The financial strains that drive clients to consider bankruptcy also create difficulties in relationships, and visa versa. I regularly meet with clients who are either separated from their spouses or who are going through a divorce proceeding. In this post and the post to follow, I will touch on the matter of attorneys fees in divorce proceedings, and how they can either be protected or discharged in bankruptcy.

I recently met with a new client who wanted and needed to file for bankruptcy, but who had just paid their divorce lawyer a $5,000.00 retainer to defend a matrimonial action. Despite the pressing need to file bankruptcy, I advised the client to wait at least 90 days from the date that the check to their divorce lawyer cleared.

The basis for this advice arises from an area of bankruptcy law known as “preferences.” Simply stated, Section 547 of the Bankruptcy Code provides that a trustee in bankruptcy may recover payments to “non-insider” creditors paid within 90 days prior to the date of filing when such payments are not in the “ordinary course of business” (for insiders – relatives, business relations, etc. the lookback period is one year). Further, Section 541 of the Code provides that the unused retainer, sitting in the divorce lawyer’s trust account constitutes property of the bankruptcy estate.

In the case of this client, an argument could be made that the $7,500.00 transfer would not be in the “ordinary course of business” since it was a non-recurring (“one-time”) payment. My concern was that if I had filed a Chapter 7 on behalf of this client within the 90 day period, the trustee could demand the $5,000.00 from the divorce lawyer. As you might imagine, this would make for a very unhappy divorce lawyer as well as possibly leaving the client without representation in the divorce action.

Preference issues also arise in other situations. You should ensure that you disclose any “out of the ordinary” payments to anyone made within the one year period prior to your projected filing date.

The New York Times reported that, on Thursday, July 29, 2010, the Federal Trade Commission announced restrictions on companies that mislead innocent consumers that they can reduce or eliminate unsecured debt.

The new rules, which will take effect this fall, will prohibit Debt Settlement and Debt Consolidation Companies from charging a fee before they settle or reduce an unsecured debt, such as a credit card. The rules will also require that Debt Settlement Companies set up dedicated accounts for debt relief payments by consumers (similar to escrow accounts), disclose how long it will take to settle or reduce a debt (similar to the new regulations imposed on the credit card companies disclosing the amount of time it will take to pay off a credit card), and the potential negative consequences that may occur during the process (such as the impact of defaulting on credit cards and creditor collection and enforcement efforts).

“Too many of these companies pick the last dollar out of consumer pockets and, far from leaving them better off, push them deeper into debt, even bankruptcy,” said FTC Chairman Jon Leibowitz in announcing the regulations. He also stated that these rules “…will stop companies who offer consumers false promises of reducing credit card debts in half or more in exchange for large, upfront fees.”

For the past 20+ years, I have been warning consumers of the inherent weaknesses in the Debt Settlement Process. Too many times, I have encountered clients who have dealt with Debt Settlement Companies, paid them exorbitant up-front fees, only to ultimately file for Chapter 7 bankruptcy. (See our post on Debt Consolidation vs. Chapter 13 Bankruptcy)

The FTC is to be commended for finally bringing this issue to the forefront and placing controls on Debt Settlement Companies.

One of the most popular questions that I am asked by both prospective and existing clients is “How long will it take for me to re-establish my credit?” The real answer is – not nearly as long as you may have thought before reading this posting.

If you think about it, this is truly an amazing question. Here you are speaking to a bankruptcy lawyer because you are buried in credit card debt, and you are inquiring about “getting back into the game.” The “game” as I call it, is the cycle of credit that the banks have allowed us to create over the past 30+ years.

The only reality regarding your credit is that the filing of a bankruptcy petition is reported to the major credit bureaus and remains on your report as a public record filing for up to 10 years. Beyond that, there are no longer any hard and fast rules of thumb as to how long it will take you to re-establish credit.

Yes – it is extremely important to re-establish credit after bankruptcy. Let’s face facts. We live in a plastic society. You need to have a credit card, even if just for an emergency. The hope is that, coming off of a bankruptcy filing, you will realize that you will need to use credit a little more safely going forward, and the banks know it. They also know that (a) you can only receive a discharge in bankruptcy once every eight (8) years; and (b) if they offer you a line of credit, and you accept it, THEY WILL LOVE YOU because you can’t bail out of them for another eight (8) years!!

Believe it or not, the banks will actually come back to you – you will not have to go to them. It may not be the banks that you have scheduled in your bankruptcy filing, but there are thousands of banks out there that want you as a new customer.

I recently received an email from a client who had recently filed Chapter 7 bankruptcy approximately 60 days earlier, and was awaiting the issuance of her discharge. I was amazed to find out that she had already received three solicitations in the mail and was inquiring about whether she should accept any of them. Unfortunately, this is how easy it has become to re-establish credit.

