Caution Urged Concerning Consumer Bankruptcies

By Stephen J. Dunn

Certain factions of the consumer bankruptcy bar reacted violently to my recent post, Consumer Bankruptcies Do More Harm Than Good, as I suspect they will to this offering.  It is a badge of honor.

They doth protest too much.  That we are having a discussion about whether chapter 7 bankruptcies are in consumers’ best interests says a lot about this area of legal endeavor.

I do not maintain that a chapter 7 bankruptcy is never in a consumer’s best interests.  Chapter 7 bankruptcy is an option.   Usually not it is not the best option.

Take for instance Contractor.  He has been through a terrible time in the recent recession.  He has seen his business drop from 10 employees down to one, himself.  I have talked with him about  walking away from his debt-ridden company and starting a new company.  He has personally guaranteed substantial debts of the company.  He could do a chapter 7 bankruptcy to discharge the guaranties.  But his house would be at risk, as fitting his equity in the house within the available exemption would be a reach.  And he would be cutting his own throat by stiffing his long-time parts suppliers.  Most importantly, he does not want to do a bankruptcy.  So we will get the best terms we can for him in workouts with the banks on the guaranties.  Things will get better for him.

I spoke with the IRS offer examiner’s manager about  the offer in compromise of Disabled Man, mentioned in my last post.  In recommending rejection of Disabled Man’s OIC, the examiner assumed that all of the income reported on Disabled Man’s most recent income tax return was Disabled Man’s.  But it was a joint income tax return, and Disabled Man’s wife earned at least half of the reported income (this gives you insight into the relative care or lack thereof exercised by IRS in considering OICs).  IRS is reconsidering Disabled Man’s OIC in view of his correct income.  Most importantly, Disabled Man does not want to do a chapter 7 bankruptcy.

Relief from taxes in bankruptcy is illusory.  I have come to realize that the 10-year statute of limitations on collections is the tax debtor’s best friend.  Under 26 USC § 6503(h)(2), the filing of a bankruptcy case extends the collection statute by the pendency of the bankruptcy case plus six months.  IRS will not acknowledge in writing that taxes have been discharged in bankruptcy.  IRS certainly will not record discharge of a Notice of Federal Tax Lien recorded in a register of deeds’ office.  The Federal tax lien may well continue in the debtor’s property notwithstanding discharge of the debtor in bankruptcy.

The woman described in my last post probably discharged about $50,000 in credit card debt, for which she likely paid $2,000-$3,000 in fees and costs.  Her bankruptcy did not discharge any of her tax obligations.  The filing of her chapter 7 bankruptcy case prompted IRS to re-investigate her finances, which led to IRS asserting a nominee lien in her son’s house.  As a result her son is losing the house.

I have seen countless ill-advised consumer bankruptcies.  In considering filing a chapter 7 bankruptcy case, consumer debtors should proceed cautiously, and only upon the advice of competent, fully informed counsel.   Indeed such bankruptcies often do more harm than good.

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