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If You Already Owe Income Taxes

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What do you do (and not do) if you already owe 2018 or 2019 income taxes, or earlier, and haven’t yet sent in the latest tax returns?     

 

What if you owe 2020 income taxes even though the IRS is not taxing $10,200 of unemployment income that year? That was our topic last week. The first $10,200 of unemployment is not being taxed because of last month’s American Rescue Plan Act. This week’s topic covers your options if you owe income taxes for prior tax years. Even if you don’t owe for 2020, or owe less, that may not help much if you were already behind.

If You HAVEN’T Submitted Recent Tax Returns

For tens of millions of Americans the last year has been the most financially disruptive in their lifetimes. Many lives were turned upside down around a year ago. If that includes you it’s understandable that you had trouble preparing and sending in your 2019 income tax returns.

The IRS recognized this to some extent by extending its tax return deadline from April 15 to July 15, 2020. So did virtually all states with income taxes (which include 41 out of the 50 states). But if your financial challenges went beyond last July, you may still not have made that deadline. Indeed you may not have submitted them even now, if you owe and have no ability to pay.  That may be especially true if you were already a year or more behind on taxes at that point.

If any of this is true, you most likely realize that you’re in a scary and rather dangerous situation. It’s only natural to try to avoid something that’s scary, especially when there seems to be no practical way out.

The reality is that this is indeed a dangerous situation. The IRS imposes a series of penalties for not sending in income tax returns when due. For individuals there’s an initial $435 failure-to-file fee. (That’s for returns due starting 1/1/2020. It’s a more than doubling jump from $210 for returns due during the years 2018 and 2019.). In addition, there are significant steep penalties for each month you don’t file. On top of that there are monthly penalties for the failure to pay the amount due. IRS’ Common Penalties for Individuals. States with income taxes impose similar penalties.

So the sooner you send in your tax returns the less failure-to-file penalties you’ll owe. But what if you can’t pay what you owe?

If You HAVE Submitted Prior Tax Returns

Now what if you did submit tax returns for a prior year or two—for 2018 and/or before—and you already owe income taxes?

That may further tempt you not to submit the 2019 tax returns if you think or know that you also owe for that year. If you’re in an IRS payment plan and you can’t pay more, you don’t want to upset that payment plan. If you’re not in a payment plan and lying low, you may not want to catch the IRS’ attention. You sensibly figure nothing will catch their attention more than a new tax return showing that you owe even more.

But you know that this can’t end well because the IRS knows that you haven’t submitted the 2019 tax return. If you are in a payment plan with them you violate that plan by not timely submitting subsequent tax returns. If you’re not in a payment plan you know that it’s only a matter of time. Indeed the missing 2019 tax return may well spur the IRS into action.

Besides, the not submitted 2019 tax return is accruing serious failure-to-file penalties, quickly increasing the amount you owe.

So you’re in a real conundrum.

The Only Practical Solution

There’s only one way out of this serious Catch-22: find out your real options. Consider the following:

  1. Do you owe prior year’s income taxes for which you’ve submitted tax returns? You may be able to write them off in bankruptcy. If you meet certain conditions you can “discharge” them and owe nothing. That usually includes the tax and the accrued penalties and interest.
  2. What if you owe income taxes which don’t qualify for discharge? Discharging other debts with a Chapter 7 “straight bankruptcy” may enable you to afford to pay the tax. The IRS and many states have reasonable payment plans, allowing you to stretch out the payments over a long period. The Chapter 7 filing would even stop any immediate collection efforts by the IRS/state for a few months. During that time you’d set up the payment plan. You can even likely minimize your contact with the IRS by applying online, and getting immediate approval.
  3. What if you still can’t afford an IRS payment plan? Or what if the IRS is amenable but your state is not? Or what if you have other aggressive creditors whose debts Chapter 7 does not discharge? Examples are child or spousal support, or vehicle loans or mortgages you’re behind on and need to bring current. Chapter 13 “adjustment of debts” stops tax collections, as well as by other special creditors, much longer than Chapter 7. Then through a court-approved payment plan you can prioritize paying the more urgent debts. The other creditors—including the IRS/state—have to wait their turn in line. Tax interest and penalties usually stops accruing—for up to five years—saving you a ton.

Your Next Step

These give you just a small taste of the many ways Chapter 7 or Chapter 13 could get you out of the seemingly impossible situation you’re in.

The additional really good news is that finding out more would likely cost you nothing. What you need to know is whether and how Chapter 7 or 13 could help your personal situation. Your local bankruptcy lawyer’s job is to understand your situation and give you honest advice about your options. Not just about your income tax conundrum, but about all your debts and financial life.

A significant step in that direction will happen at your initial consultation meeting, which is free. Of course you have no obligation to hire the lawyer or to file any kind of bankruptcy after that meeting. But you’ll leave with crucial information about whether and how you can get out of your tax Catch-22. You’ll learn about options for getting your financial house in order. Most of the time people are deeply relieved, and often really surprised, at how good the solution is. Often our clients very much wish they would have come to see us earlier, avoiding the anguish they’ve been feeling for way too long.  

 

If You Owe Taxes (Even If Unemployment Benefits Aren’t Taxed)

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Do you owe 2020 income taxes even though the IRS is now not taxing the first $10,200 of unemployment income? What to do and not to do.  

Last week we discussed the extent to which unemployment income is not taxed because of the American Rescue Plan Act. Generally, you don’t pay federal (and possibly state) income tax on the first $10,200 in benefits you received in 2020. Section 9042(a) of the Act. (See our last blog post about qualifying for this, and other details.)

Let’s get into two significant practical problems you may still have in spite of this substantial benefit:

  1. You received more than $10,200 in unemployment benefits and so you owe income taxes on that extra amount.
  2. You had other income separate from unemployment benefits and owe income taxes on that other income.
  3. You owe income taxes for prior tax years. So now you’re afraid of filing the 2020 tax returns and having the IRS/state start to chase you down.

We’ll discuss the first two of these situations today, the third one a week from now.

1. More Than $10,200 in 2020 Unemployment Income

If you were unemployed for a substantial part of 2020 you may well have accrued more than $10,200 in unemployment income. That’s especially true if you qualified for the additional $600 per week (later reduced) in extra federal pandemic unemployment income. Note that the income exclusion applies to both state and federal unemployment benefits. U.S. Dept. of Treasury Fact Sheet, March 18, 2021 (see final paragraph). So they can add up fast is you were unemployed for an extended time.

