Posts Tagged ‘Chapter 13’

Small Business Owners and Bankruptcy

Tuesday, August 14th, 2012

Submitted by Attorney Pernell McGuire

In today’s economy more and more small business owners are being forced to seek protection from creditors by filing bankruptcy.  In many cases, the small business owner has tax liability for payroll taxes and wants to know how a bankruptcy can help them.  In certain circumstances, bankruptcy can help deal with payroll taxes by either eliminating them altogether or providing more favorable repayment terms then if the business owner is left to deal with the IRS on their own.  Payroll or employment taxes are comprised of two parts:

    1. the employer portion, and
    2. the employee portion.

Employer Portion of Payroll Taxes is Dischargeable – Sometimes.

The employer portion of the payroll tax is the tax which the employer owes directly to the IRS. The employer portion includes the employer’s obligation to match the employee’s 6.2% social security tax and the 1.45% Medicare tax.

For sole proprietors, the employer portion of the employment tax can be discharged in bankruptcy if:

  1. there are more than three years between the date the 941 tax return was last due, including extensions, and the date that the bankruptcy was filed;
  2. there are more than two years between the date the 941 tax return was filed and the date the bankruptcy case was filed; and
  3. the employer did not willfully evade payment of the tax.

Employee (Trust Fund) Portion of Payroll Taxes is Never Dischargeable.

The employer is required to withhold the employee portion aka “trust fund” portion from the employee’s pay check and remit it to the Internal Revenue Service (IRS).

The employee portion of the tax is referred to as a trust fund tax because the employer is collecting the employee paid portion of the payroll tax from the employee in the capacity of a trustee for the IRS.

The employee paid portion of the payroll tax includes the 6.2% Social Security tax and the 1.45% Medicare tax.

Trust fund taxes are never dischargeable in Chapter 7 bankruptcy.  Thus, if the business owner files chapter 7, he or she will still have to deal with the IRS to resolve the tax liability.  In that case, interest and penalties on the outstanding tax liability will continue to accrue.  Under such circumstances, the business owner should strongly consider filing chapter 13 to deal with the tax liability.

Under Chapter 13, the business owner submits a plan to repay its tax (and other) debt over a there to five year period of time.  The tax debt must be repaid in full over the term of the plan.  However, the tax debt does not continue to accrue interest or penalties – only the tax existing as of the date of filing the bankruptcy must be repaid.  Further, the tax debt has priority over any other unsecured debt and thus, gets paid before any other unsecured debts.

There is no escape from trust fund recovery taxes. However, trust fund taxes will become uncollectible if the 10 year statute of limitations expires without the IRS filing suit, regardless of whether the taxpayer files bankruptcy or not.

Any business owner facing significant tax liability should consider visiting with an experienced bankruptcy attorney to determine whether bankruptcy can provide the necessary relief.

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Chapter 11- Not Just for Corporations Anymore

Friday, June 1st, 2012

In the past, Chapter 11 of the Bankruptcy Code has been used primarily by corporations hoping to reorganize and stay in business.  However, with the real estate market downturn, more individuals have taken advantage of Chapter 11 to reorganize and retain their investment property and other property.

Most individuals are familiar with Chapter 7 of the Bankruptcy Code.  Fewer are familiar with Chapter 13.  These two chapters of the Code are used most often by individuals seeking to file bankruptcy.  For example, during the last twelve months, there were approximately 1.5 million individual bankruptcy filings.  Of this amount, 71% were filed under chapter 7, while 28.8% were filed under chapter 13.  The remaining cases, 1,958, to be exact, were filed under chapter 11, representing a little more than 1/10th of 1% of all filings.  Over the last 10 years, however, Chapter 11 filings have been on the rise.  In 2000, only 711 individuals filed under chapter 11, so the 2011 figure represents an almost 300% increase!

With almost 2,000 individual filings under chapter 11 last year, there must be some benefit for individuals under this chapter of the bankruptcy code.  To understand the possible advantages to a chapter 11 filing it’s important to have a basic understanding of how chapter 7 and chapter 13 work. 

Under chapter 7, the person who files bankruptcy (the debtor) files a petition and schedules listing out all of their assets and debts.  The Court appoints a bankruptcy trustee who takes the debtor’s non-exempt assets and sells them for the benefit of the creditors.  Assets are determined to be exempt under either state or federal law.  In exchange for turning over their property, the debtor receives relief from their debts, called a discharge.  A debtor who has a large amount of non-exempt assets will normally not elect to file under chapter 7.  In addition, individuals with large incomes normally do not qualify under the “means test,” a new test established by Congress in 2005.