Practically speaking, I used to advise clients that it would take between 1-2 years to begin to re-establish credit. Now, I honestly don’t know. What I do know is that it will happen much sooner than you may have ever expected…..

When the bankruptcy laws were overhauled in 2005, it became mandatory for a debtor to reaffirm a secured obligation encumbering an automobile whether or not the debtor was current in the remittance of payments at the time of filing. Essentially, the age old concept of “pay and retain” an automobile in bankruptcy was no longer an option.

Initially, some auto companies were extremely aggressive and initiated programs to repossess cars in cases in which a reaffirmation agreement was not executed.  Then, as time passed, and the economy weakened (and, in particular, the auto industry), the car companies softened their position in that they did not want to be burdened with a inventory of repossessed cars in addition to an overabundance of unsold new cars.

We then experienced TARP.  The government bailed out the car companies and provided incentives to clear out the new car inventories – Hooray for the Auto Industry and the beginning of the return to 2006…

Since some of the U.S. based car companies have come back to financial stability, we are again facing the prospect of post-discharge repossessions if a debtor attempts to simply “pay and retain.”  If you are considering bankruptcy, please bear in mind that you will be required to reaffirm your auto obligation, in particular if it is financed by either a U.S. car company or a U.S. financial institution.

Are you using a debt management firm to settle your debts? Have you recently completed a short sale? Have you had a property foreclosed and the bank received less than the outstanding balance on the mortgage? If you have answered Yes to any of these questions, you should be on the look out for a 1099C from your creditors.

A 1099C forgiveness of debt is a statement that is issued to the IRS by a creditor in instances in which that creditor has not received payment in full of a debt. In essence, the foregiveness of debt can become ordinary income that you must declare in the year the debt was written off.

A creditor is required by law to issue a 1009C to any individual who settles a debt or has a debt written off that is in excess of $600.00. This is a very big trap that people with a large amount of debt may find themselves in. If you have received a 1099C in the mail, you may have to declare the amount stated on that form as ordinary income, and you will have to pay tax on it.

The 1099C is required to be issued by any creditor that settles a debt, or writes the debt off and the amount is over $600.00 For example, lets say that you settle a $25,000.00 credit card debt for $10,000.00. You will eventually receive a 1099C for $15,000.00 from your creditor.  You will be required to declare that amount as income on your tax return and you may end up paying tax on it.  This could, depending on your tax bracket, add up to an additional $5,000.00 to the cost of your so-called settlement.

There are two exceptions to the 1099C rule for most debt. The first applies when you are insolvent as the time the debt is written off. This is defined by the IRS. The second is if you file bankruptcy before the debt is written off and the 1099C is issued. In either of these events, there is no income to declare. Please note that if you file bankruptcy after the 1099C is issued, you may still have to declare that as income.

There is a third exception that has a limited impact on certain real estate trasnactions. It is the Mortgage Forgiveness Act of 2007. It applies to the homeowners of residential real estate only.  It also only applies to only to homeowners who had the debt written off during 2007 to 2012. The IRS website has examples to help you determine if you can qualify for this exception.

The issuance of Form 1099C and its consequences are often overlooked before making the decision to file bankruptcy. Its impact must be considered and may become the primary reason to choose the filing of a Chapter 7 bankruptcy or a Chapter 13 bankruptcy.

Are you approaching retirement? Are you still burdened with massive minimum monthly payment obligations on your credit cards? Are you concerned that you will not be able to continue to maintain these payments once you stop working?

U.S. News and World Report noted in a recent posting that an increasing number of Americans are entering their retirement years with debt. Some 63 percent of U.S. families headed by someone 55 or older still owed money on their home, credit cards, or other debts in 2007, up nearly 10 percentage points from 1992

Over the past 20 years, I have encountered countless individuals in mid-life who have agonized over the prospect of filing bankruptcy. I call it the “moral dilemma”. We have been ingrained with the concept that you work hard and pay your bills on time. I have also observed that, at some point, most of my clients reach a personal “breaking point” in which they come to realize that they have to consider filing for bankruptcy.

If you have answered “Yes” to any of the questions above, I suggest that you consider a different approach. Although it is never too late to actually file for bankruptcy, you could end up in a more advantageous financial position in retirement if you consider bankruptcy in the last 5 to 10 years before you retire – particularly if you have never owned a home and have limited retirement savings.

Many people exhaust everything they have – including retirement funds – to avoid filing for bankruptcy, but yet end up in a situation where it still becomes necessary to file bankruptcy.

In New York, where I practice, all ERISA qualified retirement accounts (IRA, KEOUGH, 401k, 457, etc.) are fully protected from the claims of creditors, even in bankruptcy. Technically, it is considered exempt property, or an exemption.