Regarding this, first realize that for joint filers you’re EACH entitled to the $10,200 income exclusion. BUT, you can’t just double the excluded amount to $20,400 if you’re filing jointly; each spouse has a $10,200 maximum. IRS Post Release Changes to Forms, New Exclusion of up to $10,200 of Unemployment Compensation. For example, assume you had $15,000 and your spouse had $5,000 in the unemployment income, totaling in $20,000.  In the joint return you wouldn’t be able to exclude all $20,000. You could exclude just $10,200 of the $15,000, while your spouse could exclude all $5,000, a total of 15,200.  That means that $3,800 of your benefits would be federally taxable (and likely by your state, too).

Second, just because you have taxable unemployment income (the $3,800 in the above example), doesn’t necessarily mean you’ll owe taxes. There are countless considerations determining whether you’d actually owe tax if you have a relatively low amount of taxable income. One important consideration is that the standard deduction in 2020 for individuals is $12,400, $24,800 for those filing jointly. IRS News Release, IR-2019-180. Your applicable standard deduction (or itemized deductions) may more than cover any non-excluded unemployment income.

However, after all is said and done you may find out that you do owe federal income taxes. And possibly state income taxes as well. See below, after the next section, for more about what to do then.

2. Owe Tax on Other 2020 Income

Let’s say you did have unemployment income in 2020 and it was all covered by the $10,200 federal exclusion. But you had other taxable income for which you did not withhold or pay any (or enough) estimated taxes.

Similar to what we stated above, you may still not owe any federal income taxes because of other considerations. (As just one example, the stimulus (“Economic Impact”) payments are not taxable income. IRS Tax Tips, May 12, 2020.) So you absolutely should prepare your tax returns or have them prepared for you. Do not live in fear; as the saying goes, it is better knowing rather than not knowing. This is especially true if 2020 was different for you financially than prior years. It sure has been different for just about everybody! You might be pleasantly surprised that you don’t owe, or that you owe only a modest amount.

If You Still Owe 2020 Income Tax

So you do prepare your 2020 tax returns and find out you owe regardless of the $10,200 unemployment income exclusion. What now?

Let’s say the tax owed is quite modest, but still too much to pay in a lump sum. The most sensible solution might be to apply online for an IRS payment plan. One advantage is you don’t need to talk to anyone—it’s all online. Plus they have a lower fee than other options. Both individual and business taxpayers can qualify. There are short term (120 day) and long-term monthly plans available. The long-term plans are not expensive: $31 for individuals—potentially waivable for low income—and potentially that low for businesses. However, interest and penalties continue to accrue and can add up quickly.

But what if the tax owed is more than you can afford to pay monthly on an IRS payment plan? You may have no room whatsoever in your monthly budget to pay the IRS anything. Or you may owe more to the state taxing authority (especially if it’s fully taxing your unemployment) and have no money to pay it.

Maybe you’ve never been behind on income taxes. So you are understandably worried about having the IRS and maybe also your state chasing you. Or you have some experience with the federal and state taxing authorities and know something about their collection powers.  Either way, you’re justifiably concerned.

Don’t Avoid Sending in the Tax Returns

If you owe income taxes don’t do what may feel tempting: not submitting the tax return when it’s due. You might think you’ll buy some time by laying low. You figure if they don’t know you owe, they won’t start chasing you for it. It’s all too human to hide from something that’s scary, especially when there seems to be no practical solution.

But you’ll pay a very heavy price for the time you think you’re buying. There are a series of penalties by the IRS (and by your state) for failure to timely file income tax returns. For individuals there’s a flat $435 starting failure-to-file fee (for returns due starting 1/1/2020). In addition there are significant steep penalties for each month you don’t file. On top of that there are monthly penalties for the failure to pay the amount due.

So almost certainly you want to submit the tax returns when they are due.

Get Good Guidance

However, both for practical reasons and for your mental health you’d be wise to get some guidance about your options. And common sense says you should get that guidance before you submit the returns.

Let’s face it. If you cannot afford to pay the IRS (and/or state) monthly payment plan, most likely you’re in broader financial trouble. You likely have more than one high-priority debt that you’re trying to juggle. This new debt to the IRS/state is a sign that you need to find out your legal options.

Without going into greater detail here, you likely do have some sensible options. For example, it may be worth getting rid of other debts through a Chapter 7 “straight bankruptcy.” Then you could much better afford to pay your income tax debts. Or you may have other competing special debts—like a mortgage or vehicle loan in arrears, or child/spousal support. A Chapter 13 “adjustment of debts” would protect you from all these especially powerful creditors.

See more information about these options elsewhere in this website. And call us, your bankruptcy lawyers, for some good guidance about your options, bankruptcy or otherwise.

 

Unemployment Benefits Not Taxed

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If you’re one of the 1 in 4 Americans who received unemployment benefits during the pandemic, the IRS is not taxing the first $10,200 of it.   


Unemployment Benefits Are Generally Taxable

As the IRS states plainly, “[i]f you received unemployment compensation during the year, you must include it in gross income.” Unemployment Compensation, IRS Topic No. 418. Furthermore, “unemployment compensation” explicitly includes not just the usual “state unemployment insurance benefits.” It also includes “Federal Pandemic Unemployment Compensation provided under the… CARES Act of 2020.” Unemployment Compensation.

If you received unemployment benefits in 2020 you had the option of having income taxes withheld. Or you could have paid quarterly estimated tax payments. But you may not have been aware that unemployment benefits were taxable. Or money was so tight that there just wasn’t enough to have some of it withheld. And there wasn’t any money to pay estimated tax payments, if you even realized when those were due.

All of which means that you may have been dreading preparing and filing your 2020 income tax returns. You’ve been afraid of owing income taxes because of having received unemployment benefits in 2020. Or you hadn’t heard that those benefits were taxable but now you’re worried about it.

American Rescue Plan Exempts $10,200 of Unemployment Benefits

There’s some very good news about this. Because of the recently passed American Rescue Plan Act, you likely won’t pay federal income tax on the first $10,200 of those benefits. And you may not pay state income tax on it either, depending on the state.

