Preferential Payments to Creditors and Ordinary Business Defense

A creditor, who receives a significant payment right before a debtor files bankruptcy might believe he is entitle to keep the money. After all he no doubt provided legitimate goods or services that the funds are paying for. When such a payment is over $600.00 however and is received within three months of the bankruptcy filing (or within a year if the creditor is considered related to the debtor) this can be considered a preferential payment, and while it usually comes as a surprise to the creditor, he may be contacted by a bankruptcy trustee, who wants him to give the money back, so the funds can be divided more fairly among all the creditors.

If this lender contacts a bankruptcy lawyer, he might be advised to raise the defense that the funds were received in the ordinary course of business. This means that the bankrupt debtor was following an established pattern in making the payment. Thus if a business man customarily pays a supplier six months after delivery and all at once decides to pay a year's debt right before he files bankruptcy, his creditor could have a problem. Even if the payment follows the normal rate, the creditor could still find himself with a preferential payment, if he took unusual steps to collect the debt during the three month period, such as bringing a lawsuit.

Can Same Sex Couples File A Joint Bankruptcy

On October 18, 2012 the United States Second Circuit Court of Appeals found the Defense of Marriage Act unconstitutional. The Defense of Marriage Act restricts the legal benefits of marriage under Federal Law to couples of the opposite sex. In the case Edith Schlain Windsor v United States however, a taxpayer raised the issue of whether a same sex marriage could be recognized for estate tax purposes. The IRS refused to accept this position, but the court ruled in favor of the taxpayer. The judges did not feel that the Defense of Marriage Act was closely related enough to an important government interest to pass the test of constitutionality.

This issue will likely go to the Supreme Court next, so we can hardly consider this a final answer, but with the tendency of appeal courts to uphold the decisions of lower courts, the ruling has a good chance of surviving.

Since the case involved estate taxes the results might seem to be of greatest interest to estate
planning attorneys, who work with same sex couples. However, if the Defense of Marriage Act is thrown out it will affect other areas of the law as well, such as bankruptcy.

Currently same sex couples are not allowed to file a joint bankruptcy. However, if the Supreme Court rules in their favor we would expect joint bankruptcies to become available to same sex couples as well.

Republican Proposal On Fiscal Cliff

Yesterday the Republicans put forth a proposal for avoiding the fiscal cliff, and as a bankruptcy lawyer I  do not feel comfortable about the state of our economy, if they stick to their guns. They have proposed $800,000,000,000 in tax increases over the next ten years; however, they have claimed that they can find this amount by limiting deductions rather than raising the rates.


While arguably this loophole plugging approach could theoretically work, it requires that someone identify which deductions will be closed, and the Grand Old Party has not bothered to take this step. They just contend that with all the loopholes out there, they can work the details out later, and they want to pretend they do not have to deal with the fact that all loopholes are popular among their own constituencies. They seem to be oblivious to the fact that, if they take away the mortgage interest deduction homeowners will be up in arms, or if they reduce charitable deductions the charities across the country will be lobbying to keep their benefits.

The bottom line is that until the specifics are identified, and the opposition comes to the surface, there is no way to tell, if the so called proposal has a serious chance of passing.

What the Republican proposal has done is create more uncertainty about what the tax law will be next year, which Congress should have learned by now makes it nearly impossible for the job creators in America to make informed investment decisions,

RESULTING TRUSTS IN BANKRUPTCY

When an individual files a Chapter 7 bankruptcy the trustee can take his property and sell it to pay his debts. Of course certain property is exempt from creditors by law, and since people filing bankruptcy do not tend to have a lot of assets, in most Chapter 7 bankruptcies the debtors do not end up losing any of their possessions.

As a bankruptcy lawyer I do run into people, who have property in excess of the exemptions, and sometimes the question arises whether the court can take certain property that is in the debtor’s name, but which the debtor does not consider his or her property.

A common example would be, when a teenager buys a car with the earnings from her part time job, but she puts the car in her mother’s name for insurance purposes. If the mother goes bankrupt the court will consider taking the car to pay the mother’s debts, even though the daughter paid for the car and is its sole user.

One thing the mother could do in this situation is argue that while she holds legal title, there is a resulting trust giving her daughter the right to the equity in the car. Whether this argument will work depends on the facts. The courts will look at whether the debtor has had any use of the vehicle or made any contributions toward the cost. Obviously the best solution would have been to have the daughter put the car in her own name in the first place, so she would not have to worry about losing the argument in court, but since bankruptcies are normally unanticipated events, this does not always happen.

