Category Archives: Debt Relief & Bankruptcy

Debt Forgiveness and Income Tax

Debt forgiveness, which is the cancellation of a debt that you owe to someone, often can lead the IRS to see an increase in your income tax bill. However, there is no simple rule to be applied to every situation. For example, if you are in bankruptcy, the IRS is unlikely to see income that can be taxed after debt forgiveness. On the other hand, when a commercial lender cancels your obligation to repay a debt, you may find yourself with income equal to the amount of debt forgiven. In this situation, you do not have any money in hand, but you can expect a tax bill on the amount of money that the lender decided could not be collected from you. Your former lender usually should send you an IRS Form 1099-C (“Cancellation of Debt”) to let you know that the debt that you no longer owe triggered an increase in income taxes at the time of debt forgiveness. Remember that the IRS also gets a copy of the 1099-C and is unlikely to forget the incomes taxes that you now owe.

You may wonder why you receive debt forgiveness income when you cannot repay a loan. One point that will be discussed later is that the IRS does not see income when a debt is cancelled so the explanation here is general. The idea behind debt forgiveness resulting in income begins with the fact that the funds you originally borrowed were not income since those funds represented money loaned to you that had to repay to the lender. When a debt is forgiven, you no longer have to have any obligation to pay back whatever amount of the loan remains unpaid – essentially, your wealth has increased now that you have money that you can keep.

As long as none of the exclusions or exceptions (which will be mentioned below) regarding debt forgiveness income applies, the formula for calculating income simply involves subtracting the fair market value of the property from the debt owed at the time that the lender took a specific action, such as foreclosure or repossession. Also, you may receive a capital gain due to foreclosure, for example; this is not debt forgiveness income but usually occurs when the property’s fair market value is greater than its adjusted basis (approximately your original purchase price plus the costs from major improvements). An amount could be excluded due to the length of time that this was your personal residence during the last five years – I won’t go into the details here because the focus is on debt forgiveness for the moment.

There are several exceptions when debt forgiveness does not lead to taxable income. The examples provide general rules about various exceptions, which could be subject to exceptions themselves – consulting with someone who handles these matters about your specific situation always is advisable.

In general, a debt that is cancelled through a gift, a bequest or devise, or an inheritance is not considered income. Certain student loans also provide that all or part of the debt incurred to attend a qualified educational institution will be canceled if the person who received the loan works for a certain period of time in certain professions for any of a broad class of employers. If your student loan is canceled as the result of this type of provision, the cancellation of this debt isn’t included in your gross income. To qualify for this treatment, the loan must have been made by entities in one of three categories: 1) the federal government, a state or local government, or an instrumentality, agency, or subdivision of one of those governments; 2) a tax-exempt public benefit corporation that has assumed control of a state, county, or municipal hospital, having employees defined as public employees under state law; or 3) an educational institution (an organization that has a regular faculty and curriculum as well as regularly enrolled students who attended educational activities at that place). Other criteria have to be met for these loans not to be income if they are cancelled. One major reason for debt forgiveness here is to encourage students to serve in occupations or areas with unmet needs in which the services provided are for, or under the direction of, a governmental unit or a tax-exempt Section 501(c)(3) organization.

There also is an exception for deductible debts. Most individuals use the cash method of accounting so income is seen when the money is received while expenses are counted when money is paid for goods or services. Therefore, when a debt was supposed to be paid but the obligation to do so was forgiven, you would not realize income at that time if payment of the debt would have been a deductible expense for you.

The Home Affordable Modification Program (HAMP) also has some exceptions to debt forgiveness income. Reduction of your principal mortgage balance generally is not income when Pay-for-Performance Success Payments and PRA investor incentive payments are involved. Meanwhile, when the principal balance is reduced due to Principal Reduction Alternative under the same program, you should expect that you have taxable debt forgiveness income. Any exception to possible debt forgiveness income can become complicated; again, seeking a professional’s assistance is the best way to protect yourself from making costly mistakes in this area.

After any possible exceptions are reviewed, you then look at the exclusions. For individuals, some of the most common situations that are excluded from consideration as income from the cancellation of a debt would be the following. The most common one probably involves bankruptcy – if a debt is discharged in a bankruptcy case, then it cannot be counted as income from debt forgiveness. Insolvency, which involves a situation when your assets have a fair market value that is less than the amount of all of your debts, also would exclude you from having debt forgiveness income. However, this is not easily determined so you would be wise to have a tax professional examine your financial position to determine if you are insolvent.

Another category of exclusion that is complicated and would require the help of a tax professional usually deals with certain farm debts. The IRS also has noted that non-recourse loans are not subject to debt forgiveness. These loans permit a lender to repossess the property that you financed with the unpaid debt or, if this does not apply, the property that you used as collateral in the event that you defaulted on the loan. There is no personal liability for the default on a non-recourse loan, which is why you do not gain taxable income from the debt’s cancellation. On the other hand, this type of loan still could result in a capital gain when the property is sold.

Exceptions should be applied before you apply the exclusions because their effects on “tax attributes” of yours are different. Unlike exceptions to tax forgiveness income, exclusions require you to reduce tax attributes, which include certain credits and losses as well as the basis of assets. Remember that, while income due to debt forgiveness can seem to be a relatively simple concept, there are many twists to this concept of which you must be aware, and the only way to approach this is to consult with a tax professional about all of the implications that ultimately will impact your tax bill.

There is one final word of caution when the possibility of income from debt forgiveness exists. Whether or not a Form 1099-C was received does not determine income tax implications. The IRS requires these forms only under certain circumstances. When a creditor cancels a debt of less than $600, you may not get a Form 1099-C. However, you must look at the possibility that you received income that is taxable due to debt forgiveness despite the absence of the 1099-C because the IRS would look for income in this situation and will not be do forgiving if you neglected to pay tax that you owed.