To qualify, your adjusted gross income for 2020 must be less than $150,000. Section 9042(a) of the American Rescue Plan Act. This adjusted gross income maximum is the same even if you are filing jointly. If your adjusted gross income is $150,000 or more you aren’t able to exclude any unemployment compensation. IRS Post Release Changes to Forms, New Exclusion of up to $10,200 of Unemployment Compensation.

If you do qualify, this income exclusion applies to both traditional state unemployment benefits and the additional federal ones added in 2020.  U.S. Dept. of Treasury Fact Sheet, March 18, 2021.

Plus, “in the case of a joint return… each spouse” may exclude $10,200 of such benefits from gross income. Section 9042(a). However, that maximum does not increase for one spouse if the other did not receive any or less unemployment benefits. Each person can exclude no more than $10,200. Note that you CAN exclude as much as $20,400 of unemployment benefits if both spouses received $10,200 or more.

What about State Income Taxes?

Whether you pay state income taxes on unemployment compensation in general circumstances depends on your state. Now whether this new $10,200 exclusion applies also depends on your state.

In some states—California and New Jersey, for example—unemployment benefits are simply never taxed as income. Many other states follow federal law regarding what income is taxed, so in these states the $10,200 exclusion should apply. Check with your state’s taxing authority for information about whether the federal unemployment benefit exclusion applies. Here’s a list showing which states tax unemployment benefits, and which are “coupled” to this new exclusion of those benefits.

If You Haven’t Filed 2020 Tax Returns

Prepare your tax returns—or have your tax preparer do so—appropriately excluding the right amount of your unemployment benefits. Actually you’ll report your total unemployment benefit amount as income. Then you’ll separately exclude the right amount based on the IRS Unemployment Compensation Exclusion Worksheet. You can find that Worksheet at the end of these IRS instructions.  

If You’ve Already Filed 2020 Tax Returns

Have you already filed your income tax returns without knowing about this income exclusion? If so, you obviously want to take advantage of it. It will likely lower your tax liability and/or increase your tax refund. Depending on your tax rate, it could swing you in the right direction by about $1,000.

Common sense may tell you to quickly submit an amended return to take care of this. But not necessarily. This is what the IRS is saying at the moment:

If you have already filed your 2020 Form 1040 or 1040-SR, you should not file an amended return at this time. The IRS will issue additional guidance as soon as possible.

IRS, New Exclusion of up to $10,200 of Unemployment Compensation (reviewed or updated March 24, 2021).

Depending on the circumstances, filing an amended tax return could potentially actually slow things down. The IRS is dreadfully understaffed and is taking a long time to process both tax returns and especially amended ones. It may be quicker to let it process your original tax return, and potentially automatically exclude your unemployment benefits. This is what at least one state is saying in response to this specific situation:

You do not need to file an amended return. The [state department of revenue] will correct it for you, and, in most cases, you will receive a refund or have a lower tax bill.

Of course, talk with your tax preparer, if you have one. And keep checking back to this IRS webpages for updates on the topic of Unemployment Compensation and Coronavirus Tax Relief.

 

Avoid Misuse of Your $1,400 Stimulus

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Paying your stimulus payment to various combinations of creditors, in the hopes of avoiding bankruptcy or before a planned one, is dangerous.     

 

 Before You Make Decisions That Hurt You

Last week we introduced the radical idea that the best use of your upcoming or already received $1,400 stimulus payment might be to pay for a bankruptcy case. We focused then on how to figure out when you should throw in the towel and decide to file bankruptcy. One clue is if you find yourself making questionable decisions. That can tell you that you’re starting to feel desperate. Then the bad decisions can turn your situation even worse.

The problem is that you often don’t have enough information to know whether a financial decision is a smart one. They often involve knowing legal information that you would have no reason to know. It’s often impossible to know what is sensible and what is not without knowing the legal consequences. Today we give some examples where sensible-seeming choices end up being a mistake.

Paying the Tax Man

Let’s say you owe the IRS $10,000 in income taxes from a tax year of a few years ago. You’re expecting to get $5,600 in the new stimulus payments ($1,400 times 4 for a family of 2 adults and 2 kids).

You might figure the IRS will just take your $5,600 stimulus money in payment for the tax you owe. Not true: the stimulus payment “cannot be offset to pay various past-due federal debts or back taxes.” IRS News Release, March 12, 2021.

You also figure the IRS will put a tax lien on your home or other possessions at any time. You are afraid of your paycheck getting garnished, and your employer finding out about your tax debt. These two likely ARE realistic fears.

So you decide to pay the $5,600 to the IRS and then work out a monthly payment plan for the balance.

Maybe Don’t Give the IRS Your Stimulus Money

Under certain circumstances paying your stimulus money to the IRS would essentially be a waste of the $5,600. And it could be a waste of whatever else you’d pay on this $10,000 debt. That’s because you may be able to completely discharge—legally write off—that debt. The tax just needs to be old enough and meet a couple other conditions. You could do that with either or Chapter 13 “adjustment of debts.”

The $10,000 income tax debt might qualify for complete discharge under a Chapter 7 “straight bankruptcy.”  

Even if it wouldn’t qualify (such as if it were too recent), Chapter 13 “adjustment of debts” could really help. It would give you a lot of flexibility in paying off the tax debt. You may well have more urgent uses of the stimulus money—paying child support or catching up on a mortgage. With Chapter 13 you’d pay the IRS more on your own schedule, and likely avoid additional interest and tax penalties. Plus, you’d be protected from the IRS’ aggressive collection activities in the meantime, as well as from other creditors.

So, in this example, if you’d financially invest in bankruptcy that could save you $10,000 (plus future interest and penalties). Or at least it would enable you to better prioritize your financial obligations. Either way it would buy you peace of mind in the meantime.

Other Situations

There are literally dozens of other situations like this IRS one where a sensible-seeming decision can backfire on you. Here are a few more.

Waiting for the Stimulus While a Creditor Gets a Judgment Lien

For many people the stimulus payments have already arrived or are coming very soon. But for some people it’ll take a while. If you own a home, be careful about letting a creditor get a judgment against you in the meantime. The judgment can turn very quickly into a lien against your home. So instead of having a debt that you can completely wipe in bankruptcy, it’s one you have to pay in full. Plus you risk losing your home in the meantime. Instead, filing bankruptcy would prevent the judgment and the judgment lien. Get legal advice before these kinds of irreversible events happen.

