divorce: when a spouse or former spouse files...
TRANSCRIPT
Divorce: When a Spouse or
Former Spouse Files Bankruptcy Understanding the Impact of Bankruptcy on Domestic
Support Obligations, Property Settlements, and Taxes
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WEDNESDAY, JULY 18, 2012
Presenting a live 90-minute webinar with interactive Q&A
Shayna M. Steinfeld, Attorney, Steinfeld & Steinfeld, Atlanta
Ian M. Falcone, Attorney, The Falcone Law Firm, Marietta, Ga.
Vivian Hoard, Attorney, Taylor English Duma, Atlanta
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DIVORCE
When a Spouse Files Bankruptcy
Shayna M. Steinfeld, Esq.
And
Ian M. Falcone, Esq.
Congress Says:
Bankruptcy is Federal Law
Prior to 1994, Debtors could file for bankruptcy & could
eliminate non-support debts.
In 1994, Congress added §523(a)(15), allowing for the
non-discharge of non-support debt in certain situations
in Chapters 7, 11 and 12. This provision was dubbed
“legislative sausage” and required litigation.
In April 2005, Congress passed BAPCPA, leaving Chapter
13 as the only window for the discharge of non-support
divorce-related obligations.
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Changes under BAPCPA that are
important to Divorce Lawyers
There are many changes under BAPCPA – we are not
going to discuss them all.
BAPCPA amended the Bankruptcy Code, codified under
Title 11 of the U.S. Code. It did not replace it.
There is a new definition for a “Domestic Support
Obligation” – “DSO”
There are New Automatic Stay Provisions relevant for
family lawyers
There are new Discharge provisions relevant to divorce
lawyers
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WHAT IS A DSO:
A DSO is a debt that may include interest … which is–
(A) owed to or recoverable by
(i) a spouse, former spouse, or child of the debtor or
such child's parent, legal guardian, or responsible relative;
or
(ii) a governmental unit;
(B) in the nature of alimony, maintenance, or support …
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(C) established or subject to establishment before, on, or
after the bankruptcy case [big change here – it can be post-
bankruptcy!]
(i) a separation agreement, divorce decree, or property
settlement agreement; (ii) court order or
(iii) by a governmental unit; and
(D) not assigned to a nongovernmental entity, unless
voluntarily for collections. §101(14A)
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The Stakes & Other
Consequences of the DSO
Is the claim “in the nature of support or maintenance”?
It may NOT be discharged in Chapter 7, 11, 12 or 13
Any Arrearage will be a priority claim under
§507(a)(1)
Any Arrearage must be paid in full under a confirmed
Chapter 13 Plan
Pre-Petition payments on it are not recoverable as a
preference under 11 U.S.C. § 547(c)(7)
There are sanctions for non-payment of post-petition
DSOs in Chapters 11, 12 & 13
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THE AUTOMATIC STAY AND DIVORCE
11
Section 362(a) broadly provides for all collection
activity to stop once a Bankruptcy Case is filed –
“Except as provided in subsection (b) of this
section”
The filing operates as a stay as to the
“commencement or continuation, including the
issuance or employment of process, of a judicial,
administrative, or other action or proceeding against
the debtor that was or could have been commenced
before the bankruptcy case or to recover a claim
against the debtor.”
Essentially, all collection activities must stop
unless there is an exception under subsection (b).
The net impact for family practitioners is:
Proceed cautiously;
The division of property and the enforcement of
property settlements are most likely going to be
subject to the automatic stay;
Get an Income Deduction Order for any DSO if
you can
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Exceptions to the Automatic Stay
A. The commencement or continuation of a civil action
or proceeding to:
i. Establish paternity or
ii. Establish or modify a DSO; or
iii. Regarding child custody or visitation; or
iv. To dissolve a marriage, except to the extent that
it involves the division of property that is property
of the estate or
v. Regarding domestic violence.
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(B) To collect a DSO from property that is not property of the
estate.
(C) A pre-petition Income Deduction Order may continue post-
petition:
(D) License withholding (of a driver’s license, a professional
license, occupational license or recreational license) may
proceed under State law, as specified in section 466 of the
Social Security Act.
(E) Reporting past due support under section 566(a)(7) of the
Social Security Act may proceed;
(F) Tax refunds may continue to be intercepted; And
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G. The enforcement of medical obligations may proceed under title IV of the Social Security Act.§362(b)(2)
H. There have been a number of cases evaluating whether the Debtor should have his or her Driver’s License reinstated upon the filing of a Chapter 13 Case and Bankruptcy Courts have relied on§105 to reinstate licenses in cases that appear to have a chance for success.
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Discharge:
§523(a)(5) and §523(a)(15)
A discharge under section 727, 1141, 1228(a), 1228(b), or
1328(b) … does not discharge an individual debtor from any
debt…..