The worst thing that you could do is to tap your retirement savings to pay credit card debt. If you are considering bankruptcy, do not look to your retirement savings to bail you out. I ask you to look only at your present cash flow. If you cannot meet your obligations based upon your present cash flow, I suggest that you seek the counsel of a qualified bankruptcy attorney.

If you act before you spend down your retirement savings, you may still be able to eliminate your credit card and other debts and still retain your nest egg as you approach retirement.

Unfortunately, if you have already tapped some or all of your retirement savings, attorneys cannot go back and get the money that was already paid out. What we can do is to assist you to protect your remaining and future retirement savings. Filing for bankruptcy will help to stop the harassing phone calls and letters, and leave you debt free so that you can move forward as you approach retirement. While it is never too late to file, the smart move is to seek counsel when the first sign of trouble is apparent – not after you have exhausted your retirement savings.

Brittni T. Feldenkreis, Esq. contributed to this posting

If you are considering filing for bankruptcy, this is not time to go it alone. Much of what goes into the filing of a bankruptcy petition comes from the insightful and probing questioning from a qualified bankruptcy attorney. Under New York State law, only a licensed attorney can provide legal advice. Paralegals and other bankruptcy petition preparers are strictly prohibited from practicing law, and therefore, can not give you legal advice or ask the necessary questions to make sure that you completing your paperwork fully and completely.

There is nothing in the law that prohibits an individual from filing a bankruptcy petition without the assistance of counsel. However, if you choose to file a bankruptcy petition without the assistance of an attorney, the Bankruptcy Court Trustee and the Bankruptcy Court Judge will presume that you have the knowledge and experience of an experienced bankruptcy attorney. When you file bankruptcy papers with the Court, you file these documents under the penalty of perjury. If you list information incorrectly in your petition, or omit necessary items, it is your problem and your problem alone.

When you file a bankruptcy petition, it is extremely important to be comfortable and have confidence in your representative. You will be revealing all your financial records. Do not be afraid to ask questions about fees, in particular, whether payment terms are available. Some paralegal services charge a minimal fee to prepare and file the necessary paperwork to file a bankruptcy petition. It has been my experience that the risk is simply not worth the small savings.

Last, don’t be penny wise and pound foolish. Many attorneys are willing to take your case for a similar fee than which may be offered by a non-attorney. You must choose intelligently. Retaining the services of a professional to protect your property is serious business. You should be confident with your final choice.

There has been a long standing misconception that all tax liabilities were not dischargeable in personal bankruptcy. While the bankruptcy law has always held that payroll and sales tax liabilities incurred by the owner of a business could not be discharged in bankruptcy, certain personal income tax liabilities can be discharged in either a Chapter 7 or Chapter 13 bankruptcy provided that the tax liability meet three distinct criteria.

First, the tax liability must be at least three tax years old. This criteria is not as straight forward as it sounds. The Internal Revenue Code states that an individual’s tax liability is due and payable by April 15th of the year after the tax came due. The three year period starts from April 15th of the year after the tax became due, not December 31st of the tax year. For example, an individual’s tax liability for the tax year ending December 31, 2008 did not become due and payable until April 15, 2009. A taxpayer’s 2008 tax liability would not be eligible for discharge until April 16, 2012.

Second, it must be at least two years since the tax return was filed and accepted by the taxing authority. This criteria is also a little tricky. Prior to October 17, 2005, an individual could discharge certain personal income tax liabilities in Chapter 13 bankruptcy without meeting this criteria – in fact, an individual was not even required to prove that they even filed a return. This has now all changed. In order for a tax return to be eligible for discharge in bankruptcy, a return must be actually filed with the taxing authority.

Let’s look at the terms “filed” and “accepted” individually. An income tax return is considered to be “filed” by a taxing authority when it is received – again fairly straight forward. A tax return is deemed “filed” when either it is filed electronically and you have an e-filing receipt, or it is physically received by the taxing authority. The term “accepted” has an entirely different meaning. In tax terms, the word “accepted” does not have the same meaning as “received”. The term “accepted” means that the taxing authority has received and reviewed your return. If a taxing authority makes an inquiry, or conducts an audit of a return, the return is not deemed “accepted” until that process in completed and closed by the taxing authority. Sometimes, this process can take months, or even longer.

Last, it must be at least 240 days since the tax has been “assessed” by the taxing authority. The date of “assessment” is the date that the taxing authority has closed their file (in the case of a review, recalculation or audit) and has issued a demand for payment.