When Can Mortgage Debt Forgiveness Be Tax Free

Last week we talked about the fact that as of January 1, 2013 a person, who loses their home, because he or she cannot pay their mortgage, might have to report the amount of unpaid mortgage debt as taxable income, on his or her tax return. This could prove very costly for individuals, who go through a foreclosure, dispose of their home in a short sale, or sign the title to their home over to the mortgage company in a deed in lieu of foreclosure.

This is because the general rule in the Internal Revenue Code provides that a forgiveness of debt creates taxable income unless the debtor files bankruptcy  or is insolvent. When the housing market collapsed, Congress passed a temporary law to avoid the tax on mortgage indebtedness under certain circumstances, and the law is scheduled to expire at the end of 2012. Of course our lawmakers have made it a regular habit of extend tax laws about to expire at the last minute, so it is still possible, we will continue to have this relief available.

What I wanted to point out today were the requirements for avoiding tax on mortgage forgiveness under the "temporary" law. In the first place a taxpayer can only claim the relief, if the  mortgage is on his or her principal residence. A person will be out of luck, in the case of a vacation home or rental property.

Furthermore, the forgiven mortgage must be home acquisition indebtedness. If a homeowner paid off the original mortgage and took out a new loan on the house to make investments, she will have to pay income tax on the debt she does not have to pay. Qualified acquisition cannot exceed $2,000,000 or $1,000,000 for a married individual filing separately. It can include mortgage indebtedness for substantial improvement of the residence. It can also include refinancing of home acquisition indebtedness provided the amount refinanced does not exceed the original acquisition debt.

Bankruptcy And Joint Child Custody

The means test is a mathematical formula that the bankruptcy law used to determine whether an individual has a low enough income to file a Chapter 7 bankruptcy rather than a Chapter 13 bankruptcy, in which he or she will have to make monthly payments to partially repay the debts. If an individual or a married couple have a high enough income to required them to file a Chapter 13 bankruptcy, the means test will also be used to calculate the amount of their monthly payments.

The means test begins with the debtors monthly income, and then subtracts out the allowable expenses which are set by the bankruptcy law, and which are not the same thing as the debtors’ actual monthly expenses. The means test is calculated by household size, and even if a person does not file a joint bankruptcy with their husband or wife, if they are living with their spouse, the husband’s or wife’s income and expenses are considered in calculating whether the debtor qualifies for Chapter 7.

The bankruptcy law is not as clear on who will be considered a dependent as the income tax law is. In fact in bankruptcy the cases do not agree, if someone needs to qualify as a dependent to be a member of the household. In some cases where divorced parents share the custody of children debtors have been allowed to combine the fraction of the time various children and step children live in their house to add up to the total number of household members that will be allowed under the means test.

Taxation of Home Mortgage Debt Forgiveness

        Home values in America have dropped substantially in the last five years, and many people, who have found their homes worth less than they owe on the mortgage, have been forced to abandon their homes in short sales, deeds in lieu of foreclosure, or court foreclosures. As a bankruptcy lawyer I have dealt with a number of people in this situation, and while losing one’s home is not a happy experience, I know that in many cases the homeowners can at least the avoid owing a deficiency to the mortgage companies, when the house sells for less than the debt.

        When a homeowner shorts sells a home or grants his mortgage company title in a deed in lien of foreclosure, the agreement with the mortgage company usually calls for no additional liability once the transaction is completed. When a home is foreclosed the court can enter a deficiency judgment ordering the homeowner to pay the mortgage company the difference between the sales price on the home and the amount owed to the mortgage company, but in many cases the court does not enter this deficiency judgement, and the homeowner ends up owing nothing more.

        Beginning on January 1, 2013 however, the homeowner might face an income tax liability on the amount of mortgage debt that does not get repaid in one of the above transactions. The general rule under Section 108 of the Internal Revenue Code provides that cancelled indebtedness is taxable income for the debtor. However, when the housing market collapsed, Congress passed a temporary law relieving distressed homeowners of this liability, provided the cancelled debt was the result of acquiring the house as one’s principal residence, and the acquisition indebtedness does not exceed $2,000,000 (or $1,000,000 in the case of a married individual filing separately).

        Unfortunately, like with many other recently enacted provisions of the Internal Revenue Code, this law is set to expire on January 1, 2013 unless Congress takes some last minute action to salvage the relief .

The Coming Estate Tax Increase

        On January 1, 2013 the Federal estate tax exemption is scheduled to go down from $5,200,000 to $1,000,000, which means that the death tax, which has only been the a concern for the relatively wealthy will begin to impose a burden on many families, who consider themselves middle class.

