Historically stigmatized as a shameful last resort, an acknowledgment of moral and financial failure, bankruptcy proceedings have morphed into a valuable tool for resolving a broad range of personal and/or business situations. Begin with the fact that a bankruptcy judge essentially has the power of a god. To do just about anything when you’re in that god’s world, you need a pastor with a direct line of communication, who knows why getting permission in advance from a bankruptcy judge is a far better idea than asking forgiveness later. With that premise in mind, once you’ve filed for bankruptcy, there are things that you simply should not do, even if you technically could, and while the list depends at least to some extent on which “Chapter” you filed, there are some overall flat no-nos:

• Hiding property from the bankruptcy proceeding — a really bad idea
• Making any payments that are not pre-approved — also a really bad idea

Basic Forms of Chapter Proceedings

First, a brief overview of the general background is necessary, as each form of Chapter proceeding has its own unique set of complications and nuances.

• Chapter 7 – Business or Individual Liquidation

  • Bankruptcy under Chapter 7 of the Bankruptcy Code is for businesses and individuals whose debts exceed their assets. The Court appoints a Trustee to liquidate the assets and determine which creditors are to be paid and how much each is to receive. Any remaining eligible obligations are then discharged.
  • Some notable items that can be preserved with proper counseling include your home ownership, within certain limits (including household goods, furnishings, and appliances), or rental (if your rent payments continue to be made). Also, within limits, you can retain your interest in motor vehicles, pensions, work tools and equipment, and welfare benefits.
  • What tax liabilities can be discharged in a Chapter 7 proceeding?
    • Federal and state income taxes, penalties, and interest can be discharged if they meet the following criteria:
      • 3-Year Rule: The tax return was due at least three years before the bankruptcy filing date.
      • 2-Year Rule: The tax return was filed at least two years before filing for bankruptcy.
      • 240-Day Rule: The IRS assessed the tax debt at least 240 days before the bankruptcy filing date.
      • No Fraud or Evasion The tax debt cannot result from willful evasion of taxes or filing a fraudulent return.
      • Lien on Property Remains Although a Chapter 7 discharge eliminates the personal obligation to pay the tax debt, it does not eliminate a tax lien on the property. If the IRS has placed a lien on your property before you file for bankruptcy, the lien will remain.

• Chapter 11 – Business Reorganization

  • Filing under Chapter 11 allows businesses to alleviate financial distress by proposing a plan of reorganization for creditor approval, which essentially becomes a contract with creditors, enabling the business to keep its doors open and continue operations.
  • A significant distinction between a Chapter 7 and a Chapter 11 bankruptcy is that under Chapter 7, business operations cease and all assets are distributed. In contrast, under Chapter 11, the business assets and debts are restructured, and the business continues.
  • Due to the greater complexity of Chapter 11 proceedings, an even greater degree of expertise is required to develop and negotiate a successful plan of reorganization, and the breadth of bankruptcy counsel’s knowledge and experience is crucial.
  • What tax liabilities can be discharged in a Chapter 11 proceeding?
    • Tax liabilities are treated similarly to those under Chapter 7.
    • Tax Liens can be challenged, or the value of the tax lien can be fixed and “stripped” or reduced to the fair market value of the property to which it attaches.

• Chapter 13 – Individual Restructuring

  • A filing under Chapter 13 is commonly known as a Wage Earner’s bankruptcy, allowing individuals with a regular income to restructure their debt repayment over three to five years. The primary benefits of filing under Chapter 13 are like those of a business filing under Chapter 11, shielding the debtor from creditor interruption and foreclosures while allowing an orderly plan of debt repayment.
    • What tax liabilities can be discharged in Chapter 13 proceeding?
      • The same criteria govern the discharge of these liabilities and the survival of tax liens as those set forth above for Chapter 7 and Chapter 11 bankruptcies, but with many additional opportunities to eliminate tax claims, penalties, and interest. Tax debts that are not discharged are included in the three- to five-year repayment plan.

Debtor’s Responsibilities in Bankruptcy

            Key Responsibilities:

1. Accurate and Complete Disclosure:

• • Provide truthful and detailed information about your financial situation, including all assets, liabilities, income, and expenses.

1. • File all required schedules and statements accurately.

1. • Disclose any anticipated changes in income or expenses.

2. Attend Mandatory Sessions:

1. • Complete credit counseling with an approved agency before filing.

1. • Complete a debtor education course after filing to receive a discharge.

3. Cooperate with the Trustee:

1. • Provide requested documents and information promptly to the bankruptcy trustee.

1. • Surrender all property of the estate and related documents to the trustee, if applicable.

4. Attend the Meeting of Creditors:

1. • Attend the meeting of creditors (341 meeting) and answer questions under oath about your financial affairs.

5. Fulfill Obligations Under the Plan (Chapter 13):

1. • File a repayment plan with the court.

1. • Make all payments required under the confirmed plan on time and in full.

6. Maintain Accurate Information:

1. • Notify the court and the trustee of any changes in address or other important information.

1. • Keep the trustee informed of any inheritances, lawsuit proceeds, or other significant changes in circumstances.

7. Financial Responsibilities:

1. • Keep current on domestic support obligations like child support and alimony.

1. • Continue making regular payments on secured debts if you intend to keep the property.

8. Restrictions on Actions:

1. • Do not incur new debt or sell assets without court approval during the bankruptcy process.

1. • Do not gamble while in Chapter 13 bankruptcy.

Consequences of Non-compliance: Failing to fulfill your duties can result in dismissal of your case, denial of your discharge, or even criminal charges.

Dealing with the IRS Insolvency Unit

When a debtor files for bankruptcy, an IRS Bankruptcy Specialist is assigned to resolve tax liabilities. An “automatic stay” immediately goes into effect, preventing creditors, including the IRS, from taking collection actions against the debtor. Generally, the debtor should not handle communications with creditors, and communications with the Bankruptcy Specialist in the Insolvency Unit are no exception.

More often than not, there will be several different items to be coordinated through the Insolvency Unit, including the filing of certain past-due returns, the determination of the fact and amount of any liability outstanding, the identification and quantification of fraud and other tax claims that will be non-dischargeable, and of the specific items that will be dischargeable, the handling of any installment payment agreements that were suspended by the bankruptcy, etc. Due to this complexity, experienced counsel is better equipped to resolve these matters with a comprehensive view of the debtor’s best interests. The next-to-last person you want to have an “oops” relationship with is the IRS Insolvency Unit; the last person is the Judge. And remember, the worst person to handle your bankruptcy proceedings is yourself.

The experienced counsel at Tax Workout Group collaborates with the Bankruptcy Specialists of the IRS Insolvency Unit on a daily basis – let them ensure your tax claims are resolved most favorably.