Be prepared for your meeting of creditors. We let our clients know what to expect at the meeting of creditors as conducted in the Central District of California.
I was present in Court on January 11, 2013 when Judge Robin Riblet, Central District of California, Northern Division, explained her views of so-called "Chapter 20" bankruptcy lien stripping and reviewed various authorities. I have written a short blog post on our main website describing those views and reviewing the cases cited.
This issue must be decided by the Ninth Circuit. We now have a distinct and wide chasm between the San Fernando Valley Division and the Northern Division. We have a dramatic split between various courts around the country. The Eighth Circuit in In re Fisette, (8th Cir. BAP 2011) 455 B.R. 177 did not actually address the merits of this issue.
Should student loans issued by private for-profit lenders be eligible to be discharged under the Bankruptcy Code? Rep. Steve Cohen (D-Tenn.) just introduced H.R. 2028, the "Private Student Loan Bankruptcy Fairness Act," which would allow private education loan debts to once again be erased in bankruptcy just like other types of debts.
The full text of the bill is here.
The Washington Post reports that nearly 30% of college students who took out educational loans dropped out of college. Those who leave school early are then four times more likely to fall behind on their educational debt obligation. This is occurring against the backdrop of student debt now exceeding $1 trillion.
Because student loans are (practically) non-dischargeable in bankruptcy, these facts further highlight the debt and bankruptcy complications we are likely to soon encounter from such a high level of non-dischargeable debt.
Under the Bankruptcy Code, divorce-related debts are given one of two classifications. One classification is "domestic support," which includes child and spousal support. Other divorce-related debts, such as hold harmless obligations or equalizing payments, are non-support debts.
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (hereinafter “BAPCPA”) enacted on April 20, 2005, and generally applicable to all cases filed on or after October 17, 2005, made various revisions to Title 11 of the United States Code (hereinafter “Bankruptcy Code”) with regard to divorce-related debts. For example, debts such as child and spousal support were given the new classification of “domestic support obligation” and were given added protection.
A debtor who receives a Chapter 13 discharge will receive a discharge of non-support debts. Under limited circumstances, the non-filing spouse can object to discharge but must file an adversary proceeding in the bankruptcy court within sixty days of the first meeting of creditors to do so.
Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA), non-support debts are now treated much differently in Chapter 7. A debtor who receives a Chapter 7 discharge cannot discharge any debts incurred in connection with a divorce or separation.
Are you the beneficiary of a revocable trust? Many families use revocable trusts for estate planning purposes. Like so many Americans, let us assume that you are in debt and contemplating the need to file for protection under the bankruptcy code. What happens if you are the beneficiary of such a trust and your parent or loved one dies suddenly? Must the assets in the trust flow to you and then out to your creditors?
In California, the answer is, "no." The United States Court of Appeals for the Ninth Circuit decided Gaughan v. Costas in February, 2009. In that case, the court found that a "pre-petition disclaimer" of the trust assets was valid.
In California, a disclaimer is a procedure whereby a beneficiary can elect to forego an asset. The disclaimer must be in writing. It must be filed within a reasonable time after the person who is to take assets under a trust learns of the right to take the assets. Typically, a reasonable time is nine months or less. Finally, the disclaimer must be filed in the Superior Court in the county in which the estate of the decedent is administered.
One might think that using the California statute allowing one to disclaim trust assets (and thereby causing those assets to flow to family) would be classified as a fraudulent transfer and therefore violate 11 U.S.C. section 548. To constitute a fraudulent transfer a disclaimer would actually have to transfer "property." In determining the definition of property, however, the Federal courts look to state law. A disclaimer is defined as a refusal to accept an interest in property. One cannot transfer property that one never accepted.
The United States Court of Appeals for the Fifth Circuit recently opted to follow Gaughan v. Costas. In that decision, Laughlin v. Nouveau Body & Tan, LLC (In re Laughlin), 602 F.3d 417 (5th. Cir., 2010), the court found:
The Ninth Circuit's reasoning is sound: the bankruptcy code defines "transfer," but to effect a transfer there must be "property" or an "interest in property." And the Supreme Court has repeatedly held that "property interests are created and defined by state law" in the absence of a controlling federal interest.
As it currently stands, the law allows a debtor to disclaim assets coming to him or her under a trust, thereby allowing those assets to go to other family members, and then file for bankruptcy protection.
"Income" from the Cancellation of Debt
Generally, if you owe a debt to someone and they cancel or forgive the debt, you are treated for income tax purposes as having income and may have to pay tax on this income. At the moment, there are major exceptions for debt forgiveness and reduction on principal residences. However, these exceptions are due to expire at the end of 2012.