Business and Chapter 11 Bankruptcy

Business – particularly small business – forms the backbone of the U.S. economy. According to the Small Business Association website, there are 28 million small businesses in this country, and they account for 54 percent of all sales and 55 percent of all jobs. There is no good definition for “small business” because this classification differs from industry to industry. However, all businesses face an unfortunate fact of life: most that start up must wind down sooner than later. Depending on the industry, at least one half of new businesses are unlikely to survive for five years. When a business begins to fail, it may look to protections that the Bankruptcy Code can provide. This often means looking at a Chapter 11 filing in an attempt to save the business, but this is a possibility exists mainly for one established as a separate legal entity, such as a corporation (including a Limited Liability Company) or legally formed partnership (including Limited Liability Partnerships).

A sole proprietor is in a different position. If the business or the individual files for bankruptcy, the individual or the business, respectively, also files. Chapter 11 generally is not available here. However, if the debtor wants the business to survive the bankruptcy, then a filing under Chapter 7 would not be helpful since a trustee will be appointed and will control the bankruptcy estate. The trustee is likely to shut down operations and liquidate assets in order to make payments to creditors.

When a debtor who is a sole proprietor wants business to continue in business after a bankruptcy filing, the individual should consider incorporation prior to filing or, possibly, a Chapter 13 case since the debtor generally would remain in possession of the business in a filing under Chapter 13. If there was an incorporation, then Chapter 11 again can be viewed as a possibility. This article will look at separate legal entities seeking to continue operating into the future. As with General Motors during the last decade, bankruptcy under Chapter 11 can succeed, but a small business that looks to protection under this chapter must understand what it is getting into and the likelihood of getting out of it successfully.

The general purpose for filing for bankruptcy under Chapter 11 is “reorganization.” This actually amounts to a plan for the repayment of debts while the entity continues in business. As an aside, Chapter 11 can be used by certain individuals when their amount of debt prevents them from filing under Chapter 13; however, this is the exception to the usual filing under Chapter 11. There also is Chapter 11 “liquidation” for a business, but this not the usual reason for a Chapter 11 filing so it will not be discussed here.

A business that continues to operate as it pursues bankruptcy under Chapter 11 is a “debtor-in-possession,” which essentially places it in the position that an appointed trustee usually occupies. The trustee is supposed to manage the bankruptcy estate and to sell off its assets in order to pay creditors when possible, but, with an ongoing business, its assets remain in the hands of the entity to provide an opportunity to continue operating. This also means that the business has fiduciary responsibilities and must act in the best interests of its creditors, which may be contrary to its own best interests.

While the business faces obstacles due to fiduciary responsibilities to creditors, Chapter 11 does give it various powers that can increase the chances of success. These include is ability to object to creditors’ claims, avoid liens, reject leases and contracts without penalty, extend the time to repay to current creditors and potentially reduce the amount owed to them.

Although having the potential to use these powers is beneficial, there also are realities that reduce the chance of emerging from Chapter 11 successfully. There tends to be more litigation involved in these bankruptcies – creditors suing the business, and vis-a-versa. Even if the litigation ends favorably, the cost to finance it can be considerable.

There are other practical problems when a business files under Chapter 11. It not only involves a time-consuming process (which could take years to resolve), but it also entails the likelihood of considerable costs beyond those already mentioned. As of February, 2016, the filing fee to begin the process is $1,717. However, there are additional costs that can be much higher. For example, attorney’s fees and related costs can begin in excess of $10,000 and may increase considerably depending on the case’s complexity and amount of work that is likely. Also, attorneys and any other professionals usually need to be paid prior to filing since any further payments require authorization by the Bankruptcy Court. There also are numerous administrative burdens along the way – there are reports that must be filed regularly with the Court as well as the Office of the United States Trustee, along with additional fees to be paid.

With so many difficulties facing a business that already is failing, one should not rush to file under Chapter 11. If there will be any chance of success, there must be significant planning in advance. Of course, this really applies to all bankruptcies – a successful outcome is unlikely when a debtor pushes to file right after meeting with the attorney. However, this is even more applicable to Chapter 11 filings, which have the additional financial burdens and administrative requirements that cannot be avoided. Therefore, anyone who would consider such a filing must plan well in advance of an attorney’s involvement in the case, producing as much relevant documentation as possible for the attorney to review before any decision is made.

With all of the requirements during the process itself, it must be remembered that the fundamental purpose here is to prepare a viable Plan of Reorganization that the Bankruptcy Court will confirm. This essentially becomes a contract with creditors, with details about how debts will be repaid as well as the source for payments. Before seeking court approval, creditors generally vote on the plan. They do so by particular creditor classes (secured, unsecured, etc.) that are established. If a creditor class does not approve the plan, the class members still may have to accept it, although this also may force the business to relinquish some assets as a result.

To improve the likelihood of a plan’s approval, a business should attempt to negotiate agreements with creditors for the payment of its debts. A skilled attorney who can craft a proposal that is acceptable to creditors and provides the business with an opportunity to attempt to move forward in a stronger, more stable position is essential.

In the end, all of these efforts may serve simply to forestall the inevitable – a business filing a Chapter 11 case may intend to continue operating after the bankruptcy, but most that file under Chapter 11 will not survive. This must be realized before filing, and other options must be reviewed, including filing a Chapter 7 case.

This is a quick primer on business reorganization under Chapter 11. Any entity that is considering this possibility needs to explore all of the details and implications involved before deciding to pursue this option.

