What happens to tax refunds in bankrutpcy?

This time of year I often get this question asked of me by new clients.  It’s a good question.  Because for most people it is the one time of the year that they get in many instances the equivalent of several months’ worth of salary all at once.  Depending on your situation that may seem like a great thing, but as we will see in this post, maybe it is not.

First, you need to understand in bankruptcy any property, asset or item upon which you have a claim may potentially be property of your bankruptcy estate.  Only an experienced bankruptcy attorney can tell you if some item of property is part of your bankruptcy or not and whether or not property that is part of your estate is protected under the applicable exemption statutes. 

Tax refunds are part of your bankruptcy since it is money someone (the government) owes you.  In a Chapter 7 case your bankruptcy estate is entitled to receive one year’s worth of tax refunds.  This means any refund you have not received when you file bankruptcy is part of the bankruptcy and must be turned over.  If you spend this money after filing bankruptcy your case can be dismissed, your discharge revoked and potential criminal charges brought for stealing from the bankruptcy estate.  

In an Chapter 13 case the current policy is that you must turn over a portion of your tax refunds for the first three years of your plan.  You are allowed to keep $1000 of the refund, no questions asked.  You might also be able to keep another $1000 of the refund if you receive Earned Income Credits or Additional Child Tax Credits.  Only an experienced bankruptcy attorney is going to be able to tell you your rights under the code.

So what should you do if you want to file bankruptcy and keep your tax refund?  Make plans with an experienced attorney to determine what you can spend the money on prior to filing your case.  You should also adjust your withholdings from future paychecks to make sure your refund is small and that you have that money in each of your paychecks rather than giving an interest free loan to the government. 

What is the foreclosure process in Utah?

I often encounter this question.  Prospective clients come into my office, not sure how long they have in their home.  They have failed to pay their mortgage for many months and now wonder when their lender will boot them out of the house.  Most think the bank still owns the house; they are just renters paying a mortgage with ownership tied up on the end when they pay off the loan.  This is incorrect.  If you have a mortgage, YOU own your home, NOT the bank.  This confusion just indicates people’s misunderstanding of their legal rights.  Something no bankruptcy petition preparer should tell you about.  (They still may, they sell themselves as being able to help you cheaply around the law for which they hold disdain.)  I thought a brief rundown on the foreclosure process as a bankruptcy lawyer would be beneficial!   (While not necessarily part of the foreclosure process, if you can pay the mortgage but not other bills, PAY THE MORTGAGE!  You cannot live in the medical bills or credit card accounts.)        

So you have not paid the mortgage for a while.  The lenders are calling you and you are not sure what to do.  Depending on your home, its value, the loan amount and potentially who your loan originated with, the process to foreclose on you home may not begin for sometime.  Foreclosure is a legal process where a lien holder (the lender) takes legal ownership of the property from you due to your failure to honor the loan.  In Utah, generally the foreclosure process is a “non-judicial” process which means the lender does not need to go to court to get permission to take your home from you.  This is due to two documents you sign when you get your loan, known as a “promissory note” and a “trust deed”.  A promissory note is in simplified terms a contract to pay a loan. 

 You have probably signed many of these in differing forms over the years.  Student loans, car loans, credit cards all have promissory notes.  But unlike a credit card or car loan, when most of us walk into a bank and ask for a loan of $250,000 the bank is going to require something more to protect it from potential losses.  So the bank more or less says what do you want to buy with the money?  The question is disguised as a home loan application but that is what they are asking you when you fill out the form.  You tell them I want to buy a house and they say, “Great, so long as you qualify we would love to lend you some money.”  The lender then puts conditions on the loan.  This is where the trust deed comes into play.  The bank is really saying, “Well, we don’t just let anyone have that much money, so if you are going to spend it to buy a house we want to have a lien on the home in case you don’t pay.”  So to be clear the bank understands you are buying the home, it is their money you are using and YOU actually own the house.  The rub is the lender is also saying, “You are not Bill Gates, so we want collateral for the loan.”  Collateral can be anything the lender finds acceptable, but to again simplify the process they tell you to use the home you are purchasing as collateral.  In order to do this a trust deed is signed by you giving them a lien on the home and the promise that if you do not pay the loan, they can take the home to lessen their losses.