Dividing up the Stimulus Payment Among Your Creditors

You get the stimulus payment and decide to do “the honorable thing.” You distribute the money among all of your creditors. Several months later you’re back to not being able to pay your debts. You end up filing bankruptcy a year from now, after a creditor has garnished your wages for several months. While your pay was being garnished you didn’t have the money to pay the bankruptcy filing fee and lawyer fees. The end result: you effectively lost the benefit of the stimulus money. Then you paid out more money than you would have otherwise. You dealt with lots more aggravation. And delayed starting to rebuild your credit another year.

Paying the Stimulus Payment to the Most Aggressive Creditor

You pay the stimulus check to your ex-spouse for back child support. That makes a lot of sense in most situations. There is no more legally powerful and scary creditor than the ex-spouse or the support enforcement agency. But let’s say you lose your car to repossession because you didn’t pay the money there instead. If you filed a Chapter 13 case instead of paying the ex-spouse you could stop both the repossession and support enforcement. This would happen for long enough for you and your bankruptcy lawyer to put together a payment plan that would eventually satisfy both. And there’s a good chance you could reduce both your vehicle payment and the total you’d pay on that debt.

Paying the Stimulus Payment to a Favored Creditor

You use the stimulus money to pay off a friendly creditor. You do that hoping to avoid filing bankruptcy. Or you might even consider doing this before filing bankruptcy in the hopes of excluding this creditor from it. Either way paying off a friendly creditor can backfire. If you decide to file bankruptcy, or are forced into it, the friendly creditor may have to give the money “back” to the bankruptcy trustee. It depends on the timing. Then you may still feel indebted to that creditor and could end up paying that debt twice!

The Best Advice? Get Good (Legal) Advice

If you’re in financial hurt, you simply can’t make good financial decisions without knowing their legal consequences. And best way to know all the potential legal consequences is to talk with a bankruptcy lawyer. He or she has the legal knowledge and the practical experience to advise you about the legal and practical consequences of your decisions.

 

Best Use of Your $1,400 Stimulus? Bankruptcy!?

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You no doubt have countless uses for the next stimulus payment. But if you’re like some people the very best use is to file bankruptcy. Like who? 

 

Last week Congress passed the American Rescue Plan Act and President Biden signed it into law. Among Its many parts is the $1,400 per person stimulus payment—officially called the Economic Impact Payment. On Friday, March 12, 2021, the IRS put out a news release about these payments. This provides general information about qualifying for the payments, and the amounts individuals and families will receive. There are more details in this IRS Fact Sheet. For information on your own payment, “[b]eginning Monday [March 15], people can check the status of their third payment by using the Get My Payment tool… .”

As we said, for some people the very best investment of this money—or part of it—is on bankruptcy.

Fact: Most People Wait Too Long

Lawyers who help people in financial distress like helping people. That’s why most of them chose to get into this area of law. Just about every day we talk to people who clearly waited too long before talking with us.  

Sometimes they simply put up with an emotionally challenging financial situation much longer than they needed to.  But often people have made mistakes—big and small—in which they’ve significantly hurt themselves. It’s great to be able to inform people how they’re lives will immediately become less stressful and financially sane. But it’s painful to tell some people how much better it might have been had they gotten good advice earlier from a bankruptcy lawyer.

So when is paying for a bankruptcy case the best investment of your stimulus money? First, it’s when you owe too much and you really need relief—not just short-term but long-term relief. Second, it’s when you’re risking making one or more legally unwise decisions, ones that you’ll regret. We offer some guidance about these situations; on the first of these this week, and on the second next week.

You Owe Too Much and Need Long-Term Relief

Everybody wants to be responsible and pay their creditors. It’s usually the right thing to do. Even when it’s hard and takes sacrifice. You agreed to pay and you should fulfill your promise to pay.

But there may come a point when the debt is just too overwhelming. At that point the responsible thing to do is to admit that. And then learn your legal options about that debt.

How Do You Know When You Reach That Point?

We understand: figuring out when you’ve reached that point is often not easy. Here’s some guidance:

  1. You should not wait until the situation feels hopeless. If you wait until you are hanging on by a thread, you are risking too much. The law doesn’t require you to wait until you’re desperate. In fact it’s smart and sensible to learn about your options before you are emotionally and financially exhausted.
  2. Consider your responsibilities to others besides your creditors. Yes, you certainly have a legal and moral responsibility to your creditors. But you also have responsibilities to your children and your spouse or partner, if you have any. How much are you harming those dependent on you as you strive and strain to do right by your creditors?
  3. The relevant “responsibilities” go way beyond financial. There’s much more to this than not being able to provide financially for your loved ones while instead paying creditors. How much are you unable to be emotionally present to your kids and spouse while under intense financial strain? How much are you jeopardizing your short- and long-term relationships with the most important people in your life?
  4. One person who you are absolutely allowed to consider in all this is yourself. Your health, your relationships, your peace of mind—these are clearly relevant as you weigh whether you need serious relief. Indeed, you are not only allowed to, you MUST consider your health—physical and emotional—as you try to decide when enough is enough.
  5. One other big indication: you’re getting past the point of needing help when you start making questionable decisions. These tend to be financial, but can also be personal. Desperation often results in desperate and unwise decisions. In fact if you’re feeling desperate that itself is time to get help, before there are any unwise decisions made.

Dangerous Decisions

Next week we’ll cover the kinds of decisions that can really hurt you, and indicate that you need help now.

Chapter 13 Helps You Sell Your Home

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Chapter 13 enables you to use the pandemic’s mortgage payment forbearance process and sell your home if and when you’re ready to do so.


Last week we showed how Chapter 7 helps you take advantage of the pandemic foreclosure moratorium when selling your home. Today we show how it works even better with the more powerful Chapter 13 “adjustment of debts.”

In the last few weeks there has been an important related development. The Biden Administration extended the foreclosure moratorium deadline by 3 months, from March 31 to June 30, 2021. This also extended the mortgage payment forbearance request window until June 30, and potentially lengthened certain ongoing forbearances. White House Fact Sheet, February 16, 2021.

