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.