creditor’s claim is evidenced by a judgment. That judgment constitutes a lien against the debtor’s real property.  The debtor, after filing bankruptcy, files a motion to avoid the creditor’s lien. Within the motion, the debtor alleges that the lien impairs the debtor’s homestead exemption and should be avoided pursuant to Bankruptcy Code Section 522(f)(1)(A).  Naturally, the debtor’s claim to avoid the lien is contingent upon his ability to claim the homestead exemption. However, assume for the moment that the debtor’s down payment used to acquire the real property was obtained by the disposition of personal property sold with the intent to defraud a creditor within 10 years of filing the petition in bankruptcy.  In other words, the debtor’s claim to a homestead is disallowed or discounted, pursuant to Bankruptcy Code Section 522(o)(4), for the purpose of determining what assets are available for liquidation.  If so, can the creditor allege that once the debtor’s homestead is disallowed or discounted, pursuant to Section 522(o)(4), the debtor is also denied the homestead exemption for purposes of Section 522(f)(1)(A)?

A debtor who is denied a homestead exemption, under Section 522(o)(4), for the purpose of determining what property is available for liquidation, is also denied the homestead exemption for the purpose of claiming an impaired homestead exemption as is required by Section 522(f)(1)(A).  A debtor who is unable to demonstrate an impaired exemption, of course, could not satisfy the elements necessary to strip the creditor’s lien.  The attorneys of Jeffry Hahn believe that these two sections can be construed in this fashion.  This argument has held water with some of our colleagues in other firms.  Further validation for reading these two sections together in this fashion came from a bankruptcy case in Massachusetts.  The opinion from that case reflects that the Bankruptcy Court entertained this very argument.  Whether the United States Bankruptcy Court for the District of Nebraska would accept this reading of the Bankruptcy Code is unknown at this point.

Between 2007 and 2010, as a result of a troubled regional and national economy, the notable bankruptcy filing trend has been a substantial increase in the number of bankruptcies filed both in Nebraska and nationally.  In fact, on a national level, between 2007 and 2009, Chapter 7 bankruptcy filings increased more than 40% each year. While the bankruptcy filing trend in Nebraska, over the same time period, has also been an increase, Nebraska’s strong agricultural economy has kept that increase significantly lower than the national average. Good news may be on the horizon. In Nebraska, during the first 6 months of 2011, bankruptcy filings were lower than the same time period in 2010.

It is difficult to find a silver lining from this four year bankruptcy trend.  However, there is one positive to come from this, at least for those individuals and companies that are now considering filing for bankruptcy.  The significant increase in bankruptcy filing encouraged many attorneys to either enter or reenter the bankruptcy practice. As a result, competition among attorneys for work in the area of bankruptcy has created a “buyer’s market.”

Those considering filing bankruptcy should demand that they receive a free consultation with an attorney and not just a paralegal. Moreover, bankruptcy candidates in this market should seek flexible payment terms, reasonable hourly rates or a fixed fee, and a thorough explanation of the Chapter 7 and Chapter 13 process.

At Jeffrey Hahn, our potential bankruptcy clients receive a free consultation with an attorney who thoroughly explains the Chapter 7 and Chapter 13 bankruptcy process. If, after the initial consultation, an attorney/client relationship is formed, Jeffrey Hahn offers flexible payment terms, including reasonable hourly rates and fixed fees. The lawyers of Jeffrey Hahn frequently encourage potential clients, after an initial bankruptcy consultation, to visit with other lawyers in or around Lincoln, Hastings, Kearney, or York and decide if Jeffrey Hahn is the best law firm for them.

This time of year, the debtor can expect the Chapter 7 trustee to ask the question, “Have you received, or do you expect to receive, a tax refund?”  Those who testify that they do not expect a tax refund and have not received a tax refund will not have much interest in the remainder of this blog post.  Those who testify that they do expect a tax refund or have received a tax refund will wonder what happens to that refund in Chapter 7 bankruptcy.  The answer to that question is the subject of this post.

The attorneys of Jeffrey, Hahn, Hemmerling & Zimmerman, PC, LLO frequently represent individuals who are filing Chapter 7 bankruptcy and expecting a tax refund.  In explaining the treatment of a tax refund in Chapter 7 bankruptcy, it is first necessary to understand the three components of most tax refunds.  These components may be referred to as an overpayment, Child Tax Credit, and Earned Income Tax Credit.  We will briefly discuss the nature of each along with its treatment in Chapter 7 bankruptcy.

