It’s tax season:  don’t forget to write off the deductible expenditures made by your  Chapter 13 trustee on your tax return.  Many Chapter 13 plans are paying mortgage arrears (which are almost exclusively deductible interest), taxes of some sort, or business expenses.  These items should be deductible to you.

You can get a report from your Chapter 13 trustee of the distributions she’s made during 2008.  Many trustees have this information on line for your convenience. The report will itemize payments  made with your money, on your debts.

If you’re in a Chapter 13 and  have a bushel of lemons, make lemonade, and reduce your current tax burden.

David Leibowitz points out  at the Bankruptcy Law Network that the debtor’s right to a tax refund is an asset of his bankruptcy estate.  Depending on the exemptions available, the debtor may be entitled to keep it, or it may have to be turned over to the trustee.

A common misconception is that the refund is an asset only after the taxpayer has filed his return and calculated what he should get back.  Wrong!  The right to money exists as soon as the tax year is complete; on January 1, 2009, a taxpayer who has overpaid is entitled to a refund.

For these purposes, it is meaningless that the taxpayer doesn’t know how much he is owed until the return is prepared.  So someone who files for bankruptcy in January may be gambling with the refund to be “discovered” when the return is filed.

The other side of the coin is that the taxes for 2008 are legally due on January 1, even though they are not overdue until April 15th.  I have advised a number of clients expecting a 2008 liability to wait to file their Chapter 13 cases until 2009, so the tax debt will be a prefiling debt and payable through the Chapter 13 plan.

I regularly see clients who have not filed returns because they have some issue with the IRS, either taxes that will be owed with the unfiled return, or taxes owed from earlier periods. They think they are avoiding trouble by not filing. Not so.

The IRS levies two separate penalties for non filers: a penalty for not filing the return and a separate penalty for not paying the tax.

Perhaps you can’t pay all you owe with the return, but why incur an avoidable penalty for not filing a timely return?

Tax penalties are not dischargeable in Chapter 7 until they are more than three years old. Contain the damage: file on time.

The threat of a lawsuit being filed is often what causes the first call to my office. Some collector has said he will take 25% of your wages, or will serve a lawsuit, or even will send the account to collection, and the hearer panics. Can I file bankruptcy today? the caller asks.

Remember high school civics, and the Bill of Rights’ promise of due process? Due process, at its simplest form, means that you get legal notice and a right to contest the claim of any creditor before they take your property. So, the only way the average unsecured creditor can take your wages or your assets is to file a lawsuit, serve it on you (notice) and provide an opportunity for you to resist the suit. In short, you will see this kind of creditor coming after you long before they have a legal right to take anything from you.

The unsecured creditors who can take your money without suing you are your bank and the taxing authorities. Your bank has a right of offset under state law: it owes you the return of your money on deposit and you owe it on a credit card or other loan. The bank may take the money in your account to satisfy your debt to it.

The IRS also has a right to levy on your account for unpaid taxes. The Internal Revenue Code has requirements about giving you notice of your tax debt, but the IRS does not have to file a lawsuit to collect its money.

So, in my book, the bank and the IRS are the creditors that have real powers to snatch your money on short or no notice. The collector for a credit card company wants you to think they have immediate and horrific tools to collect their bill, but it isn’t so. It’s just so much easier for them to collect if they gloss over your right to due process.

Two tax issues popped up as I discussed impending foreclosures with a client with several investment properties. Remember that a foreclosure sale is treated for tax purposes as though it was an actual sale, with the winning bid treated as though the property owner got the money. The result is that a capital gain may result. This is more likely if the property has been held for a substantial period and the tax basis reduced by depreciation or the property has been refinanced and the equity pulled out.

The second possible tax gotcha may arise in short sale situations where the amount of the shortage may result in cancellation of debt income.

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