For those individuals who do not want to file, or who do not qualify for filing, under chapter 7, they may proceed under chapter 13.  Under this chapter, debtors, in most cases, retain their non-exempt property.  However, to keep their property the debtors are required to repay all of their “disposable income” over a three to five year period of time. After all of their payments are made, the debtors are entitled to receive a discharge of their debts.  As stated above, most debtors who do not elect to file under chapter 7, or who do not qualify, will file for chapter 13.  However, there are some debtors who do not qualify for filing under chapter 13 because they have too much debt.  The current debt limitations for filing chapter 13 are $360,475 in unsecured debt and $1,081,400 in secured debt.  In addition, debtors in chapter 13 are in most cases not permitted to modify mortgages on investment property or other long term debt in chapter 13.

For these debtors, chapter 11 is an excellent alternative to simply surrendering everything to the bank or a trustee in chapter 7.  In extreme cases, a debtor who has significant income and debt may not qualify for chapter 7 or chapter 13, leaving chapter 11 as the only option.  Under chapter 11, the individual debtors file bankruptcy and become “debtors in possession.”  This basically means that they remain in control of all of “their” assets.  However, the assets are not really “theirs” any longer.  Rather, the property is now what is known as “property of the estate.”  The “estate” is comprised of all of the debtor’s rights in any property existing at the time of the bankruptcy filing.  In addition, other property, such as the debtor’s future earnings also become property of the estate.  The bankruptcy code permits the debtor to remain in possession of this property, and imposes on the debtor a fiduciary duty to use this property for the benefit of the estate’s creditors by formulating a plan of reorganization.

As part of the process, the debtor is provided 120 days from the filing to date in which it is the only person or entity who may submit a plan of reorganization.  This period is called the exclusivity period.  This period provides the debtor with a short “breathing spell” from its unsecured creditors so that it can evaluate its financial condition and submit a plan.  The bankruptcy code provides the debtor with the ability to “cram down” and “strip” a mortgage and repay what is owed based upon the value of the real property, the debtor wishes to retain.

For example, if a debtor owns a commercial building that is worth $500,000, with a first position lien owed to the Bank of $700,000, and a second position lien owed to the seller of the building for $200,000, the debtor may propose a plan that “crams down” the Bank by repaying it the sum of $500,000 as a secured debt, with the difference becoming an unsecured debt of $200,000.  The plan could further provide to “strip” the second position lien from the property and treat it entirely as an unsecured debt.  The debtor’s plan can be approved provided that it complies with the other provisions of the bankruptcy code, including paying the secured creditor a market rate of interest, paying into the plan all of the debtor’s disposable income for a five year period, and securing the vote of at least one creditor class in favor of the plan.

While obviously not for everyone, Chapter 11 provides high income, high debt individuals who own property they want to keep a less well known, but excellent alternative to either chapter 7 or 13.  Just a few of the advantages of Chapter 11 over Chapter 7 or 13 is that it allows debtors to keep their property, restructure long term debts and obtain a breathing spell from creditors to enable them to reorganize.  Individuals with high income, debts, or investment property, should consult with an experienced bankruptcy attorney who is familiar with all chapters of the bankruptcy code to best determine their available options.

 

If you have questions about bankruptcy, we encourage you to attend one of our free seminars or contact us at 800-899-2730 for a free personalized consultation. For more information about our seminars please visit http://www.freearizonabankruptcyseminar.com/.

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Could you be the next Borders Group, Inc.?

Friday, February 18th, 2011

Borders Group, Inc., owners of the popular Borders bookstores recently filed for Chapter 11 bankruptcy protection. You may be thinking, good for them, but I am going to be filing Chapter 7 or Chapter 13. The reality for many of our clients, they simply do not qualify for Chapter 7 or Chapter 13. For many higher income clients, Chapter 7 is not an option because of the means test. Without considering all of the possibilities, in general, individuals with higher incomes often do not qualify for Chapter 7. For many of them, Chapter 13 is the logical choice.

However, because of 11 USC 109(e), people sometimes do not qualify for Chapter 13 either. 109(e) contains limits on the type and amount of debt you can have and still be eligible for Chapter 13. As of this article, the current limits are $360,475 of unsecured debt and $1,081,400 of secured debt (you do not have to count debts that are contingent or unliquidated in this calculation). Many of the same clients who make too much money to qualify for Chapter 7, are also the ones who were able to borrow in excess of these limits. The result? Often these individuals have to consider a more complicated and costly Chapter 11 case as an individual.

These clients have to play by many of the same rules that Borders will be playing by in its Chapter 11 case. In our practice we have seen a steady increase in the number of individual Chapter 11 cases that are being filed. If you have substantial debt, you should speak to a knowledgeable bankruptcy attorney about your options. Please visit us at www.bankruptcylawyeraz.com to learn more.