The Value of Valuing Personal Property in Bankruptcy

If you file for bankruptcy, you also must file a Schedule B, listing all personal property in which you have any legal or equitable interest. This is important because you cannot protect what is not listed in this schedule. The description must contain sufficient detail so that the trustee and creditors have a good idea regarding what the property is, what its condition is, and so forth – this will help to determine what could happen to it prior to the bankruptcy discharge. You also need to make clear about your interest in the property since this will impact the value included in Schedule B, which leads to the point of this schedule: it must provide the current value of your interest in the property, without adjustment for secured claims or exemptions.

You must include all property, even if it would not be in the bankruptcy estate (which places it under the trustee’s control). The list includes causes of action for which you can sue, government grants for which you are eligible, security deposits, earned income tax credits as well as tax refunds that you will receive, and support obligations payable to you.

Property has to be listed so you can protect it. You will exempt the property using available exemptions — not doing so allows the trustee to sell it to pay creditors whom you owe. Without a listing and a description that is detailed, an exemption could be denied because the trustee cannot get a good idea of the property’s value – again, the potential for a sale exists. If you forget to list something, you may be able to amend the schedule to include it, but you should take care to have a complete inventory as of the date of filing. Scheduled property that the trustee has not administered by the end of the bankruptcy is abandoned to the debtor so you will not lose it, but unlisted property can cause you many problems, including losing it.

After you have the list of personal property, you need to review it and place values on items in the list. This doesn’t mean that each item has to be valued. Some things that would have an individual value below $575 and would be considered household goods can be combined into one category – for example, you could value pots and pans or silverware or your clothing in groups (although you should give some idea of how much is in these groups since details matter here). With property such as furniture, appliances, and clothing, remember that they tend to lose value quickly, and the value to list is the current fair market value, not replacement values. Basically, you look at the price that they reasonably could bring at a garage sale. Since they wouldn’t raise much money, a trustee – who seeks to raise funds to distribute among creditors – is unlikely to go to the expense of, essentially, holding this garage sale.

Personal property of greater value (such as expensive jewelry or artwork) could be worth more than the value that you can exempt. Property in these categories might be sold during a bankruptcy, which is a consideration before filing but cannot be “forgotten” in Schedule B if you do file. Also, you might want to have these appraised before they’re listed since they are not common, ordinary items like the property mentioned in the preceding paragraph.

A few other categories of personal property merit some mention here. One consists of your financial account, including checking accounts. The value as of the date of filing is needed. If you have written checks that have not been cashed yet, this is not a problem. You simply would exempt the higher value. However, never add funds after the account is valued on the date of filing because you don’t want to list a value that is too low on Schedule B.

Additionally, intangible personal property must appear on the schedule. You need to pay attention to detail in your description of this type of property because valuation often is difficult. As an example, if you have a cause of action against someone and seek a monetary award, the value to include is not the amount that you are seeking because you may not receive this. You have to adjust the value based on the odds that you will win and be awarded that amount – in law, there is no such thing as a sure thing. Beyond this reality is the possibility that, while you may be awarded monetary damages, you could have trouble collecting the judgment. The value in Schedule B should be reduced to reflect such reasonable possibilities. If the value is too hard to estimate with any accuracy, you might list it as “unknown” while providing an accurate description so that you can attempt to exempt it while the trustee has an opportunity to try to place a value on it.

The last category, for now, consists of property that is not part of the bankruptcy estate, which only includes non-exempted items and is under the control of the trustee. Because Schedule B requires the inclusion of all your personal property, everything appears in it. A common example is an interest in an ERISA-qualified pension. Generally, this is not part of the bankruptcy estate, but, if you take this position, you should include a reference to a statute that protects it in the schedule. Meanwhile, just in case the trustee doesn’t agree with your interpretation, you could claim an exemption in Schedule C “in the alternative” for additional protection.

With all personal property in Schedule B, you want to be as thorough and accurate as possible with descriptions and valuations. You don’t want to face the possible loss of property because you neglected to list it, and you also want to exempt as much of the listed value from the bankruptcy estate so that the property can remain yours after the bankruptcy has ended.

Credit Card Debt & the Statute of Limitations

When a person owes credit card debts, but the amount to be paid has grown to a level that the person realistically cannot repay, the individual may experience overwhelming anxiety about what a creditor or debt collector might do. If you are in this situation, you cannot let anxiety keep you from looking at possible options. For example, with debt collectors purchasing older debts for pennies on the dollar, you have to view the possibilities with the credit card debt’s age in mind because you might be inclined to file for bankruptcy when the defense provided by the statute of limitations could be a better solution under the circumstances.

A statute of limitations exists for most civil and criminal matters in order to provide finality and to ensure that this will occur when evidence remains reasonably fresh. In Pennsylvania, credit card debt generally stems from an open-end, or revolving, account based on a written contract. This places the statute of limitations for such debt at 4 years. This means that, if you have not used a credit card during the last 4 years, you could use the limitations period as a perfect defense against an attempt by a creditor or debt collector to obtain and enforce a judgment against you.

You have to be careful, however. If you discuss the debt with a debt collector, for example, you must avoid reaffirming that you owe the debt, entering into a new payment arrangement, or – especially – making a payment on the credit card debt because you do not want to act in a way that actually starts the statute of limitations over again. The defense cannot protect you for at least another 4 years.

For this reason, you want to avoid talking with anyone attempting to collect an old debt. You do not want to do anything that would be seen as an acknowledgment by you that you owe the debt. You always should bear in mind that you do not have to speak with a creditor or debt collector, which is the safest course of action to take.

You could have an attorney speak or write on your behalf not to make a deal but to deal with the issue of the statute of limitations. A letter also can be written which communicates that you are not to be contacted and that doing so could result in a penalty being paid by a debt collector to you under the Federal Fair Debt Collection Practices Act. Pennsylvania has a similar law – the Fair Credit Extension Uniformity Act – that applies to creditors as well. It describes unfair and deceptive debt collection practices and sets forth the penalties that can be enforced against those engaging in these practices.