One more preliminary note. As of this writing (March 7, 2021), the U.S. House of Representatives will likely vote on the Senate’s version of Biden Administration’s American Rescue Plan legislation on Tuesday, March 9. Current indications are that it will pass, and President Biden will sign it this week. It appears to include a further extension of the foreclosure moratorium through September 30, 2021. President Biden Announces American Rescue Plan, January 20, 2021. This huge piece of legislation will very likely be the subject of our blog posts in upcoming weeks.

But for now, here’s how Chapter 13 can greatly help you sell your home, on your own timeline, whether or not you qualify for a mortgage forbearance agreement.

Chapter 7 vs. Chapter 13 in Selling Your Home

Last week we emphasized that filing a Chapter 7 “straight bankruptcy” provides two main advantages when selling your home. It 1) gives you financial stability and 2) buys you time to sell your home. In many situations Chapter 13 does both of these and does so much better.

1) Chapter 13 Brings Financial Stability

Chapter 7 bankruptcy brings you stability primarily by writing off (“discharging”) most or all other debts. That way you can focus on your house. You can focus your financial resources on the mortgage payments, now or when your forbearance agreement expires. And you can focus your emotional energy on getting the house ready for sale and on going through the selling process.

But in many situations discharging the debts that Chapter 7 discharges does not help enough. Chapter 13 gives you financial stability in important ways that Chapter 7 does not.

Chapter 13 protects you from debts that Chapter 7 does not discharge. You’re not left at the mercy of aggressive creditors like an ex-spouse and the tax authorities. You pay debts like theirs under a court-approved payment plan based on what you can reasonably afford to pay. In the meantime these creditors are forbidden to try to collect on their debts. You just need to pay into the plan as you and your bankruptcy lawyer proposed and the bankruptcy court confirmed. Then you really can focus your financial resources and your attention on selling your home.

Chapter 13 also gives you much more leverage over various other kinds of creditors, and particularly over your mortgage lender. This is mostly in the form of buying you much more time to sell your home.

2) Chapter 13 Buys You Time

A Chapter 7 case buys you some time not much. It immediately prevents a home foreclosure procedure from starting, or from finishing. But that protection usually lasts only a few weeks, seldom more than a couple months. That may be what you need when you just need a little bit of time to finish closing a house sale. Or to stop a judgment or tax lien from hitting your home’s title. But a Chapter 7 case buys you only this limited time.

Chapter 13 can buy you more time. Sometimes it gives you much, much more time. It can do so in various ways. These ways can all tie into the foreclosure moratorium and a resulting forbearance agreement that you may have with your mortgage holder.

Ways Chapter 13 Buys Time

First, assume you’ve decided to sell your home but need time to get it ready. Chapter 13 can usually give you months to do this. Let’s say you are getting to the end of a forbearance agreement. You know you won’t be able to pay the regular mortgage payments at that point. Or you won’t be able to pay that plus the catch-up amount. Chapter 13 will often buy you many months, even longer under the right facts. So you would get the highest sale price instead of getting low-balled for being a desperate seller.

Second, now assume you wish you didn’t need to sell your home for a year or two or three. You have kids in school and so don’t want to force them to transfer. Or you’re taking care of an elderly parent who needs the current stability for a while longer. Or you’ll be able to downsize in a couple years for whatever reason but it would be very disruptive now. Chapter 13 will often buy you a couple years, maybe even up to 5 years, to sell when the time is right for you.

Third, you may currently not know whether you’ll be able to afford to hang onto your home or will need to sell it. You don’t know because you’ve been on a crazy rollercoaster ride of extensions to the pandemic foreclosure moratorium. And like tens of millions of other Americans your income has taken a big hit. You don’t know where you’ll land in 6 months or a year or two. Chapter 13 can give you and your home protection now and the flexibility to adjust in the next couple years.

Conclusion

Chapter 13 could make it possible for you to sell your home until the time is right for you. Do you fear you cannot afford to catch up on the arrearage accrued during your forbearance period? A Chapter 13 payment plan could put off paying that arrearage until you sell your home. That could maybe even be years from now.  Do you wish you didn’t have to sell, or aren’t sure whether you will, depending on your job situation? Or depending on health or other personal circumstances? A Chapter 13 case can buy time until those circumstances develop.

You may even not have to sell. Chapter 13 may enable you to stretch the catch-up payments out longer than your mortgage holder would allow so that you could afford to stay.

 

Bankruptcy Helps You Sell Your Home

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 Beyond the pandemic’s foreclosure moratorium, Chapter 7 bankruptcy gives you serious advantages if you’re selling your home.  

 

In the last two blog posts we presented 10 ways bankruptcy significantly helps you take advantage of the foreclosure moratorium. One of those ways—from two weeks ago—was in the context of selling your home. We drill down into this now, to show how it works in practical terms.  We start today with Chapter 7 “straight bankruptcy.” Next week we’ll show how it works with the even more powerful Chapter 13 “adjustment of debts.”

The House-Selling Example

You’ve decided to sell your home. Let’s say you’ve taken advantage of the pandemic’s foreclosure moratorium. So you’ve gotten a forbearance agreement from your mortgage lender. This means that you’ve been able to legally avoid paying the mortgage for many months. But at some point you’re going to have to catch up on the many thousands of dollars of missed payments. You either have an agreement about the terms for catching up, or the terms for doing so are up in the air. But either way you know you just won’t be able to afford the significant extra monthly obligation. You’ve decided your only solution is to sell your home. Property values have gone up and there are buyers with money, so it makes sense to take advantage of this now.

Or maybe you haven’t gotten a forbearance agreement for whatever reason. Maybe your mortgage is not a federally-connected one so it doesn’t qualify for the pandemic’s mortgage moratorium. Or your mortgage may qualify but still somehow you haven’t gotten your lender to let you stop making mortgage payments. So you haven’t been able to keep up on those payments and your lender is threatening foreclosure. You’ve decided to sell to get what you can from the house and move on with your life.

How does bankruptcy—today specifically, how does Chapter 7—help in these situations?

Your Home without Bankruptcy Protection

Most likely you have other financial challenges beyond the home mortgage itself. But let’s focus first on the mortgage itself. The pandemic moratorium did not do anything to address the accruing missed mortgage payments. You are effectively at the mercy of your mortgage lender or servicer about how you’ll need to catch up. There is nothing currently that prevents the lender from foreclosing on your home as soon as the moratorium is over. The lender could demand that you pay all the accrued missed payments in full, and foreclose if you don’t pay.