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Debt Limits for Chapter 13 Bankruptcy Recently Increased

Tuesday, August 3rd, 2010

Debt Limits for Chapter 13 Bankruptcy Recently Increased

More and more we are seeing clients who make too much money to qualify for a Chapter 7 bankruptcy as a result of the “means test“.  (You can read more about the means test in our other blog postings).  For some of these individuals Chapter 13 appears to be their only option.  However, when we take a closer look at how much debt they have, some of them don’t qualify for a Chapter 13 case either.  Strange as it may seem, Congress has actually put a cap on the amount of debt you can have and still be eligible for a Chapter 13 bankruptcy.

Many of those same clients who didn’t qualify for a Chapter 7 bankruptcy had too much debt, either secured or unsecured to qualify for Chapter 13, leaving a more expensive, complicated Chapter 11 case as their best option.  However, some relief was recently offered when on April 1, 2010, the debt limits were increased.  Now, debtors can have up to $360,475 of unsecured debt and $1,081,400 of secured debt and still file Chapter 13.

You should still talk to an experienced bankruptcy attorney about your debts and whether they are counted toward these limits.  Not all obligations are included in the calculation and you may find that you thought you didn’t qualify for a Chapter 13 case, when in fact you do.  These issues are best addressed in a personal consultation with an attorney.  If you have questions about bankruptcy, please call us today or visit our website at www.bankruptcylawyeraz.com.

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Who pays capital gain taxes relating to the sale of appreciated property sold to pay creditors in a Chapter 13 bankruptcy?

Wednesday, July 21st, 2010

Who pays capital gain taxes relating to the sale of appreciated property sold to pay creditors in a Chapter 13 bankruptcy?

Often debtors facing financial crisis have the ability to pay all or a large portion of their debts.  Yet, the cash available to pay these debts is tied up in illiquid investments (i.e. raw land, rental properties, etc.).  These debtors often utilized a Chapter 13 bankruptcy as a means of obtaining immediate relief from aggressive creditors while attempting to liquidate assets to satisfy their debts. These debtors need to beware of the potential capital gain tax consequences associated with selling appreciated assets.

At of the time a bankruptcy petition is filed, all of the debtor’s assets become property of a “bankruptcy estate”.  See 11 U.S.C. § 541.  In a Chapter 13 case, the bankruptcy estate includes all of the debtor’s earnings from the date the bankruptcy is filed through the date the case is closed.  11 U.S.C. § 1306(a)(2).  To confirm a Chapter 13 plan of reorganization, the debtor must pay all “projected disposable income” into the Chapter 13 plan.  So, when an appreciated asset is sold to pay creditor and all of the debtor’s income is being paid to creditors; who pays the capital gain taxes?  From most people, the knee-jerk reactionary response would be: it only makes sense that the Chapter 13 Trustee should pay the taxes from the money paid through the Chapter 13 plan.  Unfortunately, in some cases, this may not be the correct answer.

In an unpublished but very detailed memorandum decision entered by Judge Joel B. Rosenthal, Bankruptcy Court Judge for the District of Massachusetts, In re Brown, 2006 WL 3370867 (2006), it was held that the tax liability can be satisfied from the amount paid into the Chapter 13 plan only if the taxing authority filed a post-petition proof of claim pursuant to 11 U.S.C. § 1305(a)(1).  Such a proof of claim enables the debtor to treat the claim as if it had been incurred prior to the date the bankruptcy was filed as opposed to being treated like every other post-petition debt.  The Brown court clarified that

The choice belongs to the creditor, however, as the effect of filing the proof of claim is to treat the postpetition claim as arising prepetition. If the creditor does not file a postpetition claim, a debtor may not file one for him. [citation omitted].  Instead the creditor may chose to await discharge and then pursue its claim against the debtor directly. [citation omitted]. The postpetition tax creditor does not have a choice between filing a proof of claim under § 1305 or receiving an administrative claim under § 503(b)(10(B). The result is no different if it is a debtor attempting to force the taxing authority into accepting treatment under the plan, even if the treatment is payment in full.

Brown, 2006 WL 3370867 at Pg. 2.

While the Brown decision is an unpublished memorandum decision, Bankruptcy Courts from the District of Arizona have seen the well-reasoned decision as authoritative.  See In re Hall, 376 B.R. 741, 745-47 (Bkrtcy.D.Ariz.,2007).  Accordingly, debtors seeking to liquidate appreciated assets to satisfy debt in a Chapter 13 bankruptcy need to be aware that if the IRS does not cooperate and file an appropriate post-petition proof of claim, the debtor may be responsible for the capital gain tax liability associated with the sale but lack the ability to pay the taxes from the sale proceeds or any income earned during the pendency of their Chapter 13 bankruptcy.

For more information, or to register for one of our free bankruptcy seminars, please visit www.mcguiregardner.com or www.freearizonabankruptcyseminar.com.

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