Bankruptcy always offers an alternative way to ensure that debt forgiveness does not result in income being reported by the lender. It adds insult to injury to be taxed on the "forgiveness" of debt resulting from financial hardship.
Tax Consequences of a Short Sale, Foreclosure, or Modification
In April 2010, California passed a law that provides homeowners with an exclusion from income tax obligations when a short sale results in debt forgiveness. The law provides an exclusion from tax for individuals who have received up to $800,000 of forgiven debt. The full $800,000, though, is not excluded. Instead, the state excludes the first $500,000 of all forgiven debt up to $800,000. Individuals who have received debt forgiveness that is greater than $800,000 will not have any relief from tax consequences. They must report all of the forgiven debt as income. The law applies to state income tax for 2009 through 2012.
The Federal government has an even more generous exclusion. The Mortgage Debt Relief Act of 2007 typically lets taxpayers exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief. p to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately).
For both California and the Federal government, these laws "sunset" or end at the end of 2012. It is currently unclear whether either program will be extended.
Also note that both of these exclusions (California and Federal) apply only to debt from a principal residence.
Tax Consequences of Debt Discharged in Bankruptcy
Debt cancelled in a Chapter7 or Chapter 13 bankruptcy is excluded from income. You must still file a form to report your cancelled debt. See a tax professional to ensure that you file your taxes properly to benefit from the protection afforded by bankruptcy.
You also do not include a cancelled debt in income to the extent that you were "insolvent" immediately before the cancellation of the debt. Insolvency is defined as a circumstance in which your liabilities excelled the fair market value of assets.
For more information, see the IRS website. This does not constitute tax or legal advice. Please retain qualified bankruptcy counsel and seek the assistance of a tax professional to further explore these topics.
I am continually amazed at the growing crisis of student loan debt. Government backed and private student loans are not dischargeable in bankruptcy except under the most extreme circumstances. The following is an excerpt from a news summary by the American Bankruptcy Institute.
The Federal Reserve Bank of New York reported today that debt from educational loans in the U.S. rose 3.4 percent to $904 billion in the first quarter, Bloomberg News reported. Outstanding student debt increased from $874 billion three months earlier, the New York Fed said in the report. ...Ninety-day delinquency rates for student loans increased to 8.69 percent from 6.13 percent in the first quarter of 2003, higher than that of mortgages, auto loans and home equity lines of c redit, the New York Fed said.
The high balances students are incurring on student loans, coupled with the fact one cannot discharge student loans in bankruptcy, presents one of the greatest challenges for the next generation. We now face a 3% increase in student loan interest rates. The ABI and the Washington Post now report the following:
The Senate held two votes yesterday on measures to ensure that student loan rates do not double in July—and the issue remained exactly where it began: stuck, The Washington Post reported yesterday. The measures each failed to reach the 60-vote threshold necessary to move forward, as the parties remain at loggerheads over how to pay for the $6 billion loan subsidy. If unresolved, loan rates will rise from 3.4 to 6.8 percent on July 1. Leaders in both parties have said they want to freeze rates for another year. Democrats have proposed paying for the additional year of loan subsidies by ending a tax provision that allows executives of some small businesses to collect some of their income as business profits instead of wages. On a 51-43 vote, the measure failed to advance. The Republican proposal would have paid for the loan-rate freeze by eliminating the preventative health care fund created in the 2010 health care act. The White House has said Obama would veto that bill, but it failed to move ahead in the Senate on a 34-62 vote.
It is crucial that individuals filing a Chapter 13 bankruptcy and who are self-employed or business owners know that they must provide additional information to the Trustee. That information includes:
(A) Projection of average monthly income and expenses for the next 12 months;
(B) Evidence of appropriate business insurance;
(C) Inventory of goods as well as a list of business furnishings and equipment as of the date of the filing of the petition;
(D) Monthly income and expense statements for at least the 6 months preceding the date of the filing of the petition, or for such shorter time if the business has been in operation for less than the requisite 6 months, signed by the debtor under penalty of perjury, including a statement regarding incurred and unpaid expenses;
(E) Tax returns for at least 5 years or since the start of the business, whichever period is shorter; and
(F) Such other evidence requested by the chapter 13 trustee, including bank statements, canceled checks, contracts, or other information relevant to the debtor's ability to fund the proposed plan.
These items are required by local bankruptcy rules in the Central District of California. Be aware these requirements may only apply to the Central District of California. As always, do not take this information as legal advice and by providing it you are not entering any form of attorney client relationship with Andrew Mansfield. Seek the advice of an attorney if you are contemplating filing bankruptcy.