So what’s the practical effect if you are in the process of selling the home? A pending foreclosure signals to potential buyers that you’re a desperate seller. In most circumstances that will bring down the dollar amount of the offers you get. It will likely completely scare away some buyers—especially if there are also creditor-related liens against your home. Instead you’ll have buyers trying to take advantage.  In less desirable areas, you may have trouble getting any reasonable offers.

Most importantly, you may run out of time. Once the foreclosure is completed, your house is gone. You no longer have anything to sell. If that happens before you close your home sale, you can’t close the sale. (This is one of the reasons buyers are scared off by a house in a foreclosure. Why put in an offer if there will be no house to buy in the end?)

Beyond the mortgage itself, you may well have other debts that are causing you major headaches. Some debts may have already latched onto your home’s title, or are in the process of doing so. These eat into your equity. (See last week’s blog post about strategies for dealing with judgment and income tax liens.)

Chapter 7 Brings Financial Stability

Assume that you’re OK with your mortgage holder, at least for now. You’ve decided to sell your home. Maybe that’s in part because you won’t be able to afford paying for it once the moratorium is over. But you’re behind on other debts. You are being harassed by debt collectors. You’ve either already been sued or expect to be any time. You know that those debts can turn into liens against your house. Those debts would then have to be paid in full, instead of going to you. Plus those debts can result in garnishment of your bank accounts and your paychecks.

If you see a bankruptcy lawyer and file a Chapter 7 case, most likely you can legally get rid of most of your debts that are not attached to your house. That would give you some peace of mind so that you can focus your attention on selling your home. It takes time and energy to prepare a house for sale to get the best value. It takes more to hire a realtor and to work closely with him or her to do everything it takes. It’s extremely hard doing all that while dodging creditor calls and threats.

Filing a Chapter 7 case also stops pending and future creditor lawsuits from hitting your home’s title. So YOU will get your hard-won equity from your sale proceeds instead of that money going to your creditor.

You might even be able to “avoid”—legally undo—an existing judgment lien, with the same result. YOU get that money when the house sells instead it going to that creditor. (See our last blog post about the judgment lien avoidance procedure.)

Chapter 7 Buys You Time

Besides immediate peace of time, filing a Chapter 7 case buys you time in various ways.

It takes pressure off to sell right away to deal with creditors unrelated to your home.  If you have a large debt or debts you’re behind on, Chapter 7 immediately stops those creditors’ collection actions. Then you can prepare your house and sell it without that pressure. And, as we said above, you protect your equity from judgment liens (and maybe other forced liens).

Assume instead that you’re close to a home sale but have a foreclosure either imminent or already started. A Chapter 7 filing prevents or stops the foreclosure and keeps it on hold for at least a few weeks. It may even buy a few extra months. That may be all the time you need to get your house sold.

But what if you’re nowhere close to selling your home?  Instead you want to sell your home before the foreclosure moratorium and your forbearance agreement with your lender expires. With all the extensions of the moratorium, who knows when that will be? You want to be prepared to file a Chapter 7 case before you would lose the house to any subsequent foreclosure. It may be wise to focus your energy now on selling your home. Then be ready to file a Chapter 7 case at a time strategically determined. That way you protect your house equity if it doesn’t sell fast enough.

Of course, life is complicated and your situation likely includes pieces of more than one of the above scenarios. That’s when you especially need the advice and counsel of an experienced bankruptcy lawyer.  There’s usually a lot to sort through to decide on the course of action that’s best for you and your home.

Conclusion

Chapter 7 gives you peace of mind from your aggressive creditors.  It protects your upcoming home sale proceeds so that money goes to you instead of to your creditors. And it buys you time so that you can maximize the money you get out of your house sale.

Chapter 13 accomplishes these same goals, but with quite a different process. It usually takes longer but can be more powerful and flexible. We’ll get into that next week.

 

More Bankruptcy Advantages with the Foreclosure Moratorium

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In the midst of the foreclosure moratorium, you may be dealing with or trying to avoid judgment or income tax liens. Bankruptcy hugely helps.


Last week we wrote about the ongoing foreclosure moratorium and the related mortgage forbearance opportunities. We discussed how bankruptcy can hugely increase the practical benefits of this for you and your home. We gave 6 important examples how bankruptcy can really help. Here are 4 more.

1. Judgment Lien “Avoidance”

Let’s say that during the last year of pandemic you’ve fallen behind on a debt or two and been sued. You didn’t respond to the lawsuit and a judgment was entered against you, and a lien put on your home. If you haven’t had to pay your mortgage because of a forbearance agreement, that doesn’t help with the judgment lien. You feel that debt and its lien on your neck and it’s appropriately really concerning you.

You may be able to legally get rid of such a judgment lien in bankruptcy. This happens if that judgment lien on your home’s title is “impairing” your homestead exemption. The homestead exemption is a specific dollar amount of equity that’s protected in bankruptcy. (The amount greatly varies depending on which state your home is in.) Your homestead exemption amount is “impaired” by the judgment lien if that lien “eats into” that protected homestead equity.

Assuming you qualify, judgment lien avoidance turns a secured debt that you’d have to pay to protect your home into an unsecured debt. Section 522(f)(A) of the U.S. Bankruptcy Code.  You could then usually discharge (legally write off) that entire unsecured debt in a Chapter 7 “straight bankruptcy” case. Or you could pay relatively little or even sometimes nothing on that debt in a Chapter 13 “adjustment of debts” case.  Instead of being stuck with that judgment and the lien on your house, you’d be free of it. Free both of the debt and the lien on your home.

2. Prevent Upcoming Judgment Liens

Now let’s say that you’ve fallen behind on a debt or two but have not yet been sued. But you expect to be. Or you’ve just gotten a summons and complaint announcing a creditor’s lawsuit but you still have time to respond. Either way, your creditor has not yet gotten a judgment against you and a lien against your home.

Filing bankruptcy immediately stops both ongoing and future lawsuits against you. That way the lawsuits cannot turn into judgments against your home (and possibly your other assets). This power that bankruptcy gives you is called the “automatic stay.” Section 362(a)(1) and(6) of the Bankruptcy Code.