Now that you have a background on your relationship with the lender how do they kick you out and take YOUR home from you.  The first step is they file with the county records and send you  by mail (generally certified) a “Notice of Default” and “Substitution of Trustee”.  This is your official notice you are delinquent on the loan and they have appointed someone to foreclose if you do not get the loan current.  You have ninety (90) days after this notice is served on you to “cure” the delinquency on the mortgage.  This means you must get the loan current, by paying ALL late payments, late fees and any other charges you have promised to pay due to collection of the loan.  For most people this is an amount they do not have.  Some people can get help from family but in the majority of cases people do not have the money to cure.  If you want to keep the house, a Chapter 13 bankruptcy may well help you cure it over time through installment payments instead of coming up with it all within ninety (90) days. 

Well, unless you have filed bankruptcy or come up with all the money needed to “cure” the loan after ninety (90) days the lender will set a date to sell you home.  This sale will be usually on the local courthouse steps.  This sale date is about a month away.  The lender must publicly notice the sale.  I am sure you have seen those notices in the paper about trustee’s sales.  This is what they are letting you know about.  The notice of sale must be for three (3) consecutive weeks and the sale can occur during the fourth week. 

This means that from the time you get the Notice of Default you have about four (4) months before the home is taken by the lender.  Any time during this period if you file bankruptcy the automatic stay goes into effect and the process stops.  You heard me correctly; the lender can no longer pursue the foreclosure without bankruptcy court approval.  In fact, should you have a sale set for noon on Tuesday, as long as you have a bankruptcy filed on 11:59 am that day, all the actions by the attorney who goes to the courthouse at noon and does the last step in the sale, have no affect on your ownership rights in the home.  There it is.  Now if you do not file for bankruptcy to stop the sale, the home is taken by the lender or sold to someone on the courthouse steps.  Either way you no longer will own the home after the sale. 

Only an experienced bankruptcy attorney can let you know what your rights regarding foreclosure are, and how bankruptcy can assist you in keeping your home.         

Can I pay tithes to my church while in bankruptcy?

Under the bankruptcy code Charitable contributions are allowed in amounts to actually be contributed up to fifteen (15%) of a debtor’s gross income.  However, the bankruptcy code once contained language held by courts to preclude payment of tithes or offerings unless is was determined as a necessary part of a debtor’s employment.  See In re Diagostino, 347 B.R. 116 (2006) No. 06-10384 (Bankr. N.D.N.Y. 8/28/2006).  This holding was overruled by Congressional amendment to the bankruptcy code when it passed the Religious Liberty and Charitable Donation Clarification Act of 2006 (S. 4044), making it clear money given by a debtor to a charitable organization, including tithing to a church, is not to be included when considering disposable income to be paid to a creditor in bankruptcy. 

But how has this panned out in real life.  In southern Utah where I practice bankruptcy it has been only allowed if a debtor can show a historical amount they have paid.  For example, a debtor who files for chapter 13 bankruptcy and wants to claim a deduction in the means test and in their budget for tithes must provide a copy of the last 12 months of giving and the trustee takes the average amount per month as the historical average allowed.  At one time the trustee allowed for stipulation that debtors could claim the amount they assert they would pay with a review in 12 months and plan adjustment at that time, if needed, based upon the actual contributions given.  The trustee however ended the practice. 

Recently, I argued this issue in the bankruptcy court.  My position was that my clients had restricted their charitable giving when they went into financial distress.  That as LDS Church members they wished to resume paying a full tithe and the historical average was not an accurate indicator.  The trustee had objected on the grounds that my clients should only be restricted to the historical average and the debtors’ claim of approximately 10% of their gross should be disallowed. 

I had told my clients prior to filing they needed to begin paying their tithing in the amount they wished to claim moving forward.  The time between their filing and the ultimate argument in the court was about 6 months.  I was able to show the payment for the 6 months and the court said it was persuaded.  The monies were either going dollar for dollar to the church or to pay unsecured creditors.  The judge said in passing during arguments that a question would appear where the debtors thought it would do the most good. 

The court ultimately ruled that it believed in this case there was room to negotiate on the issue and ordered amendments based upon the amounts we were able to prove.  While this does not give a hard and fast ruling and the trustee will likely still hold to the historical average position, perhaps there is room to create a plan provision to allow both the trustee’s concern of debtors who do not pay as promised and those that will and should be allowed to under the law. 

Only an experienced bankruptcy attorney can tell you what your rights are in regards to bankruptcy.  But my advice at this point would be don’t fail to pay the mortgage and tithes to your church if you want to keep the house and continue to give to your church.  

Should I withdraw money from my 401(k) to pay down debt and avoid bankruptcy?