These and other laws provide some protection against harassment by creditors and debt collectors. However, even after the statute of limitations has run out your credit card debt, the debt still exists. You may find yourself receiving notice of a lawsuit to obtain a judgment for this debt. This is when you need to know what to do – after you have been served with the required notice, you probably should consult with an attorney to make sure that you are protected and, possibly, to pursue a claim for damages under the various laws that apply.

When this situation occurs, you no longer are safe if you do nothing. Because you owe the credit card debt, you will face a default judgment if you do not answer the other party’s complaint. You could lose things that you own when such a judgment is enforced. Also, judgments have a 5-year statute of limitations but can be revived before this period ends, potentially resulting in a long string of 5-year periods when you may face enforcement of the judgment.

However, instead of doing nothing, you need to have an answer to the complaint filed on your behalf in which the statute of limitations that applies to credit card debt is raised as a defense. As long as it applies and is raised in a timely manner after you receive the complaint, you have a perfect defense against the creditor or debt collector because, although the credit card debt exists, the other side waited too long to enforce the right to a judgment for that debt. This is the power of the statute of limitations.

I had mentioned bankruptcy earlier. Your factual circumstances will dictate whether or not it should be considered. When faced only with an unsecured debt, such as most credit card debts, that can be defended by the appropriate statute of limitations, you probably would want to delay taking the more drastic action of filing for bankruptcy. You do not want to file now because you have a perfect defense against the creditor or debt collector at this time. Also, you may need to pursue a bankruptcy in the future but could be prevented from doing so if you file when you would not gain more relief through bankruptcy.

In addition, you need to consider the statute of limitations regarding credit reports. The credit card debt can be reported for 7 years, even though it technically can be collected only for 4 years. Even so, a bankruptcy can remain on your credit reports for ten years after you file. This means that you should be able to clean up your credit reports sooner in this scenario by relying on the 4-year statute of limitations applicable to your credit card debt.

Of course, this is a brief look at some options that you have in handling your debts. Different situations will point to different courses of action. The defense provided by the statute of limitations may be the best solution when people attempt to collect credit card debt from you. To review and understand what you can do, you should contact an attorney when problems with debt need to be resolved.

Income Tax: Priority Debt in Bankruptcy?

The general rule for income taxes owed to federal, state, and local governments is that they will not be discharged in a Chapter 7 bankruptcy – you will owe them after your bankruptcy ends because they often are classified as priority debts. However, as with all generalizations, there are exceptions. We will look at both the general rule regarding priority debts as well as some exceptions. Also, the way that these taxes are handled in Chapter 13 bankruptcies will be mentioned briefly.

The first point to remember is that we aren’t looking at taxes for which a lien exists. For example, if the IRS files a federal tax lien against you for income taxes that you did not pay, there are no exceptions because this makes the tax debt into a secured debt that must be paid.

When there is no lien, any income taxes that you owe are unsecured debts. While the general rule with unsecured debts is that they are dischargeable in Chapter 7 bankruptcies, general rules – while not made to be broken – do bend at times under our laws. There are a number of unsecured debts that have been classified as priority unsecured debts. These must be paid prior to other claims, which is why they are termed “priority debts.” Although the nondischargeability makes them look like secured debts, this category of debts has no collateral protecting the creditor. However, their payment is considered more important than most unsecured debts, which is why this category exists.

Income tax debts – when not secured by liens – belong to this select group of unsecured debts given priority in bankruptcy. I had mentioned that income taxes generally are not discharged but need to explain when they are given priority. First, taxes on income for a year that ends no later than the date that you file your bankruptcy petition “for which a return, if required, is last due, including extensions, after three years before the date of the filing of the petition” are given priority. When these words from the Bankruptcy Code read very carefully, they basically mean that, if you fail to file a tax return that was due within three years before you filed for bankruptcy, you face a priority debt for any taxes that you owe for that tax return.

A second factor also can create a priority debt. The tax liability must have been assessed by the government within 240 days of your bankruptcy filing. When an “assessment” is made is defined by federal and state laws, but this date is when the amount of taxes that you owe has been determined by the government. In addition, if an offer in compromise existed or was pending during the 240 days, then the length of time that the offer existed is added to this period, along with an additional 30 days. In addition, there also are times when a bankruptcy previously filed during this time frame can extend the period for filing a new bankruptcy beyond the 240 days.

A third way that income tax debts can become priority unsecured claims is when you don’t file a tax return when it was due, which usually is April 15th of the following year for individuals. If the tax return was not filed, you cannot get the tax debt discharged in a Chapter 7 bankruptcy. You also can’t get the debt discharged if you failed to file the return when it was due and only filed it fewer than two years before filing for bankruptcy. In addition, if you filed a false return or simply attempted to evade paying your taxes, then you have created a priority debt. Income taxes that are assessable after a bankruptcy is filed will remain after the bankruptcy ends, as well.

As for interest and penalties on any income tax debts, you should expect these to be nondischargeable, too. On occasion, a tax penalty might be discharged if it is found to be punitive, which basically means that the penalty is so excessive to be a punishment instead of reflecting the cost of investigating and the loss based on what you did (or didn’t do), for example.

Although this is a somewhat simplified version regarding how income tax debt becomes a priority debt, some exceptions that will allow these debts to be discharged need to be noted. An income tax debt that is more than three years old with a return filed when it was due can be discharged. Another exception is when a return was filed late but was filed more than two years before the bankruptcy was filed – this debt may be dischargeable. In addition, any assessment of your tax liability by any of the taxing authorities (federal, state, or local) that occurred more than 240 days before you filed for bankruptcy can lead to a discharge of the tax debt. As mentioned earlier, older income tax debts are much less likely to be classified as priority debts.