(5) For a domestic support obligation…..
(15) to a spouse, former spouse, or child of the debtor and
not of the kind described in paragraph (5) that is incurred by
the debtor in the course of a divorce or separation or in
connection with a separation agreement, divorce decree or
other order of a court of record or a determination made in
accordance with State or territorial law by a governmental
unit.
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OLD LAW (1994 – 2005)
523(a)(5) obligations non-dischargeable
523(a)(15) obligations were dischargeable unless the
creditor-spouse filed an adversary proceeding within a
60 day deadline to have them declared non-
dischargeable
The 523(a)(15) litigation provided the debtor with two
defenses: (1) inability to pay, and (2) greater benefit to
debtor outweighs detriment to creditor spouse, or
former spouse, or child for the discharge of the debt.
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Under BAPCPA, both 523(a)(5) and
523(a)(15) obligations are automatically
non-dischargeable .
The defenses under 523(a)(15) have been
eliminated in a Chapter 7 case and no
complaint is needed.
523(a)(15) obligations can be discharged only
in a successfully completed chapter 13 case.
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NEW LAW
HOW DO YOU TELL THEM APART?
§ 523(a)(5) vs. §523(a)(15)
DSO’s are “in the nature of support”
Old cases are still valid on this issue:
A debt is in the nature of support and consequently non-
dischargeable under 11 U.S.C. §523(a)(5) only when it is
“in substance support.”
The court must determine if the obligation is “actually in the
nature of alimony, maintenance or support” in order to
determine if the obligation is a domestic support obligation
for all purposes under the Bankruptcy Code.
It is a matter of Federal Law and is made at the time of the
divorce.
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Factors in the Support
Determination:
The Court will consider numerous factors in the support
vs. non-support analysis.
Generally, if the obligation is essential to enable a
party to maintain basic necessities, the payment of
the debt is in the nature of support – Support usually
looks forward and non-support usually splits things and
looks backwards.
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Duck-like characteristics for
support:
If it “looks like a duck, walks like a duck, and
quacks like a duck, then it is probably a duck.”1
“Duck-like” characteristics for such awards
include: traditional state law alimony factors, the
label given to an obligation as “alimony,”
“support,” or “maintenance,” the payment being
payable directly to the spouse and not to a third
party, and the fact that the payments are
contingent on events such as remarriage, death or
eligibility for Social Security benefits
1Sorah v. Sorah (In re Sorah), 163 F.3d 397, 401 (6th Cir.
1998).
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Is it Alimony, Maintenance or Support?
(1) The amount of alimony, if any, awarded by the state
court and the adequacy of any such award;
(2) the need for support and the relative income of the
parties at the time the divorce decree was entered;
(3) the number and age of children;
(4) the length of the marriage;
(5) whether the obligation terminates on death or
remarriage of the former spouse;
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Is it Alimony, Maintenance or Support?
(6) whether the obligation is payable over a long period of
time;
(7) the age, health, education, and work experience of both
parties;
(8) whether the payments are intended as economic
security or retirement benefits;
(9) the standard of living established during the marriage.
(10) the language of the divorce agreement;
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Is it Alimony, Maintenance or Support? (11) the relative financial positions of the parties at the time of
the agreement;
(12) the amount of the property division;
(13) the number and frequency of payments;
(14) whether the agreement includes a waiver of support rights;
(15) whether the obligation can be modified or enforced in state
court; and
(16) whether the obligation is treated as support for tax
purposes.
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DSO’s or not? – specific
examples Attorneys Fees
Guardian ad Litem Fees
Mortgages
Accrued expenses for grown children
Birth expenses
Medical expenses/Life Insurance/Dental
College expenses/ day care expenses
Car Payments
Share of business “equity”
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OBLIGATIONS TO THIRD
PARTIES
523(a)(15) covers debts “to the spouse, former spouse,
or child of the debtor. . .”
What about obligations to credit card companies, banks,
family, etc.
Hold harmless language may be required
On the other hand, if both parties need a bankruptcy
case, be careful avoid indemnities.
Contempt remedy probably suffices.
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MAGIC WORDS TO CREATE
DSO? Request findings of fact and conclusions of law in a trial
setting to make a record of trial court’s intention
In a settlement, labels don’t matter, but they don’t hurt.
Say what you mean (make sure support obligations are
clearly support obligations)
List factors that give your client a need for (or no need
for) support
Don’t overreach
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The Third Party
The Divorce Decree is a contract between the two
divorcing parties. It does not impact third party
creditors.
Ex-spouses never understand this!
It is important to try and get debt isolated into the
paying parties’ name.
If a bankruptcy is filed, the underlying creditor has
every right to collect from any other individual that
signed on the debt and to negatively report on that
person’s credit
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Is a Bankruptcy Case in your
Client’s Future?