In my meetings with potential bankruptcy clients I often get asked a version of this question by people who are looking for any last ditch efforts to avoid filing bankruptcy. They generally believe if they pull out a bunch of money and propose a debt settlement with creditors they can avoid bankruptcy. This may or may not be true. There are other concerns to take into account when considering this course of action. One not addressed here, but will be in another post is tax implications. First, are retirement contributions protected if you file bankruptcy? For those looking to file in the State of Utah, the short answer is yes. However, there are some qualifications. They relate to the fact that the contributions must be in a properly qualified retirement account, which an attorney can help you determine. Second, any contributions to your retirement account made by either you or on your behalf (such as employer contributions) in the twelve (12) months prior to your bankruptcy filing are not protected. Therefore, in Utah if you file Chapter 7 your trustee is likely to require all contributions to your retirement accounts in the last year to be turned over to help pay your creditors. If you file a Chapter 13 case the impact of this can be mitigated. Only an experienced attorney who understands Chapter 13 bankruptcy can help you work this issue out. Because an experienced bankruptcy attorney like those at Red Rock Legal Services can help you protect your retirement I usually discourage liquidating a retirement account prior to filing bankruptcy. If you work through a bankruptcy and keep the amounts in your retirement account how can this benefit you? First, there are worst things than bankruptcy, such as not having a retirement waiting for you when you need it. Let do a simple example. Let’s pretend you have $40,000 in credit card debt running up at 18% interest and a 401(k) from a prior employer in the amount of about $25,000. The thought occurs to you to pull out the money and pay down a chunk of this credit card debt. You need to consider if you withdraw early you will need to pay ordinary income taxes as well as a 10% penalty, reducing the balance by about 25%. So immediately you go from $25,000 in the account to $18,750. If you put that all towards the $40,000 you will still have $21,250 accruing 18% interest and NOTHING in retirement. For many families considering this extreme measure there is a good chance you have put off other expenses and the temptation to use this influx of cash on other items will be great. You might not even be able to get $18,750 to the credit card balances. There is another much greater cost to you. When you take the money out of the retirement account early you now lose the advantage of the long-term growth that comes with a 401(k). Let’s assume you make no additional contributions to the 401(k) and your $25,000 grows at an average rate of 6% per year for 35 years. At the end your 401(k) would be worth $ 192,152! Every $1,000 you take out of the 401(k) to pay down debt today will cost you $10,281 in future retirement funds. Considering retirement is more or less protected under bankruptcy law in Utah, this is a costly way to pay credit card debt you can get rid of by bankruptcy and have probably paid on original principle loaned to you out several times over all ready!

Bankruptcy Filings in Utah Bucking National Trend

According to an article in the Salt Lake Tribune found here the filings for bankruptcy are up in the State of Utah. This is opposed to the national trend where filings are down nationally. The article quotes Jason Kilborn, a visiting scholar at the American Bankruptcy Institute and professor at the John Marshall Law School in Chicago. He stated that “What you’ll often see is that more people will file for bankruptcy if they think the economy is improving,” Kilborn said, explaining that by eliminating or reducing debt those consumers believe they will be better positioned to take advantage of the turnaround. “And it could be that some consumers in Utah see the economy a little different than elsewhere.” He also says in the article that Utah's home foreclosure rate could be playing a part in the amount of bankruptcies that are being filed. He contends that in other states there is an enormous backlog of home foreclosures to be processed, which allows many consumers to stay in their homes, even though they are seriously in arrears on their payments. However, it appears from his research that the "foreclosure process in Utah is clipping along" at a more normal rate and may be more quickly affecting consumers there than in other parts of the country. The article states that RealtyTrac, which tracks foreclosure filings nationally, reported that Utah had among the 10 highest rates of filings for the third quarter of 2011. Citing to statistics maintained by the bankruptcy court in the State of Utah, of the 14,552 Utah consumers who sought bankruptcy court protection from their creditors through the first nine months of this year, 33 percent filed for Chapter 13, according to the U.S. Bankruptcy Court for Utah. The remaining 67 percent filed for Chapter 7. Chapter 13 gives people the opportunity to formulate a plan to repay all or most of the time only a portion of their obligations over time. Chapter 7 involves a trustee liquidating a debtor’s assets and distributing the proceeds to creditors. What might be the best course for you can only be determined by an experienced bankruptcy attorney. Contact Red Rock Legal Services in St. George or Cedar City for a free consultation regarding your options and how to protect yourself through bankruptcy.

How long will it take to get a mortgage after bankruptcy?