       This would seem to indicate that these newly affected individuals should be seeking out the services of estate planning attorneys  to take advantage of the opportunities to reduce this tax. Unfortunately, the planning process is complicated by the fact that no one knows whether this tax increase is really going to take place or whether Congress at the last minute will restore part or all of the higher exemption.

      Unfortunately, ever since 2001 when our lawmakers decided to phase out estate taxes over ten years, we have had to deal with having no permanent answer on what estate taxes will be. The 2001 law called for raising the $1,000,000 exemption to $3,500,000 over a number of years with the estate taxes disappearing in 2010. However, in 2011 the estate tax would resume with the exemption automatically reverting to $1,000,000. Up until the end of 2010 many people expected this would actually take place, but at the end of December Congress provided for a $5,000,000 exemption beginning in 2011. However, once again they provided that the exemption would revert to $1,000,000, this time beginning in 2013, and once again as the day of reckoning approaches we do not know what is going to happen.

Length of Chapter 13 Bankruptcy Plan

In a Chapter 13 bankruptcy an individual debtor makes payments (usually monthly) under a plan and over the plan period pays back part or all of her debt. The amount of the debt paid depends on how much income the individual has available.

The maximum period allowed by law for a Chapter 13 plan is five years or sixty months, in which the debtor usually makes sixty monthly payments and at the completion of the period the individual receives a discharge from the court. One reason Congress has set the five year limit is that anything longer looks dangerously like involuntary servitude. While some plans run for less than five years, most people filing bankruptcy have financial problems that make it necessary for them to utilize the maximum time available, and it is probably fair to say that five years is also the normal period for a Chapter 13 plan.

Based on the law the courts will not confirm a plan that requires more than five years, but the question sometimes comes up of what happens, if because of subsequent events the debtor fails to complete his payments in sixty months. Does the case automatically get dismissed?  The answer is no, not necessarily.

In the first place the dismissal would not be automatic. A party in interest such as the trustee would have to bring a motion for the court to dismiss the bankruptcy, and I have seen cases where the trustee has proven willing to work with the debtor, when extenuating circumstances have arisen. Furthermore, the bankruptcy court has the discretion to allow a debtor additional time to complete the plan, and if he felt there was a reasonable cause for the delay a bankruptcy judge would not necessarily grant the motion to dismiss.



Disposal of Secured Property Prior to Bankruptcy

When the borrower on a secured loan against property, such as a mortgage on a home or a car loan, files bankruptcy, the debt is discharged against the property, but the security interest remains. Thus in the case of a car loan after the bankruptcy, the bank may repossess the car, if the borrower fails to make payments, but the bank may not go after the borrower for any deficiency, if they fail to sell the car for the entire amount of the loan.

The question that sometimes arises is what happens, if the borrower has disposed of secured property prior to filing bankruptcy. In the case of a house the mortgage holder could still foreclose on the house, and I suspect they would. What happens though, when a smaller item such as a television or a refrigerator is given away or thrown out before the bankruptcy. The legal answer is that the security interest stays with the property, and if you go bankrupt the retailer could trace down the computer you gave to your Aunt Millie for her birthday and demand it back. The practical answer is that with most types of property it is not worth the effort to trace the property to the new owner, and in affect the debt is discharged.

If the debt is large enough to make it worth while though, which is more likely to be the case in business bankruptcies than consumer bankruptcies, the secured creditor may have an additional remedy. Disposing of property in violation of the terms of the secured loan agreement is conversion, which is a tort. Under Federal Bankruptcy Law, if a debtor has committed a willful and malicious tort the creditor may bring an action in bankruptcy court to declare the debt nondischargeable.

Can Fraud Issue Be Raised For The First Time in Bankruptcy Court

While bankruptcy allows individuals in need of a fresh financial start to discharge many of their debts in bankruptcy, certain categories of debts are nondischargeable. Some debts are automatically not dischargeable, such as child support or criminal fines. Others types of nondischargeable debts though, such as loans obtained through fraud, place the burden of proof on the creditor to convince the bankruptcy court that he or she should be allowed to collect the debt.

Thus a bankruptcy attorney will sometimes find it necessary to defend an adversary action filed by a bank or a credit card company, seeking to hold the debt nondischargeable on the grounds of fraud. However, often by the time an individual files a bankruptcy, a creditor has already brought a lawsuit in a state court to collect the debt, and the question can arise whether he can claim fraud in his bankruptcy claim, when he never brought the matter up in the state court.