The first component of a tax refund is an overpayment.  The overpayment is simply the difference between the amount withheld from an individual’s check per pay period during the calendar year and the individual’s income tax liability.  For example, during the course of a year, an individual with $2,000.00 of tax liability that paid $5,000.00 in withholdings can expect a $3,000.00 refund resulting from his or her overpayment.  In other words, this taxpayer overpaid his or her tax liability and is owed money back.  A refund attributable to an overpayment is an asset of the bankruptcy estate that the Chapter 7 trustee will claim unless the overpayment is exempt under Neb. Rev. Stat. § 25-1552.

The second component of a tax refund is a Child Tax Credit.  The Child Tax Credit is, generally speaking, claimed by parents of children 17 years of age or younger.  The Credit of $1,000.00 per child will offset a taxpayer’s tax liability.  If the Credit exceeds a taxpayer’s liability, he or she may expect to receive a refund.  A refund attributable to claiming a Child Tax Credit is an asset of the bankruptcy estate that the Chapter 7 trustee will claim unless the Credit is exempt under Neb. Rev. Stat. § 25-1552.

The third component of a tax refund is an Earned Income Tax Credit.  The Credit is a subsidy for low income families and is determined by household size and income.  A refund attributable to an Earned Income Tax Credit will be exempt, in its entirety, pursuant to Neb. Rev. Stat. § 25-1553.  In other words, a Chapter 7 trustee will not be able to claim any part of the debtor’s refund to the extent the refund’s origins are from the Earned Income Tax Credit.

In conclusion, be careful to examine components of a tax refund.  Its origins will determine, at least in part, what a debtor keeps in bankruptcy and what the Chapter 7 trustee will claim.

Sadly, Hostess was forced into filing Chapter 11 bankruptcy last month. Surely, this should put us all on notice. In an economic climate where the maker of the Twinkie cannot thrive, what hope is there for the rest of us? But Hostess, with over $860 million of debt and over 100,000 creditors, expects to move through bankruptcy without the Twinkie production line ever coming to a halt. Clearly, there is hope for life post bankruptcy.

For the majority of our clients, the choice to file bankruptcy is one of the most difficult decisions they will ever make. At Jeffrey, Hahn, Hemmerling & Zimmerman, we will do everything that we can to make your bankruptcy as painless as possible. After all, there could be a Twinkie at the end of the bankruptcy Tunnel.

For more information regarding Hostess’ bankruptcy, feel free to visit the sources below:

http://dealbook.nytimes.com/2012/01/11/hostess-files-for-bankruptcy/

http://www.usatoday.com/money/industries/food/story/2012-01-11/hostess-bankruptcy-twinkies-wonder-bread/52495162/1

http://online.wsj.com/article/SB10001424052970204257504577154402317896574.html

In some instances, the proceedings included relatively simple consumer bankruptcies filed under Chapter 7 or Chapter 13. In other instances, the proceedings involved more complex commercial and farm bankruptcies filed under Chapter 11 or Chapter 12. The firm has also represented many of its individual and corporate clients in adversary cases filed in the context of bankruptcies concerning the dischargeability of debts under Section 523 of the Bankruptcy Code. Additionally, the Firm has advised its individual and corporate clients regarding the treatment of tax liabilities within bankruptcy.

While the Bankruptcy Code and the nature of bankruptcy proceedings may change over time and between clients, the attorneys at Jeffrey, Hahn, Hemmerling & Zimmerman, PC, LLO always pride themselves on having the resources and experience necessary to provide competent and responsive representation to their bankruptcy clients. With this in mind, the Firm has created this blog so that its attorneys may share their experiences in bankruptcy proceedings with present and prospective clients and also with their colleagues in the legal community.

You should know that the Firm’s attorneys practice in areas beyond Bankruptcy, including Estate Planning, Wills and Trusts, Estate and Trust Administration, Business Planning, Farm Planning, Municipal Law, Corporate/Business Law, Collections, Landlord/Tennant, Real Estate law, Commercial Litigation, and General Litigation. From time to time, you can expect blog posts to appear that address these areas as well.