For the last decade the media has pounded into the heads of American consumers that having a high credit score is the key to financial success. It should come as no surprise that the funding for all those commercials and PSA’s came from lenders, both mortgage companies and credit card providers. Of course lenders want people to pay their debts, and by creating a false pride in the “scores,” those debts have a better chance of getting paid.
When faced with overwhelming debt, a person faces a moral choice about how far to go in trying to pay creditors. Many agree that people should pay their debts, but not if payment means not having food on the table or a roof overhead. Creditors know that many borrowers will default, and the losses are figured into the cost of doing business as a creditor.
To be sure, scores were very important in the last decade as creditors would lend to anyone with a high score, whether or not that person had the ability to repay. However, to obtain a loan now, the two most important things a borrower must prove are stable income and sufficient assets. Thus, a “good borrower” is someone with a job and assets. The score is no longer the most important qualifying factor.
Creditors make money by loaning money. If they refuse to loan money to people with jobs and assets just because those people have low scores, they will not be providing many loans. What is important is the reason a score is low. If due to a one-time foreclosure, a lender may be more willing to lend to someone with a job and assets. Likewise, landlords will rent to someone with a job and assets over someone without a job and assets, no matter what the score. Scores are important, but just not that important.
In today’s exceptionally hard economic times nearly everyone has thought about bankruptcy, even those with no intention of filing. We all have at least one friend or acquaintance who has filed bankruptcy. Many local businesses as well as quite a few large corporations have filed for bankruptcy protection.
Most of us are also aware that in 2005 the banks and credit card companies successfully lobbied Congress to make it harder for individuals and small business owners to file bankruptcy (yes, these lobbyists represented the same banks – JP Morgan-Chase, Citibank and corporations like AIG and Goldman-Sachs that brought you this new economic crisis in the first place and the same banks have now been bailed out with corporate welfare money) by limiting the amount of income a person can make and still file for Chapter 7. Most people that come to our law office already understand that domestic support, student loans and governmental fines cannot be discharged in bankruptcy. But, what about tax debt? Are taxes dischargeable? The traditional answer is that tax obligations to the state and federal government cannot be discharged. However, like many things in the law, there are exceptions. Depending on the type of taxes, when they were assessed and certain other factors, the tax debt may be dischargeable. Bankruptcy tax dischargeability analysis is not only hard to say but a very tricky area of law and even some bankruptcy lawyers have difficulty accurately determining whether tax debts can be discharged.
During times of massive layoffs and corporate downsizing, many newly unemployed people tap into their 401(k), IRA, or similar tax sheltered retirement vehicle. In some cases the taxes are paid (often as much as 30-40%!) at the time of withdrawal, but when they are not paid at that time, the consequences can be devastating. We have seen clients cash out their 401(k) prematurely, not pay the proper taxes at that time, and find themselves owing the government $50,000 to $100,000 in taxes, penalties, and interest. When a tax debt of that magnitude hits someone without a job and depleted savings, there is really no way to pay the tax debt. Some people will go to their graves owing back taxes and penalties to the IRS. The most important keep in mind thing when significant taxes are owed to the IRS or to the State of California is that there may be some relief.
Some debtors can get tax debt relief through a Chapter 7 bankruptcy. The facts have to be just right for this type of discharge, but it is not impossible. Another really important and powerful weapon against oppressive and overwhelming tax debt is the Chapter 13 bankruptcy plan. In some cases, a person may be able to treat tax debt as general unsecured debt. If this is the case, then only a percentage of the tax debt gets paid, and the balance is discharged. If the taxes are secured (for example by a tax lien) or the taxes are determined to be priority debt (recent taxes for example), there are still ways to reduce the taxes, or at the very least, to pay only the principal amount of the taxes without interest or penalties. The tax arena is filled with laws and loopholes, and this is why both experience and knowledge are necessities when dealing with “back taxes.”
When substantial taxes plus other debts are owed, it is prudent to consult a bankruptcy attorney who clearly understands the tax implications of the Bankruptcy Code.
Many of us hoped that 2010 would start an economic turnaround that would enable individuals and businesses to keep their heads above water and avoid bankruptcy. While some pockets of the economy show signs of modest improvement, much of Southern California’s economic base has not responded well to the “economic stimulus.” Many small businesses and self-employed persons, have, or are considering, simply throwing in the towel. Is there an alternative to closing the doors or letting everything go? Absolutely!
When we hear the word “bankruptcy,” the immediate picture that comes to mind is that of a Chapter 7 liquidation which ends the business. If the business has a chance of survival, Chapters 11 or 13 may be the more appropriate way to save the business. When large corporations suffer financial losses, Chapter 11 provides a method of restructuring their debt and allowing them to stay in business. However you don’t have to be GM or Pacific Gas & Electric to file Chapter 11. Small businesses, corporations, partnerships, sole proprietorships, and individual professionals may file Chapter 11, remain in business, and avoid liquidation. There are provisions in the law for a “Small Business Chapter 11,” to speed the process and make it less costly.
A Chapter 11 is based on a new business plan that you formulate. Under Chapter 11, the debtor may seek an adjustment of debts by reducing the debt, by extending the time for repayment, or seeking a more comprehensive reorganization. There is no debt limit in a Chapter 11. The only real requirement is that there is some hope of reorganization.
Chapter 13 is also a debt repayment plan. In contrast to a Chapter 11 plan, the 13 plan is very simple and more structured. Chapter 13 eligibility is limited by a debt ceiling but many small businesses qualify (if not, the small business 11 may be appropriate). Most people think only an individual can file a Chapter 13. While partnerships and corporations cannot file a Chapter 13, sole proprietorships or individual professionals may be eligible for relief under Chapter 13.
One important advantage of Chapter 13 is that the plan can include a home mortgage and provide individual debtors with an opportunity to save their homes from foreclosure. Chapter 13 plans allow time to “catch up” on past due payments to the 1st mortgagor, and, in some cases, “lien strip” a junior trust deed. A “lien strip” can treat a junior lien on real property as unsecured for purposes of the Chapter 13 plan. In some cases, when the plan is completed and a discharge entered, the junior lien is completely extinguished.
If reorganization is not possible, Chapter 7 can provide relief and protection for business’s owners. To qualify for Chapter 7 relief, the debtor may be an individual, a partnership, or a corporation or other business entity. Under Chapter 7, there is no limit to the amount of debt and no consideration of whether the debtor is solvent or insolvent. In 2005, Congress passed legislation making qualification for Chapter 7 more difficult by requiring the use of a “Means Test” which used gross income as a limiting factor. Fortunately, if your debt is primarily business debt, the income limits may not apply.
Bankruptcy law in 2010 is more complicated than ever, but with highly skilled counsel guiding the process, you and your business can survive this unprecedented downturn. While successful Chapter 7 and 13 bankruptcies require modest experience, a successful Chapter 11 filing is complicated and is nearly impossible without years of experience. The final message here is that there is help for struggling businesses.