Income tax debt also has implications in Chapter 13 bankruptcies. To summarize Chapter 13’s treatment of income tax debts, a lien again creates a secured debt, and this must be paid. Without the lien, an income tax debt can become a priority debt when it falls within the criteria outlined for a Chapter 7 filing. Although interest could be dischargeable, it is likely to remain when the tax debt has priority status. Likewise, penalties on these debts are nondischargeable to the same extent as they would be with Chapter 7. Therefore, your Chapter 13 plan would have to account for making payment of these debts.

Finally, it should be remembered that, when only one spouse owes the tax debt, a married couple’s property owned by the entireties is protected in a bankruptcy. In addition, this applies to the property of a spouse who does not owe taxes and is not part of the bankruptcy filing. And there is a last word of caution that anyone with income tax debts needs to remember: you can’t get around the priority nature of income tax debts by paying them with credit cards or other types of debt instruments – your new debt will be nondischargeable, even though your tax debt is gone.

As this brief look at priority debts that involve income taxes owed to federal, state, or municipal governments illustrates, this can be a difficult area of the law to navigate successfully. Of course, the same can be said of bankruptcy in general. This is why, if you are thinking of filing for bankruptcy, you also should think of discussing the possibility with someone who has experience helping individuals through this process. You do not want to get yourself into a situation that might do you more harm than good in the end.

Chapter 7 Bankruptcy and the Means Test

When the Bankruptcy Code is changed in 2005, the idea that this would force people to file under Chapter 13, which requires a plan to repay as much of your debt as possible, instead of using Chapter 7 to get a “fresh start” by discharging most debts and allowing you to keep most (if not all) of your possessions was a commonly held belief. The new law did have a bias against Chapter 7 bankruptcies, but the reality is that most people still can file under the chapter that gives them their best options.

The means test, which can be used to force you pursue a Chapter 13 bankruptcy, has “safe harbors” that protects the average filer’s choice of which bankruptcy to pursue. For this reason, you need some understanding of this test and when the safe harbor based on income will allow you to consider a range of possibilities, including those under the Bankruptcy Code if necessary, to handle your financial struggles.

Due to the formula involved, we will take a greatly simplified journey through the means test. Its starting point is “current monthly income,” which actually looks at the average income from the previous six months to find a monthly average. Also, the focus is on income from all sources used to pay household expenses of the debtor and the debtor’s dependents on a regular basis during this period. The bankruptcy law provides for various deductions from the total and also excludes some sources of funds from being counted. The most prominent of these would be any benefit received under the Social Security Act. However, not everything paid under this Act is not counted necessarily – for example, the Advisory Committee on Bankruptcy Rules did not include Unemployment Compensation as being excluded. Also, we will see some other sources that are omitted due to the use of data regarding income from the Census Bureau.

“Current monthly income” must be calculated, after which it is multiplied by 12 to turn it into a yearly amount. The new total then can be compared to the median income in your state; the median income is the amount at which half of the households fall below it while the other half will be above it. As mentioned previously, the source of this data is the Census Bureau. For this reason, we have to be aware of various items that it leaves out of its income calculations, including Food Stamps, public-housing benefits, and lump-sum inheritances, so that the comparison is based on the same information. Meanwhile, in addition to income, your household size is important for establishing the median income level, as reported by the Census Bureau, that you would use for the means test. Unfortunately, this is another case in which the bankruptcy law does not provide clear guidance, which has made the definition of the size of any particular household an issue of contention at times.

However, despite the problems with ambiguity with the additions to the bankruptcy law in 2005, the means test eventually does produce an income figure to be compared to the median income borrowed from the Census Bureau. As of May 1, 2014, in Pennsylvania, the median income for a one-person household has been $47,809 while, for a household of two, this rises to $56,690. It continues to increase as the household size increases. The issue now becomes what all of this means to you.

Essentially, it means that the means test will be meaningless to you as long as your household income falls below the median level for a household of the same size in Pennsylvania (or the level for whatever state you live in). You would be in one of the safe harbors that Congress built into the means test. In turn, this means that the “presumption of abuse” (which focuses on a debtor’s ability to repay creditors) does not apply to you so that, if you decide to file for bankruptcy, you should be able to choose the chapter that would be most beneficial in meeting your goals for filing.

Most people who pursue a bankruptcy tend to be under the median income figure that applies to them, which means that the means test that can seem so intimidating due to its complexities actually has no effect on them. For those above the median income, the test will have implications, which can be explored at another time. What matters here is that you generally will not have to worry about the means test with its presumption of abuse preventing you from considering all of your options, including a possible Chapter 7 bankruptcy as a last resort, as you begin rebuilding your financial world.

Protecting Retirement Funds in Bankruptcy

When you file for bankruptcy for consumer debt, everything that you own generally becomes part of your bankruptcy estate. The bankruptcy trustee in charge of the estate could sell these assets to raise funds to pay debts. However, most debtors will find exemptions under the Bankruptcy Code that will protect all, or at least most, of the property in their estate. Property that could not be exempted may remain in the estate because the trustee will look at the cost of selling it versus the amount that a sale would bring and decide to abandon or sell the property back to the debtor. On the other hand, the status of pensions, retirement funds, and similar accounts still is somewhat ambiguous in bankruptcy law.

Looking at the Bankruptcy Code, Section 541(c)(2) states that restrictions on transferring a debtor’s beneficial interest in a trust which are enforceable under applicable nonbankruptcy law will remain enforceable in a bankruptcy case. If the law shields a beneficiary’s interest in a trust from creditors, then the same protection applies during a bankruptcy.