In most cases the bankruptcy courts have ruled that not having previously complained of fraud does not permanently bar pleading the grounds in a bankruptcy action. The courts realize that as a practical matter, whether fraud existed or not, the creditor has little reason to raise the issue in state court, when all he has to prove is that the money is owed, and the judges tend to believe that it would be unfair to permanently bar the creditor from raising the argument, merely because he or she failed to anticipate the subsequent bankruptcy filing.

Discharging Income Taxes In Chapter 13 Bankruptcy

As a bankruptcy lawyer I frequently have to inform people filing Chapter 7 bankruptcy that their income tax debts will not be discharged. Income taxes will not be discharged, if less than three years has passed since the due date of the tax return, if less than two years has passed since the actual filing of the tax return, or if the taxpayer made a willful effort to evade or defeat taxes.

Since a chapter 13 bankruptcy  discharges many debts that are not discharged in a Chapter 7 the next question is will the income taxes be discharged in a chapter 13. The answer is yes "sort of."

While a chapter 13 will discharge income taxes one of the rules for a chapter 13 plan is that it will have to pay off 100% of priority debts through the plan. And to make it more complicated, some nondischargeable income taxes are priority debt and others are not.

If it less than three years since the due date of the tax return, the unpaid taxes are a priority debt, and the chapter 13 plan must pay them off in their entirety. However, if the three years has passed, and it is less than two years since the actual returns were filed, or if the taxpayer made a willful effort to evade or defeat taxes, the taxes become general unsecured debts, and the plan merely has to pay the IRS the same percentage that unsecured creditors receive.

Personal Property and The Homestead Exemption

Illinois law allows an individual to exempt up to $15,000.00 of equity in his or her home from claims brought by a creditor. For a married couple owning the home jointly the exemption would go up to $30,000.00. In many cases this provision will allows people who file a Chapter 7 Bankruptcy to keep their home.

One does not necessarily have to own a house or a condo though to take advantage of the homestead exemption. The Illinois Statute provides that the homestead exemption will also apply to personal property provided it is used as one’s principal residence. Thus a couple, who live in mobile home, can protect up to $30,000.00 of the value of the home from creditors provided they own it jointly. The exemption would also apply to a boat, if the owner uses the boat as his or her principal residence.

The wording of the statute in fact covers all personal property, so it could even apply to a car, or a tent, or an airplane. The tricky part once you get beyond mobile homes and boats though, might be to convince a court that you are really using the item of personal property as your primary home.

Exemption of Your Home From Creditors

As a bankruptcy lawyer I frequently have people ask me whether they can stop creditors from taking their homes.

This is not a question where one answer fits all though, and while creditors can sometimes take a debtor’s home, there are a number of factors that will stop this from happening in most situations.

One such factor is the homestead exemption under Illinois law. The law allows you to exempt up to $15,000.00 of your home value from creditors. Or in the case of two people owning a home jointly up to $30,000.00.

While there are not many homes in Illinois that are worth less than $30,000.00 keep in mind that other than when dealing with a mortgage foreclosure you only need to protect your equity in the home. Thus a married couple with a jointly owned home worth $300,000.00 home and a $250,000.00 home should be safe. This is because after subtracting out the mortgage and the cost of selling the home (which would normally be more than $20,000.00 for a home of this value) there is less than $30,000.00 of equity which the homeowners need to protect.

Homeowner Association Dues In Bankruptcy

When an individual files bankruptcy  he or she is frequently behind on mortgage payments and or  homeowner association dues. The amount owed on these particular debts are discharged in bankruptcy, which means the homeowner cannot be forced to pay them; however the mortgage company and the homeowners association do maintain a lien on the property for the amount owed. This means these creditors have to be paid out of the sales proceeds when the house is eventually sold before the homeowner receives anything. Or in the case of a mortgage company, they can foreclose on the house and take it away from the owner if the mortgage is not paid.


In the case of homeowner association dues there is the additional restriction, that the dues are only discharged if they were incurred before the bankruptcy was filed. The association can go to court and enforce payment for dues that fall due after the bankruptcy filing. This may sound reasonable for a person who continues to occupy the house, but if an individual finds a job in another state and is forced to move this can be a burden, especially if he cannot sell the house and it ends up being foreclosed on. In the current economic environment foreclosures often require a couple of years to work their way through the courts, and all this time association dues can be mounting up.

Using Bankruptcy to Stop Foreclosure

Many individuals facing bankruptcy are also behind on their mortgages and looking at a likely foreclosure of their homes. Thus a frequent question that bankruptcy attorneys here is whether the bankruptcy can stop the foreclosure.