First, ongoing lawsuits are stopped in their tracks so they can’t turn into judgments. Second, creditors which haven’t sued you already can’t ever do so (with some rare exceptions). In both scenarios, being unable to get a judgment, these creditors can’t ever record a judgment lien against your home.

The timing is particularly important here. All judgment liens can’t necessarily get “avoided” under the procedure referred to in #1 above. So once there’s a judgment lien on your home it may be too late. You may be stuck with that as a debt secured against your home. Then you may well have to pay it instead of being able to discharge it in bankruptcy. So it may well be crucial to file with your bankruptcy lawyer before a creditor gets its judgment. You stop the lien from coming into existence, and then can dispense with that debt through a bankruptcy discharge.

3. Prevent Income Tax Liens

Now assume that in these crazy times you’ve gotten behind on an especially scary kind of debt: income taxes. If those taxes haven’t already turned into tax liens on your home, preventing that from happening is really important. It can make the difference between discharging and paying nothing on the tax or having to pay it in full.

One scary aspect of tax liens is that, unlike judgment liens, it’s hard to predict when they will hit. Being in a mortgage payment forbearance arrangement with your mortgage lender will not stop the recording of a tax lien.

However, filing bankruptcy does stop the IRS and your state from recording an income tax lien against your home. Section 362(a)(4 and 5) of the Bankruptcy Code. You can discharge older and otherwise qualifying income tax debts under either Chapter 7 or 13. While your bankruptcy case is ongoing, the IRS/state can’t record a tax lien. Furthermore it can’t do so after the tax is discharged because the tax debt is legally gone.

So, your bankruptcy filing prevents the tax from being secured against your home. That would create serious disadvantages for you. Depending on the equity in your home, most likely you would have to pay that tax in full, or at least in part. Thus, it’s usually much, much better to file bankruptcy before the recording of a tax lien.

4. Pay off an Income Tax While Protecting Your Home

But what if your income tax debt is not old enough to qualify for bankruptcy discharge?

You can do two things.

File a Chapter 7 case to discharge all or most of your other debts. Then you can better afford to pay the tax. If you enter into a payment plan with the IRS/state after the Chapter 7 case is over other efforts to collect that tax are usually put on hold.

Or file a Chapter 13 case through your bankruptcy lawyer and pay the tax through its payment plan. Section 1322(a)(2) of the Bankruptcy Code.

This has extra benefits. Under Chapter 13 you pay the tax based on a more sensible budget compared to the IRS/state’s more aggressive one. The payment plan gives you 3 to 5 years to pay off the tax. You can delay paying on the tax while you pay more important debts–such as catching up on your mortgage. You almost never pay ongoing interest and penalties, potentially saving lots of money. During the case the IRS/state can’t record a tax lien against your home. Finally, it can’t record a tax lien after you finish your case because by then you’ll have paid off the tax.

You end up with a great way to catch up on your income taxes, while keeping your home protected.

 

Bankruptcy Advantages with the Foreclosure Moratorium

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Use bankruptcy as tool to take the best advantage of the pandemic mortgage foreclosure moratorium. Get stability in an unstable environment.


Wild Foreclosure Moratorium Rollercoaster Ride

If your mortgage has qualified for the federal mortgage foreclosure moratorium, the last 11 months have been a wild ride. Since the original 60-day foreclosure moratorium in March 2020, there have been no less than 6 extensions. Most of these extensions were announced just days before the current moratorium expired. Some extended the moratorium only a few weeks, none did so for more than a couple months. Homeowners have had to endure a tremendous amount of uncertainty and stress during this chaotic process. (See HUD’s Mortgagee Letter of January 21, 2021, the Background section, for details about this recent history.)

There’s the huge uncertainty of not knowing when you’ll have to start paying your mortgage again. Even worse is not knowing how you’re going to repay the missed payments.

All this uncertainty makes financial planning impossible. Indeed, it could drive you to the brink of financial insanity!

Getting Off the Rollercoaster and onto a Stable Plan

The situation for many people is not as bad as we just made out. In practice you don’t just stop making payments on your mortgage. You enter into a forbearance agreement with your mortgage servicer. That’s an agreement for “a temporary postponement of mortgage payments granted by the lender…  in lieu of forcing a property into foreclosure.” Investestopedia.

In usual circumstances persuading your mortgage servicer to enter into a forbearance agreement can be challenging. But not during this time of pandemic, assuming you have the right kind of mortgage. The CARES Act passed in March 2020 (and extended multiple times since the original deadline) required applicable mortgage servicers to provide forbearance to most homeowners financially affected by the pandemic.

What’s the right kind of mortgage? CARES applies only to federally-owned or -backed mortgages. But about 3/4s of mortgages are federally owned or backed by a federal agency or entity. These include the U.S. Department of Housing and Urban Development (HUD), U. S. Department of Agriculture (USDA Direct  and USDA Guaranteed Federal Housing Administration (FHA), U.S. Department of Veterans Affairs (VA), Fannie Mae (check here to see if your loan is backed by Fannie Mae) , and Freddie Mac (check here to see if your loan is backed by Freddie Mac). Also, see the U.S. Consumer Financial Protection Bureau’s How can I tell who owns my mortgage?

What Happens If You Qualify?

Assuming your mortgage qualifies, under CARES your servicer “shall… provide the [requested] forbearance.” You only need to “submit a request” and “affirm that the borrower is experiencing a financial hardship during the COVID–19 emergency.” Your servicer is not even allowed to ask for any further documentation of your financial hardship. (For example, see this FHA webpage confirming this.)

Nor can it charge any fees or penalties for the forbearance. It can’t even charge extra interest “beyond the amounts scheduled or calculated as if the borrower made all contractual payments on time and in full under the terms of the mortgage contract.” Finally, you don’t have to be in any particular delinquency status to qualify. CARES Section 4022 (b) and (c)(1).

How long can you not make mortgage payments? 

Upon a request by a borrower for forbearance… such forbearance shall be granted for up to 180 days, and shall be extended for an additional period of up to 180 days at the request of the borrower, provided that, at the borrower’s request, either the initial or extended period of forbearance may be shortened.

CARES Section 4022 (b)(2).

Careful: under the current extension, “you must request a mortgage payment forbearance from your mortgage servicer by March 31, 2021.” (From the FHA website but applicable to all qualifying types of mortgages.)