In 1992, the U.S. Supreme Court decided the language in this  section applied to certain types of pensions. ERISA-qualified pension plans were found to be excluded from the bankruptcy estate because this federal law had an “anti-alienation” provision that protected pensions that are covered by ERISA.

Then, in 2005, the Bankruptcy Code was amended. Section 522 was revised to allow the debtor an exemption, usually without limitation, in most types of retirement funds. With this change, whether or not a pension is part of the bankruptcy estate ceased to be an important issue when attempting to protect such plans after a bankruptcy filing. Congress also added provisions stating that any amount withheld or received by an employee in retirement funds or employee benefit plans are not property of the bankruptcy estate.

This does not protect everything, however. If you file for bankruptcy while you are in the process of rolling over your pension funds into another plan, you leave yourself open to the claim that these funds were not in an ERISA-qualified plan when the bankruptcy was filed. Therefore, as the argument goes, your retirement funds should not be  excluded from your bankruptcy estate. This also shows the importance of timing when you decide to file for bankruptcy. Under this scenario, to avoid a possible problem, you could wait to file your bankruptcy case or undertake the rollover. By doing so, the bankruptcy case will be filed while retirement funds are in a qualified plan.

Non-ERISA plans face other issues. For example, the Supreme Court’s 1992 decision pointed to retirement funds that do not qualify under ERISA, determining that they are not entitled to its protection as a result.

Individual retirement accounts (IRAs) would be an example here. However, IRAs now qualify as exempt under subsections 522(b)(3)(C) and (d)(12) (with a $1,245,475 waivable cap for funds that were never rolled over from another plan) and may also be protected from alienation under state law. In addition, if a debtor cannot reach funds in a plan, the bankruptcy estate has the same limitation – it cannot have greater rights than the debtor. Therefore, with the already existing protections plus the expanded ones for retirement savings, a debtor will rarely lose retirement funds in a bankruptcy case.

Other types of plans may be considered spendthrift trusts, with the beneficiary having no right to access the funds whenever the individual so desires. Under the laws of most states, due to this limitation, the beneficiary’s interest in such a trust is protected from the person’s creditors. These trusts are excluded from the debtor’s estate under Section 541(c)(2). However, it should be noted that not all spendthrift trusts are protected under state laws – an example is the “self-settled” spendthrift trust created by its own beneficiary, which most states do not protect from this person’s creditors.

Finally, when possible, the debtor also must remember to list retirement funds, pensions, and similar trust interests in Schedule B of the bankruptcy schedules, even if they do not come into the estate. Any argument that the interest is outside the estate should be noted on Schedule B with a reference to subsections 541(c)(2) or 541(b)(7) of the Bankruptcy Code. In addition, nothing prevents a debtor from claiming on Schedule B that property is outside the estate but listing an applicable exemption on Schedule C in the alternative as a backup.

A Fresh Start: The Bankruptcy Estate in Chapter 7

Most individuals who file for bankruptcy do so under Chapter 7 or Chapter 13 of the Bankruptcy Code. Chapter 13 can be very powerful when a person falls behind in payments on secured loans, such as mortgages or car loans, because it permits you to set up a plan up to five years in length to pay off those missed payments. However, you still need enough income for your necessary expenses, which include current payments of the debts on which you had fallen behind and are included in the Chapter 13 plan. Meanwhile, a Chapter 7 bankruptcy generally focuses on discharging debts that are not secured by any specific property, with a goal of giving you a “fresh” start by getting rid of these debts while keeping as much property as possible. The process of defining what is in your “bankruptcy estate” is crucial in Chapter 7. A brief look at how this means follows.

A fresh start can have no beginning if you are not honest about what you own. All of your property must be disclosed, with exemptions (with amounts and categories defined by the bankruptcy laws) applied to as much of this property as possible. Any property that can’t be exempted or isn’t excluded by law becomes part of the bankruptcy estate, which a bankruptcy “trustee” controls until the bankruptcy ends.

A major part of the trustee’s job is to sell as much of the bankruptcy  estate as possible in order to pay off as much of your debt as possible. Due to the ability to exempt certain amounts of various categories of property, hiding property is not the answer to protecting what you own in order to have an opportunity to make a fresh start after a Chapter 7 bankruptcy. If and when hidden assets are discovered, this property will end up in the bankruptcy estate, and you may face more serious consequences that can include the loss of the property to creditors, the denial of a discharge of your debts, or even criminal penalties.

As you prepare to file under Chapter 7, you begin the process of defining the bankruptcy estate. This starts with making an inventory of all of the things that you own – this means that you have to list everything to which you have some ownership right. Some property that you receive after filing also would have to be included once a right to it exists. For example, property that you inherit within 180 days after filing must be listed in the appropriate schedule.

After an thorough inventory has been completed, you will have an idea of what might be in your bankruptcy estate. To further define your bankruptcy estate, you need to place realistic values on your ownership rights in this property. Sometimes, this may not be possible due to the type of property involved. A good example of this problem is a potential lawsuit that you might be able to bring against another party because you need to consider what the potential award would be if you win, the likelihood of success (which impacts the value of the estimated award), and even the likely ability to collect any judgment that you might be awarded (because a judgment that can’t be collected won’t have much value). In a situation like this, your best approach may be to describe what your cause of action in the lawsuit would be and list its value as “unknown” when you file.

You usually will be able to place a reasonable value on your property, though. This can seem difficult, but an experienced attorney can help you as you work through the list of property that will comprise your bankruptcy estate, unless the property is exempted or, possibly, excluded by law. However, before you can exempt property, you have to make a good-faith effort to value so you can use the exemptions, which are capped at certain dollar amounts.