When prospective clients come to my office I often must deal with concerns people have about how bankruptcy will affect their credit in making future purchases. Most often the question takes the form of whether or not they will be able to get a mortgage on a home. While it used to be the general rule that you might need to wait 7 years after a bankruptcy or foreclosure, I have had clients who have told me a few years (3 years for a chapter 7) after completing their bankruptcy they are under contract to purchase a home. I have even been able to get a client while still in a chapter 13 case approval from the bankruptcy court to purchase a home with creative financing arrangements. I came across a recent article in the Chicago tribune about time frames for getting a mortgage after a bankruptcy or foreclosure. The article discussed the general rule on time frames to get a mortgage after bankruptcy or foreclosure is now about 3 years. It further said depending on the reasons for the bankruptcy or foreclosure the time frame may be less, even as little as 12 months, if the bankruptcy or foreclosure is a result of “extenuating circumstances” over which you have no control. These circumstances include job loss, serious illness or death of a wage earner. However, divorce or business failure or being overwhelmed by too much debt is not considered life events which are extenuating. But proving the life event is only one step in the process. You must also be able to show you can make monthly payments and keep your credit clean after the bankruptcy or foreclosure. The type of mortgage you are seeking affects how long you may need to wait. • VA Loans—12 months after filing chapter 13 if you can receive court and trustee approval for the loan. 24 months after filing chapter 7 and receiving a discharge, but according to the article in the Tribune it could be less with extenuating circumstances. The wait is the same if you did a deed in lieu of foreclosure or a foreclosure. However, you can be protected from any second mortgage deficiencies by filing a bankruptcy and then turning over the house. • FHA Loans—the rules are essentially the same as a VA loan and if you were to go through a short sale or foreclosure the wait is at least 3 years, but potentially shorter with extenuating circumstances. • Conventional Loans (which are generally purchased by Fannie Mae or Freddie Mac)—the waiting period is tiered. Borrowers who suffered a life event discussed above the period of time to wait are approximately 24 months. If you have not suffered such an event the time period goes up to 48 months. According to Freddie Mac's guidelines, if a borrower's financial issues were due to his own financial mismanagement, a credit status must be re-established for at least 84 months if they was foreclosed upon. The time period could be 60 months if they filed more than one bankruptcy petition in the past 7 years or 48 months after the discharge or dismissal of a Chapter 7 bankruptcy. If there is conveyance of a deed in lieu of foreclosure or a short payoff related to a delinquent mortgage the period could be 48 months. The wait to get a mortgage is 48 months for all other substantial adverse or derogatory credit reporting. It is just 24 months from the discharge date of a Chapter 13 bankruptcy. If “extenuating circumstances” can be shown, and if the credit report indicates the borrower has re-established an acceptable credit reputation, he still will have to wait 36 months if he went through a foreclosure or filed more than one bankruptcy petition in the past seven years. But the wait is just 24 months if his bankruptcy was discharged or dismissed, if he went through a short sale or deed-in-lieu, or if he suffered another significant adverse or derogatory credit event. Only an experienced bankruptcy attorney can give you a full picture of what your options include.

How bankruptcy can stop a foreclosure.

I have many clients that come into the office and want to keep their home. They are behind on payments and facing foreclosure. Most may be “under water” on the home, meaning the value of the home is substantially less than the amount they owe to the bank. They may be months behind on the mortgage payment for many reasons. Some due to unemployment, others its medical expenses or even an adjustment to the monthly payment they did not anticipate often due to the interest only period on the loan coming to an end. Can you make regular monthly payment? Whatever the reason they are behind, as they sit across the desk from me and ask how they can keep their home, my first question generally is whether or not they can make the regular ongoing payment. Many of these people want to do all that they can to save their home. Although we discuss negative equity and market forces and how long it will take for them to recoup the loan to value amounts they want to keep their home. No amount of persuasion on my part to move them forward to a brighter financial future with as broad of a fresh start as bankruptcy can provide will move them out of the house. That is a decision each client must make for themselves and I try to assist them in accomplishing their goals even though I might disagree. If they can make the regular ongoing payment, since bankruptcy law prohibits modification of a mortgage on a primary residence, I next ask could they bring the past due amounts or arrearage including all late fees, collection and foreclosure costs current over a time if we broke it up into monthly payments. They are usually a bit less sure about this but want to try. We discuss how to accomplish this goal via Chapter 13 bankruptcy proceedings. We look at their budget, look at what debts will be discharged under bankruptcy, whether or not we can get rid of the second mortgage, how much equity they have in all property both real and personal above exemption amounts and how to make certain debts like car payments more affordable by forcing a restructure of the debt on the bank (reducing interest, re-amortizing the loan, “cramming down” the principal). If they can make it work through a chapter 13 plan and it gets them current and debt free except for the remaining balance of the mortgage we do it. Only an experience bankruptcy attorney can tell you what your options are and how to accomplish your goals of saving your home and stopping foreclosure. Contact one today!