The answer is that a Chapter 13 bankruptcy in which a person makes monthly payments to partially repay their debts can include in their plan a provision to pay back any arrearage on their mortgages and thus end the foreclosure. A Chapter 7 bankruptcy in which the debtor makes no payments does not stop the foreclosure; however, it can sometimes serve to slow down the procedure and thus allow the homeowner to stay in his or her home longer.

The filing of the Chapter 7 bankruptcy creates an automatic stay, which forbids a creditor from taking any action to enforce a debt, and this requires a mortgagee to put the foreclosure action on hold until the homeowner receives a discharge. Whether this actually slows down the foreclosure is somewhat a matter of chance. The mortgage company might be waiting for the statutory minimum periods to pass and the bankruptcy will make no difference. Or the creditor could go into bankruptcy court to allow the resumption of the foreclosure.

In the current environment though in which the courts are way behind processing the backlog of foreclosures a minor delay often turns out to allow the homeowner to stay in his house for a number of additional months.

Perfecting Mechanics Liens in Bankruptcy

        Mechanic’s liens are a secured debt, and therefore while bankruptcy will discharge the obligation to pay the money owed for the services performed, the holder of the mechanics lien can still force a sale of the property to collect what he is entitled to under the contract, or wait and demand his share of the proceeds when other circumstances cause the owner to dispose of the property.

        Section 362 of the United States Bankruptcy Code creates an automatic stay when a debtor files bankruptcy, which prevents a creditor from taking any action to enforce the debt, after a bankruptcy is filed. Since a mechanics lien needs to be recorded to be enforceable, a bankruptcy lawyer  sometimes hears the question, whether the creditor may record the mechanics liens after his customer files for bankruptcy.

         At first glance the answer may appear to be no, since clearly the reason a creditor records a mechanics lien is because he is hopeful that this action will improve his chances of collecting from the creditor.  Section 362 however provides an exception for perfecting liens that are in existence prior to the bankruptcy filing. Since by law the mechanics lien arises, when the work is done, this means that the creditor holding the lien will still be able to record it after the debtor files.

Contribution for College Education of Children of Divorce

Under Illinois law a court may order a divorced parent to contribute to the higher education expense of his or her child, 750 ILCS 5/513. In making this decision the court will consider the financial situation of each parent and of the child, as well as the aptitude of the child for obtaining a higher education. In considering the child’s aptitude though keep in mind that the statute allows the court to order contributions for other forms of post secondary education besides college. Thus if a child wants to attend trade school the court may order the parent to help pay the cost of trade school.

There is no exact formula for determining how much a parent must contribute. Typically the court will look at the comparative income and expenses of both parents to see who can afford to pay more and will also expect the child to make some contribution to his or her education. The way the law is worded the courts should consider the property of the parents as well as their income, although as a divorce lawyer
I have been in front of judges who refuse to look at anything but income in these cases.

In many divorces of course the children have not yet reached the age to attend college and the court will reserve the issue until the child is ready to acquire a higher education. This has the advantage of letting the court consider the financial positions of the parties at the time the education is needed. However, if the parties do not agree it also places the burden on one of them to return to the divorce court years later to resolve this outstanding issue.

Modification of Alimony

      Under Illinois divorce law, a court granting a divorce decree can order one of the parties to pay maintenance, which is also known as "alimony" or "spousal support" to the other party. Whereas alimony was the norm in divorce 50 years ago, these days only a minority of divorce judgments include a provision for maintenance, and it is far more common for the judge to order maintenance to end after 3 to 5 years, than for the payments to continue for the rest of the recipient’s life time.

      Furthermore, in most cases either party can bring a motion before the court to modify the amount of maintenance or the duration of the payment based on a change of financial circumstances. A wife paying alimony for example may ask for a decrease in the amount of maintenance, because she is forced into early retirement and can no longer afford to pay. Or she may ask for a decrease, because her husband finds a good job and no longer needs financial help to maintain his standard of living.
One thing the party asking for a modification should keep in mind, is that the change can only be effective as of the date he or she sends notice of the motion to the other party.

      The mistake that a divorce lawyer often sees is that a husband loses his job and merely quits paying his former wife, because he no longer has the funds. In this case the amount due continues to mount up, and when he finally petitions the court for a reduction of maintenance, he will already owe a substantial arrearage, which the judge might have reduced, if the husband had asked for the reduction, when he first became unemployed. Unfortunately, it will then be too late for the court to reduce any of his liability, which became due prior to the date he sent out a notice of his motion.

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