If you contemplate a bankruptcy case in one or both of the
parties’ future – state so, precisely, in the divorce decree in
an effort to avoid divorce-related obligations being ones that
will then be non-dischargeable under BAPCPA
Expressly contemplate the bankruptcy filing
The parties may be able to handle the debt if non-mortgage
debt is at less than half of income. If the non-mortgage debt
is more than half of income, and as it approaches and
exceeds 100% of income, the bankruptcy may be inevitable.
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Thank you
Bankruptcy is a very technical area of the law.
There are many traps.
Proceed with Caution.
Shayna M. Steinfeld, Esq.
Ian M. Falcone, Esq.
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Shayna M. Steinfeld, Esq. Steinfeld & Steinfeld, PC
PO Box 49446, Atlanta, GA 30359
404/636-7786; www.steinfeldlaw.com
Ian M Falcone, Esq.
The Falcone Law Firm, PC
363 Lawrence Street
Marietta, GA 30060
(770) 426-9359 www.falconefirm.com
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Whether taxes are potentially dischargeable depends upon a series of hyper-technical rules.
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Taxes may be dischargeable if:
◦ The tax return generating the liability was due more
than three years (including extensions) before the bankruptcy petition was filed.
◦ The tax return was actually filed more than two years before the bankruptcy petition was filed.
◦ The tax was assessed at least 240 days before the bankruptcy petition was filed.
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The IRS cannot collect a tax until there has been an assessment.
An assessment is the formal recording of a taxpayer’s liabilities in the IRS records.
An assessment is made by an assessment officer signing the summary record of assessment.
35
If the tax return is accepted as filed, the assessment date is the date in the government’s records that the return is filed.
Amended returns, audits, and tax litigation can extend the assessment date from the original return date.
To determine the assessment date, order the taxpayer’s “Account Transcript” at irs.gov.
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Certain events such as an offer-in-compromise of the tax liability or a collection due process proceeding extends the waiting time for filing for bankruptcy if the client is seeking to discharge certain taxes.
Prior bankruptcy filings also extend the wait times.
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For an offer-in-compromise the three year wait time is extended during the pendency of the offer-in-compromise plus 90 days. (The wait time is extended 30 days for the 240 assessment requirement.)
For a Collection due process proceeding, or other stayed collection action, the three year wait time is extended during the proceeding plus 90 days.
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Do not rely on the tax attorneys file and the correspondence between the attorney and the IRS to determine wait times?
Order an Account Transcript. There will be notations of assessment dates, bankruptcies, collection proceedings, and when the bankruptcy or collection matter was concluded. This will assist in calculating the correct wait time.
39
When a taxpayer fails to file a return, the IRS may prepare a “substitute for return.”
Taxes assessed pursuant to a “substitute for return” are not dischargeable.
Therefore, for bankruptcy to be an option, all tax returns should be filed before the IRS prepares a substitute for return.
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The IRS will issue a notice to the taxpayer advising that it has not received a return. File it! This may prevent substitute for return status.
When no return is filed, the IRS must issue a Statutory Notice of Deficiency before assessing the tax.
File a Tax Court petition, have delinquent returns prepared, and try to negotiate acceptance of the returns (to avoid “substitute for return” status).
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The IRS does not have to accept a filed return after a substitute for return has been prepared. This would happen if the taxpayer does not file a petition in response to a statutory notice of deficiency, or if the wrong code is put in the computer.
To determine whether the return has been accepted order the taxpayer’s “Account Transcript.” If the type of return is a 1040A then the return was not accepted and the tax is not dischargeable.
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Section 523 excepts from discharge a tax where a return was not filed.
That section defines a return as including a return prepared under Section 6020(a).
That section specifically precludes a return prepared under 6020(b) from being eligible for discharge-A substitute for return.
43
A Section 6020(a) return is a return prepared by the IRS where the taxpayer participates in its preparation and signs the return.
Some Courts have interpreted the return requirement of Section 523 as meaning that a late filed return can never be discharged unless the procedures for 6020(a) are followed, which would preclude a delinquent return.
44
Can a delinquent return prepared by the taxpayer’s accountant ever qualify the tax arising from that return for discharge?
Even the IRS thinks such taxes are dischargeable provided the delinquent return is received before the tax is assessed. Chief Counsel Advice 201044008.
45
Tax liabilities that do not meet the time requirements.
Taxes for which no return was filed or a substitute for return was filed.
Trust fund penalties.
Withholding taxes and the employee’s portion of FICA tax.
Taxes arising from fraudulent returns or where the debtor willfully attempted to evade the tax.
46
A bankruptcy discharge does not affect a tax lien that has already attached to the property.
At the conclusion of the bankruptcy the IRS can still enforce the lien.