Individuals often have trouble with this. Sometimes, they may tend to overvalue some property — for example, many things do not retain much value once they have been used. Clothing and furniture fall into this category, but people often tend to value these items closer to the prices at which they were purchased. One approach to start this process is to consider what you might ask for, and be able to get, for something at a garage sale or on eBay. There also are resources that can be used to value an older car while a house may need to be appraised in order to satisfy a trustee and the court. Once you have an inventory of property in which you have rights and have made a good-faith effort at valuing it, you are at the point in which your actual bankruptcy estate will be defined.

First, you look for property is not part of the bankruptcy estate. An ERISA-qualified pension, by statutory definition, never is part of the estate. Next, you consider possible exemptions, which could be state or federal exemptions in Pennsylvania (with the choice depending on which protects your property to a greater extent). This step essentially removes some property from a bankruptcy estate, depending on the property’s value and the amount of the exemption available. For instance, a vehicle with a market value of less than $3675 currently could be exempted from the bankruptcy estate so the trustee handling your property cannot touch it. It should be noted that federal exemptions are adjusted every 3 years — the next adjustment would occur on April 1, 2016.

Eventually, as you move through the steps in this process, what remains is the property that makes up the bankruptcy estate. In many cases, all property will be exempted – this is a “no asset” bankruptcy in which a trustee has no assets to administer to pay any of your debts; in these situations, there basically is no bankruptcy estate. You also could have a “nominal asset” case in which the bankruptcy estate’s value, at best, is little more than the cost of trustee’s administration of it; you may be able to get the trustee to abandon the property that remains because it can be seen as more trouble to sell it than it is worth. If abandoned, the property would return to you.

On the other hand, if your bankruptcy estate has assets that have more than a nominal value, you might be able to pay the value of the bankruptcy estate to the trustee in order to keep your property or the trustee may sell these items to third parties. In either situation, the trustee would use the proceeds to make payments to your creditors.

In the end, this is why the bankruptcy estate in Chapter 7 is of such importance. You want to retain as much property as possible in order to get a fresh start after going through bankruptcy. This requires that, prior to filing, you to pay attention to property that might be lost if it would be turned over to a trustee as part of your bankruptcy estate.

Complications While Same-Sex Marriage Is Banned in Pennsylvania

[Note: On May 20, 2014, Judge John E. Jones III of the U.S. District Court for the Middle District of Pennsylvania actually issued the decision in Whitehead v. Wolf, in which he ruled as he anticipated the U.S. Supreme Court would rule. In short, based on the Due Process and Equal Protection Clauses of the U.S. Constitution, he determined that Pennsylvania could not justify its law banning same-sex marriages. He also entered an injunction against the enforcement of Pennsylvania’s law that was effective as of that date. The Commonwealth did not appeal so May 20, 2014 is the official date that Pennsylvania became part of the tidal wave of states across the nation that, willingly or not, recognized the legality of same-sex marriages.]


In Pennsylvania, same-sex marriage does not is against the law. Specifically, in the Domestic Relations Code, the legislature defines marriage as a “contract between one man and one woman” (Section 1102). Unlike its position on common-law marriage that was discussed in the previous post, it also has rejected the concept of comity, in which the laws of other states usually are recognized and respected. Instead, the legislature has invoked the “strong and longstanding public policy” exception to comity in Section 1704 of the Domestic Relations Code so that same-sex marriages, “even if valid where entered into,” are void here.

However, the U.S. Supreme Court’s decision in United   States v. Windsor, et. al. from June of this year may be the start of major changes throughout the country. Windsor dealt with the federal Defense of Marriage Act, in which Congress defined marriage as a union between a man and a woman. The case concerned two women who were married legally in Canada and then moved to New York, which recognized their marriage. The widowed spouse was the beneficiary in the Will, but the IRS forced her to pay the federal estate tax even though a spouse would have been exempt from this tax. With Ms. Windsor believing that she faced unequal treatment due to her gender, she filed the lawsuit that ended up in the Supreme Court. In what was a landmark decision to put it mildly, the Court found the federal definition of marriage unconstitutional, basing this decision mostly on due process grounds.

Marriage generally is a state-law issue. Windsor does not alter this but does affect federal rights and benefits of legally married spouses of the same gender. Changing the type of marriage found in the example in the previous post from a common-law marriage to a validly entered same-sex marriage, the couple who got married legally in Washington, D.C. can remain same-sex partners but no longer are considered spouses when they relocate in Pennsylvania.

While federal law usually supersedes state law, some issues – including marital and property rights – have been left to the states in most circumstances. This is where Windsor leaves many unanswered questions. The Social Security Administration made an effort to deal with this by issuing regulations after the Windsor decision. In the example, the SSA instructs the person who married in Washington, D.C. and then became a Pennsylvania resident to apply for benefits on the work record of her same-gender spouse when eligible because the marriage originally was valid.

Due to residency in Pennsylvania when she applies, the SSA currently will put a hold on the application, but the application does establish the protective filing date for benefits that may be paid later if the same-sex marriage that does not exist in Pennsylvania becomes valid again as it was when the couple resided in Washington, D.C. Meanwhile, had the surviving partner stayed in Washington, D.C., she could receive benefits now.

Bankruptcy law also relies on state law to define numerous rights, including property rights during marriage. Pennsylvania allows people filing for bankruptcy to choose to use federal or state exemptions for property. When a married couple owns their property as tenants by the entireties, this effectively prevents a spouse from transferring any ownership interest to a third party and generally puts the property out of reach for creditors of only one spouse. If most debt belongs to one spouse, the couple may decide that only that spouse will file, using the state exemptions to protect their joint property. However, a tenancy by the entireties can exist only when there is a valid marriage. Pennsylvania, by declaring same-sex marriage void, prohibits a same-sex couple from owning property in this way. Once again, there is different treatment at this point under federal law and under state law for individuals who, but for their genders, would be in the same situation.

