Divorce Decrees and Bankruptcy

Divorce Decrees and Bankruptcy

In the preparation of a bankruptcy case, a decree of dissolution of marriage may disclose the following:

  1. Undisclosed debts and assets, obviously.
  2. Medical debts of a former spouse. In Oklahoma, a person is liable for all debts that his spouse incurs for necessities during the marriage, so all such debt needs to be listed on Schedule F.
  3. Orders directing the debtor to make non-support payments to a former spouse. In chapter 7 case, such obligations are not dischargeable. Indeed, in chapter 7, basically no obligations imposed by a divorce court are dischargeable. In chapter 13 case, non-support divorce-court obligations are dischargeable, and sometimes chapter 13 is selected for that reason. One workaround for this issue is to persuade the former spouse to file a bankruptcy case of his/her own.
  4. Orders directing the debtor to pay debts that are joint with a former spouse. In chapter 7, such obligations are not dischargeable. In chapter 13, they are dischargeable, and sometimes chapter 13 is selected for that reason. Even in chapter 7, it is not a problem if the debts are joint or if the debtor was ordered to pay them; the problem arises when both of those facts are present.

Trusts in Bankruptcy

Trusts in Bankruptcy

Most inter vivos trusts contain a “spendthrift” clause. The filing of a bankruptcy petition creates a “bankruptcy estate” that includes all legal or equitable interests of the debtor in property as of the commencement of the case. 11 U.S.C. Section 541(a)(1). However, some assets or interests are excluded from the bankruptcy estate. 11 U.S.C. Section 541(c)(2) states: “A restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law is enforceable in a case under this title.” In the case of a debtor’s interest in a trust, the “relevant nonbankruptcy law” is state law. 60 O.S. Section 175.25(A) provides, “Any instrument creating a trust may provide by specific words that the interest of any beneficiary in the income of the trust shall not be subject to voluntary or involuntary alienation by such beneficiary. of Subject to the following provisions of this section, a direction to this effect shall be valid and enforceable.” 60 O.S. Section 175.25(E) provides, “The right of any beneficiary of a trust to receive the principal of the trust or any part of it, presently or in the future, shall not be alienable and shall not be subject to the claims of his creditors.” Therefore, an Oklahoma debtor‘s equitable interest in a valid spendthrift trust is normally not included in his bankruptcy estate (caution if there are out-of-state assets).

However, in Malloy vs. Morrison (In re Morrison), 2010 WL 6490255 (Bankr.N.Dist.Okla. 2010), the court ruled that the assets of a trust were property of the bankruptcy estate where, even though the trust contained a spendthrift clause, the trust also allowed the debtor to receive corpus of the trust on demand.

Another way that a debtor’s beneficiary interest in a spendthrift trust could become an asset of the bankruptcy estate, is that, within 180 days after the bankruptcy case is filed under chapter 7, or any time during the three-to-five year term of a chapter 13 plan, there occurs an event, such as the death of the trust grantor, that triggers the debtor to become entitled to an outright distribution of trust assets. 11 U.S.C. Sections 541(a)(5)(a), 1306(a).

Effect of Previous Bankruptcy Cases

Effect of Previous Bankruptcy Cases

Previous bankruptcy cases give rise to the following issues:

  1. A person is not eligible to be a debtor in a case under any bankruptcy chapter if within the past 180 days a previous bankruptcy case filed by him was dismissed, either voluntarily after a stay motion was filed, or for willful failure to abide by court orders or to appear before court. 11 U.S.C. Section 109(g).
  2. The automatic stay is lifted as to property of the estate 30 days after a chapter 13 case is filed if a prior chapter Bankruptcy 13 case was pending (not just filed) within one year before the current case was filed and the previous case was dismissed, unless the debtor files and prevails on a motion to extend the stay by overcoming a presumption of bad faith. Bad faith is presumed if in the previous case the debtor failed to file documents, to make plan payments, or to pay adequate protection, or if there has been no change in circumstances; in other words, bad faith is usually presumed. In re Havner, 336 B.R. 98 (Bankr. M.D.N.C. 2006) and In re Galanis, 334 B.R. 685 (Bankr. D. Utah 2005) list criteria regarding whether the bad-faith presumption is overcome. There is no automatic stay at all if two prior cases were pending in the past year, but the debtor can file a motion to impose the automatic stay. 11 U.S.C. Section Tax 362(c)(3). These motions should specifically address every Havner/Galanis criteria. The motions can be filed on notice and opportunity for hearing, so that no hearing is necessary if no objections are filed; however, the court itself would probably set a hearing if the Tax bad faith did not appear to be rebutted by the facts alleged in the motion. These motions should be filed with the bankruptcy petition, because the deadlines for the court to enter an order are short; in the Northern District of Oklahoma, a local rule sets a deadline for filing such motions.
  3. The debtor is not entitled to a discharge in a chapter 7 case if he received a discharge in a chapter 7 or 11 case filed within 8 years before filing the current case. The previous case’s filing date is the date that counts, not the discharge or closing date. 11 U.S.C. Section 727(a)(8).
  4. The debtor is not entitled to a chapter 7 discharge if he received a discharge in a chapter 12 or 13 case filed within six years before filing the current case. However, there is no discharge bar if (a) the plan in the previous case paid 100% of the general unsecured claims or (b) the plan in the previous case paid at least 70% of the general unsecured claims and was in good faith and debtor’s best effort. 11 U.S.C. Section 727(a)(9).
  5. The debtor is not entitled to a chapter 13 discharge if he received a discharge in a chapter 7, 11, or 12 case filed within four years before filing the current case. 11 U.S.C. Section 1328(f)(1).
  6. The debtor is not entitled to a chapter 13 discharge if he received a discharge in a chapter 13 case filed within two years before filing the current case. 11 U.S.C. Section 1328(f)(2).