IRS’s rights under the lien should be limited to the fair market value of the property subject to the lien at the time the bankruptcy petition was filed.
47
Most accountants advise married couples to prepare a joint return. Once a joint return is filed, the IRS will not accept amended separate returns.
Individuals who sign a joint return are jointly and severally liable for the entire amount of tax due.
That means if one spouse is eventually discharged in bankruptcy the other spouse may have to pay the entire liability even if the divorce decree requires the bankrupting spouse to pay the tax.
48
While waiting for the time periods to run, manage old tax debts by entering into an installment agreement.
An installment agreement does not toll the time periods.
The IRS stays collection efforts during the pendency of an installment agreement.
49
H’s S corporation is audited for 2008 which results in flow through income on the joint Form1040 increasing the tax liability by $150,000 plus interest. H didn’t pay the employment taxes either.
H and his company were audited earlier and the couple still owes 360,000 from 2005 and 2006.
The Form 1040 for 08 was under extension until October 15 but the couple filed the tax return July 16. 05 and 06 were timely filed.
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And the couple received a Statutory Notice of Deficiency proposing to assess the new $150,000 amount plus interest and penalties.
The IRS is also levying the bank account to collect on the back taxes from 2005 and 2006.
What do you do?
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Has the 2008 return been due for three years? (The due date was October 15, 2009).
Have the taxes been assessed for over 240 days? Yes, for 2005 and 2006 but not for 2008.
Are the employment taxes dischargeable? (For the Company the employer’s share is dischargeable but not the withheld portion or employee share). The personal trust fund penalty is not dischargeable.
52
Filing for bankruptcy before the time periods have run precludes 2008 income taxes from discharge. 2005 and 2006 are potentially dischargeable (if no fraud).
But filing for bankruptcy before the time runs might be necessary to stop the IRS levy.
The time for filing a Tax Court Petition is suspended until 60 days after the conclusion of the bankruptcy proceeding.
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The bankruptcy court has jurisdiction to determine the amount of tax of the debtor or bankruptcy estate.
The authority to exercise jurisdiction is discretionary and a bankruptcy court may decline to exercise it.
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Request Innocent Spouse relief for the wife under 6015 of the Internal Revenue Code, if she qualifies.
Prepare an Offer-in-Compromise. Generally, the IRS will not accept an offer for less than the equity in the taxpayer’s assets plus a portion of the taxpayer’s monthly income.
Enter into an Installment Agreement. The IRS will grant an installment agreement when the tax debt is less than $50,000. For amounts above $50,000, there is a complicated financial analysis similar to an analysis for an OIC.
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If a joint return was filed
On the joint return there was an understatement of tax
W establishes W did not know or have reason to know of the understatement
It would be inequitable under the facts and circumstances to hold W liable
Then W may be entitled to innocent spouse relief if it is requested within 2 years of the first collection activity.
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W can elect to allocate amounts due in a manner consistent with how items would have been allocated if separate returns had been filed, IF:
When W files the election she is divorced from or legally separated from H or
W has not lived with H for over 12-months ending on the date the election is filed
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The election to allocate must be made after the deficiency is asserted but not later than 2 years after the date in which the IRS begins collection activities
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The third way to obtain innocent spouse relief is to establish that W is entitled to equitable relief.
The IRS can grant equitable relief if taking into account all the facts and circumstances it would be inequitable to hold W liable for the unpaid tax or deficiency.
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W believes H is hiding assets and tells her attorney that H has grocery bags full of cash in the closet.
W (a housewife) tells her attorney that H hasn’t field a return for years and he has more money to pay for child support than he is offering.
W’s attorney advises W to file separate returns and then turn H into the IRS Criminal Investigation Division for the whistleblower reward.
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H’s taxes will not be dischargeable if: ◦ H filed a fraudulent tax return, or
◦ H willfully attempted in any manner to evade or defeat the assessment or collection of the tax.
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Could result in a fraud penalty equal to 75% of the tax + interest.
Less money for child support.
Loss of a professional license.
High living and low AGI could mean both are prosecuted.
An award is only payable from collected proceeds.
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Yes. If the transaction (the date the tax was due) occurred more than three years before the petition is filed. (At least civil penalties are dischargeable).
Provided the penalty represents compensation for actual pecuniary loss.
Penalties are dischargeable even if the tax may not be dischargeable.
A debt for a fine is not dischargeable.
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Taxpayer convicted of tax crimes was ordered to pay back taxes as part of his probation. Because it was in the order, it was considered a non-dischargeable fine.
In another case where the taxpayer’s sentence did not require payment of a tax, then the rule regarding fines did not apply and penalties were dischargeable.
The better approach is to resolve tax issues before divorce and bankruptcy, enter into an installment agreement and wait the required time before filing for bankruptcy.
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