Estates also are affected by marital status. Pennsylvania law gives rights to a surviving spouse preventing this spouse from being disinherited due to a deceased spouse’s Will. However, a person who entered into a same-sex marriage prior to settling in Pennsylvania becomes a virtual stranger regarding estate rights when the other person dies – the individual would not have the rights of a spouse. Instead, a Will would need to identify the person and specifically leave property to him or her (although the survivor essentially receives any part of the estate as a friend, not a spouse).

Also, Windsor provided that, regardless of gender, Ms. Windsor was a spouse and would be treated the same as other spouses under federal estate tax law, dropping her tax rate to zero percent as a result. Meanwhile, Pennsylvania’s inheritance-tax rate for a spouse is also zero percent, but, due to a same-sex marriage being void, an unrelated person of the same gender receiving property through a Will falls into the 15-percent tax bracket. In each of these situations, we see different treatment solely due to gender. Such issues will remain as long as same-sex marriage is rejected in Pennsylvania.

Next year could be a watershed year for Pennsylvania marriage law due to numerous court cases that involve possible recognition of same-sex marriages. A change could come soon after June when Whitewood v. Wolf, which directly attacks Pennsylvania’s statutory ban on same-sex marriage, is scheduled to be heard in a federal court in Pennsylvania. The ban on same-sex marriage and its resulting complications easily could be history in Pennsylvania before 2014 ends. Time – and, most likely, the courts – will tell.

The Status of Common-Law Marriage in Pennsylvania

Until January 2, 2005, a woman and a man in Pennsylvania could consider marrying each other without any type of ceremony or written documentation. There was not even any requirement that they lived together for any amount of time, despite a common belief to the contrary. Basically, if there was no reason why they could not marry, such as being too young or being currently married to someone else, they basically needed to exchange words in the present tense – without even needing witnesses – showing that they intended to establish the relationship of wife and husband, and a common-law marriage was created.

A marriage created in this way could create difficulties when one had to prove the date of the marriage or, even, its very existence. As a result, courts made an issue of the problems with marriages that could exist without any documentation. A 1998 decision from the Pennsylvania Supreme Court made clear that the common-law marriage certainly was disfavored but that the legislature would have to act to abolish the practice. Then, in 2003, due to the lack of legislative action, the Commonwealth Court took it upon itself to act in place of the legislature and decided that common-law marriage no longer existed in the Commonwealth of Pennsylvania. Unfortunately, all that this really did was to create more confusion.

With a Pennsylvania court saying one thing and the legislature saying nothing, the government needed to clarify what the law really was. Finally, the legislature passed a statute preventing anyone from attempting to create a common-law marriage beginning with the day after New Year’s Day in 2005. This did not invalidate such unions that took place through January 1, 2005, thereby ensuring that a possible common-law marriage that either the man or the woman involved asserted had occurred prior to the cutoff date still could prove troublesome. However, even with Pennsylvania’s abolition of the right to enter into a common-law marriage, problems caused by this concept remain.

Beyond the difficulties presented by a possible common-law marriage created in Pennsylvania prior to the beginning of 2005, there are problems because some states continue to permit a woman and a man to enter into this type of marriage at this point. They include Alabama, Colorado, Iowa, Kansas, Montana, New Hampshire (for inheritance purposes only), Rhode Island, South Carolina, Texas, Utah (which does add the requirement of an administrative order regarding the marriage), and Washington, D.C.  A common-law marriage from any of these states eventually could have an impact in Pennsylvania. While the reason often is thought to be the Full Faith and Credit Clause of the federal Constitution, this is not involved. Instead the concept of comity is the cause.

Through comity, states generally recognize and respect the laws of other states as long as the law is not deemed offensive to public policy in a particular state. Since Pennsylvania has long favored the institution of marriage (between men and women), it continues to recognize common-law marriage, despite the problems with proof that led to practice being abolished here, as long as the marriage occurred in one of the states where it was valid. Although it could not be created here, public policy in Pennsylvania favors marriage so it remains valid as long as it was valid from its beginning.

Therefore, a woman and a man could enter into a common-law marriage in Washington, D.C. in 2011 and then move to Pennsylvania. If the marriage was valid in the District of Columbia, the comity doctrine continues its validity here.

This means that these spouses will have the same rights and obligations that other married couples have in Pennsylvania. They will remain married until death – or until a divorce. While entering a common-law marriage has none of the formalities of a ceremonial marriage, its ending can occur only in the same way that any other marriage can end. Because a divorce is required while both spouses are alive, there can be equitable distribution of marital property. Meanwhile, the death of one of the spouses leaves the other with the same inheritance rights as any other surviving spouse in Pennsylvania has.

In addition, because the marriage is valid, there are rights to payments from the Social Security Administration that can vest when a spouse retires if they have been married for at least ten years. A common-law marriage also affects a bankruptcy. If one spouse basically has all of the debt while property, such as a residence, is owned as tenants by the entireties in Pennsylvania, then the bankruptcy law can be used to protect the house, with only the spouse with the debts filing for bankruptcy to get a fresh start by having these debts discharged. The marriage may have begun elsewhere, but – by the time that the couple has arrived in Pennsylvania – the fact that it was a common-law marriage in the beginning is of no consequence, regardless of Pennsylvania’s abolishing the right to enter into such marriages years ago.

In the next post, we will see another married couple that relocates from Washington, D.C. to Pennsylvania but finds the consequences much different. Instead of a common-law marriage, we’ll look at a couple that has gone through a ceremonial marriage after obtaining a marriage license, making the marriage much easier to prove. This won’t matter once they move to Pennsylvania, where they will be treated as if they virtually are strangers to one another. Their “problem” is that they happen to share not only their lives but also the same gender. The evolving area of law of same-sex marriage and its current (and possible future) implications in our changing society will be examined.