Sometimes it is beneficial to file a chapter 13 case even when the debtor is not entitled to a discharge, e.g., to stop a foreclosure or the collection of a student loan or to force a payment schedule on a tax debt or child support arrearage.

Residency and Bankruptcy

Residency and Bankruptcy

A bankruptcy debtor’s history of residency may give rise to the following issues:

Filing venue. The bankruptcy case must be filed in the federal judicial district in which the debtor resided, or his principal business assets were located, for the greatest part of the past 180 days immediately preceding the bankruptcy filing.

Exemption selection. The debtor must use property exemptions based on the state in which he lived for the two years immediately the bankruptcy filing, or, if he lived in more than one state during that two years, based on the state in which he lived for the greatest part of the 180 days immediately preceding those two years. This byzantine formula was enacted as part of BAPCPA in 2005 when nightly news reports were featuring multi-million-dollar homes/compounds being built, by executives of failed giant corporations, in Florida, which, like Oklahoma, had an unlimited homestead exemption. Sometimes those rules select a state whose laws provide that only a Tax current resident of that state may claim its exemptions; in that case, the debtor may use the federal exemption list. At, John R. Bates publishes a useful guide, covering all 50 states, as to (1) “what residency status must debtor have on date of filing to quality for the applicable state’s exemptions”, (2) “which state’s law is applicable on the date of the filing of the petition”, (3) “which of the applicable state’s exemptions apply to property located outside the state”, and (4) “what residency status must debtor have on date of filing to qualify for the federal exemptions.”

Homestead exemption. In Oklahoma, the exemption of a one-acre urban homestead or 160-acre rural homestead is not limited as to amount. In a bankruptcy case, federal bankruptcy law caps that exemption at $155,675 (that figure adjusts every three years). However, if the debtor acquired the homestead more than 1,215 days before filing bankruptcy, the cap does not apply (but caution if the homestead was purchased using non-exempt funds).

Dischargeability of Tax Debt in Bankruptcy

Dischargeability of Tax Debts in Bankruptcy

The following tax debts are not dischargeable:

1. Fraud, evasion (fraud penalties, as opposed to negligence penalties, would appear on the transcript).

2. Debt for on business payroll withholding tax (does not include employer portion of FICA) or state sales tax.

3. Debt for a tax year whose return was due (including any extension) less than 3 years before bankruptcy filed (date actually filed irrelevant).

4. Debt for tax assessed within 180 days before bankruptcy was filed, plus, if an offer in compromise was pending during that period, the days it was pending plus ___ days.

5. Debt for tax years as to which the return was filed within 2 years before bankruptcy was filed.

6. Debts to the IRS for tax years as to which the IRS has filed a “substitute for return” (SFR).

7. Debts for tax years as to which the return was filed late. In re Mallo, 2014 WL 7360130 (10th Cir. Dec. 29, 2014). This exception to discharge is the subject of vigorous ongoing debate and is certain to find itself in the United States Supreme Court sooner of later. The 10th Circuit’s holding was even more pro-IRS that the IRS’s position, which was that the mere late filing of a tax return (barring difficulties with other rules) should prevent discharge only if an SFR was filed.

The 3-year period, and possibly other tax-dischargeability periods, are tolled by the pendency of a bankruptcy and by the pendency of a “collection due process” (CDP) hearing, plus 90 or 180 days.

It is possible that a debt is not priority but also not dischargeable (e.g., tax return filed less than 2 years ago for a tax year whose return was due more than 3 years ago).

Tax liens are not affected by bankruptcy except in a chapter 13, 11, or 12 plan.

Federal tax transcripts are available at http://www.irs.gov/individuals/get-transcript (or at least that was the case until the IRS’s website was hacked in May 2015).

State tax return and tax debt information is available by faxing a tax status request form to Oklahoma Tax Commission at 918-581-2087 (for Northern and Eastern District). It must be signed by the debtor and state his social security number and name. The OTC will provide the form on request.

Effect of Bankruptcy Discharge on Tax Liens

Effect of Bankruptcy Discharge on Tax Liens

A tax lien remains on a debtor’s property in spite of a bankruptcy discharge of the tax debt, the same as a bank’s lien stays on a vehicle securing a discharged debt.

That said, I have seen the IRS spontaneously release a lien securing discharged debt, but I have no idea why they did it.
A tax lien does not apply to assets acquired after the bankruptcy is filed, so, if the debtor does not own real property or investments (retirement or otherwise), the remaining tax lien is not that burdensome. Car titles do not show the tax lien. It is against the law to sell any assets covered by the lien (i.e., all assets), so the client’s citizenship will prevent him from selling his vehicles. However, he can just drive them until they wear out, unless the tax authority seizes them, which is unusual.

If the debtor owns real property, he can use a chapter 13 plan that “crams down” the tax lien to its value, which is the equity in his house and vehicles and all assets. Clothes and furniture are not worth much. Cram-down works on tax liens same as vehicle liens. When the debtor finishes his chapter 13 plan, the tax lien is considered satisfied.

The IRS and Oklahoma Tax Commission used to have voluntary programs allowing a chapter 7 debtor to set up an arrangement to obtain a release of a tax lien by paying the value of his equity in all his assets in installments. In other words, a chapter 7 cram-down. If this option would be helpful to a client, I can speak with the tax authorities to determine whether these programs still exist.