If a personal income tax liability meet all three of the above criteria, that liability can be discharged in a personal bankruptcy filing. As a reminder, though, the calculation of the above dates and timeframes must be exact. A miscalculation of even one day can cost you thousands of dollars in tax liabilities and possible penalties and interest. You can readily find out all of the above dates by contacting either the Internal Revenue Service or your local taxing authority by requesting a tax transcript from the taxing authority.

You’re a first year grad student, and the thought of repayment doesn’t even cross your mind. “That’s so long from now!”  At every semester’s start, you long for the day you stand in the long financial aid line to get the check.  The grad school years go by and, in the last year, you go to a mandatory financial aid exit interview.  Here, you see unfathomable numbers that you have no idea how to pay back.  Entering the real world comes with the reality and hatred of the near thousand dollar payments or more a month; and sometimes, added credit card debt. Have no fear – there are options. 

In light of the down economy, if you are unemployed or don’t make enough to comfortably pay back your students loans, Chapter 13 bankruptcy may be an option to provide you with temporary relief – at least for three to five years.

In general, Chapter 13 repayment plans require that all unsecured creditors, including student loan servicing companies, be treated equally.  Chapter 13 plan payments are distributed on a pro-rata basis amongst all of your creditors.  In a Chapter 13 Bankruptcy, you will repay a portion of your student loan obligations along with your other debts.   The twist here is that a Chapter 13 bankruptcy that is filed to deal with student loan obligations does not discharge your entire student loan debt after the completion of your plan payments (unless you qualify for a very rare finding of undue hardship).  However, the remaining balance on all of your other unsecured debt is discharged after you complete your Chapter 13 plan obligations.   The goal of this strategy is that in three to five years, upon the completion of your Chapter 13 plan, you will be in a better financial position to deal with the remaining balance on your student loan obligations.  I call it “growing onto your student loans.”

There is one other option to deal with your student loans in Chapter 13 bankruptcy.  In some jurisdictions, by invoking Section 1322(b)(5) of the Bankruptcy Code, you can have your Chapter 13 plan state that the payments on any unsecured debts (such as student loans), whose last payment is due after the last payment under the Chapter 13 plan is due, are to be paid “outside the plan” by making the regular monthly payment directly to the creditor, rather than having the debt be paid through the plan.  This sometimes also allows the student loan debt to stay out of default status once the plan is completed.  More importantly, it may also result in much more money being paid toward the student loan debt, when compared to the option of having the student loans paid on a pro-rata basis along with your other unsecured debt through the plan.  If you consider this option, notice must be given to all creditors and the Chapter 13 trustee, and so long as neither the other unsecured creditors of the Chapter 13 trustee object to this strategy, you may end up ahead at the end of your plan.

One important note about student loan obligations in bankruptcy – interest will still accrue on your student loans during the plan period.  Despite this one negative, filing for Chapter 13 bankruptcy to deal with student loans may be a good option if your have used all available deferments and your monthly student loan payments are too high to handle in the short term.

Brittni T. Feldenkeis, Esq. contributed to this post.

Section 341 of the United States Bankruptcy Code provides creditors the right to meet with the debtor to determine if a discharge or a reorganization of debt is appropriate based upon the facts and circumstances presented by a debtor in their bankruptcy petition. While creditors technically have the right to attend these proceedings, and to question the debtor, creditors rarely appear at these proceedings.

In a Chapter 7 bankruptcy case, the Meeting of Creditors serves two important purposes. First, the Court, through examination by the Court appointed Trustee, verifies that all of the representations contained in your bankruptcy petition are true and correct to the best of your belief and knowledge. This is also your opportunity to correct any errors that may exist in your petition and schedules that could impact your testimony, such as changes in employment or income, or the addition of any property or creditors that were inadvertently left off of your schedules. Second, the Bankruptcy Court Trustee also utilizes this meeting to verify on behalf of the Court that there are no assets that maybe considered non-exempt, which could be sold by the Trustee to repay part, or all, of your debt. A typical meeting of creditors in a Chapter 7 case takes approximately 5-10 minutes to complete.

In Chapter 13 bankruptcy case, you are also required to appear before a Court appointed Chapter 13 trustee. In a Chapter 13 case, the Meeting of Creditors serves a slightly different purpose. In addition to verifying that all of the representations in your petition and schedules are true and correct, the Chapter 13 trustee will also verify that you have calculated the means test properly, and that you have the financial ability with which to make the payments proposed in the proposed Chapter 13 plan. Verification of your ability to make payments in a Chapter 13 bankruptcy case is based upon both your testimony at the meeting and various documentation, usually bank statements, tax returns and/or pay statements, that must be presented to the Chapter 13 trustee to verify the representations made in your Chapter 13 petition. As in a Chapter 7 bankruptcy case, a typical meeting of creditors in Chapter 13 bankruptcy case takes between 5-10 minutes to complete.