The Bankruptcy Advantages

So how does bankruptcy fit into this forbearance picture? It can give you huge advantages in many, many circumstances.

Some examples:

  1. You’re in forbearance now. But you don’t expect to be able to afford the mortgage payments when the forbearance is over. A Chapter 7 “straight bankruptcy” can discharge all or most of your other debts, enabling you to afford your mortgage.
  2. After the forbearance period ends, you know that you won’t be able to catch up on the missed payments. Let’s assume that you want to keep your home. Chapter 13 “adjustment of debts” can give you much more time to catch up on those payments. You can have as much as 5 years to do so. Stretching out the catch-up payments reduces the monthly amount, making it more affordable. While you’re catching up, your lender can’t take collection or foreclosure action as long as you follow the agreed payment plan. See Sections 1322(b)(2) and 362(a)(4) and (5) of the Bankruptcy Code.
  3. In the same circumstances, assume you have decided to leave your home, for financial or other reasons. You just don’t want to do so any earlier than you have to. A Chapter 7 case filed at a strategically determined time can allow you to stay in the home longer. In effect, this could extend your forbearance period longer than otherwise.
  4. Now assume that you want to sell your home after the forbearance period ends. A Chapter 7 case could buy you a bit more time to do so before losing it to foreclosure. But a Chapter 13 case would usually buy you much more time. You would need to resume regular mortgage payments during that time. But the missed payments accumulated during the forbearance period could likely be put off until the sale of the home. Under the right circumstances this could be several years later, if you want.
  5. Especially if you pay your home property taxes separate from your mortgage, in the midst of all this you may have fallen behind on that. Mortgage lenders do not take kindly to you falling behind on property taxes. That’s because property taxes come ahead of the mortgage in the rights to the property. Chapter 13 also gives you up to 5 years to catch up on property taxes. During that period the taxing authority can’t foreclose on your home. Nor can your mortgage lender use you being behind on your taxes to justify its own foreclosure. (Outside of bankruptcy, your mortgage contract allows them to do so.)
  6. Under some circumstances Chapter 13 allows you to “strip” a junior mortgage from your home’s title. That mortgage would no longer be treated as secured against your home.  You would no longer be required to pay that junior mortgage payment. Your mortgage debt would be reduced accordingly. Your home would cost less per month. You’d build future equity that much faster.

Taking Advantage of the Bankruptcy Advantages

These are just some examples of bankruptcy tools that can be used in conjunction with the current forbearance laws. Everybody’s situation is truly unique. Contact us to set up a consultation meeting and find out how you can benefit.

 

Short Extension to Foreclosure Moratorium

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The federal mortgage foreclosure moratorium now doesn’t expire until March 31. It may extend through September 2021 if Biden has his way.  

 

New Extension through March 2021

On the day of President Biden’s January 20 inauguration, the White House stated that:

he will ask the Department of Veterans Affairs, Department of Agriculture, and the Department of Housing and Urban Development, to consider extending foreclosure moratoriums for federally guaranteed mortgages and continuing applications for forbearance for federally guaranteed mortgages until at least March 31, 2021.

HUD’s Action

On the next day the Department of Housing and Urban Development (HUD) issued a Mortgagee Letter stating that

FHA [Federal Housing Administration]-insured Single Family mortgages, excluding vacant or abandoned properties, are subject to an extension to the moratorium on foreclosure through March 31, 2021. The moratorium applies to the initiation of foreclosures and to foreclosures in process.

…

Deadlines for the first legal action and reasonable diligence timelines are extended by 120 days from the date of expiration of this moratorium for FHA-insured Single Family mortgages, except for FHA-insured mortgages secured by vacant or abandoned properties.

As a result the covered mortgage servicers:

  • Can’t start or continue a foreclosure of a single-family regular or reverse mortgage (with the exception of legally vacant and abandoned properties)
  • Must give up to 6 months of mortgage forbearance if the financial hardship is because of the Covid-19 pandemic
  • Must give up to an additional 6 months of forbearance upon a homeowner’s extension request

There’s more information on the FHA’s COVID-19 Resources for Homeowners and HUD’s COVID-19 Resources for Native Americans web pages.

USDA’s Action

At the same time the U.S. Department of Agriculture (USDA) announced

an extension of… foreclosure moratoriums on USDA Single Family Housing Direct and Guaranteed loans (SFHDLP and SFHGLP) through March 31, 2021. The actions announced today will bring relief to residents in rural America who have housing loans through USDA.

See that webpage for the USDA’s mortgage forbearance requirements.

DVA’s Action

The Department of Veterans Affairs has also acted. It stated that the “VA is working diligently to extend the foreclosure…  [moratorium].” Accordingly, its website has been updated to say that VA-guaranteed mortgages now have a “foreclosure moratorium through March 31, 2021.” That FAQs page has additional information and resources.

Federal Housing Finance Agency’s (FHFA) Prior February 28 Extension

On the day before Biden’s inauguration the FHFA extended its prior moratorium for Fannie Mae and Freddie Mac mortgages through February 28, 2021. As of the writing of this blog post (Sunday, February 7, 2021), it’s not clear if the FHFA is extending their mortgages through March 31. However, it’s likely. Check with your mortgage servicer.  

What’s Next? Another Extension through September 30, 2021?

Biden’s $1.9 trillion American Rescue Plan includes an extension of the current mortgage moratoriums to September 30, 2021. Last Friday, both the U.S. Senate and House of Representatives passed a “budget resolution” along party lines moving this forward. It will be several weeks before we see whether this will turn into law or not.

For More Information…

Please see our earlier blog post of May 5, 2020 for details about the foreclosure moratorium in the CARES Act. The current moratorium is largely an extension of what that major legislation included.

Also see “Help for homeowners and renters during the coronavirus national emergency.” It’s a good general resource, from the Consumer Financial Protection Bureau.

Last thing: even in the best of circumstances going through a mortgage forbearance is stressful. During the pandemic for many people the entire situation is mind-blowingly difficult. There have been many extensions of the foreclosure moratorium during the last year. So homeowners have  been and still are constantly on the edge of a financial cliff as the deadlines approach, only to be extended again. It’s extremely difficult to make sensible decisions under these circumstances. A bankruptcy lawyer can help. This is the kind of stuff we help people with every day. Come see us and gain some peace of mind about how best to move forward.

 

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