On-Demand: Bankruptcy and Taxes
- Dec 10, 2020
Our webinar covered different scenarios when it comes to dealing with taxes in bankruptcy.
Dan Gibson: Hello, everyone. This is Dan Gibson. I'm a partner in the New Jersey office's Private Business Service Group. I've been with the firm for about 30 years. I have presented to a number of you in the past couple of months. The co-presenter that I've invited for this session is Jay Lindenberg. He is a director in our Insolvency Group, also in New Jersey. He will be giving us basically a tour of the bankruptcy landscape in general. Then afterwards, I'll be taking it over and talking about the interaction between bankruptcy and tax. Jay, you want to take over?
Jay Lindenberg:Sure. Thank you, Dan. Good afternoon, everyone. I'm going to discuss the b word and hopefully take some ease off the fears that you might have. Bankruptcy should actually be a last resort when all other options have failed and all other resources have been exhausted in terms of financial difficulty to a company.
Identifying financial difficulties. As a practitioner, as we continue to monitor and can see how companies are losing money from month to month, which usually is one of the first indicators, usually it needs to be looked into further to actually see what is the cause of this situation. I will say though that over my years of practicing bankruptcy, anytime I have seen a financial statement prepared for a bankrupt company prior to, it usually has the going concern opinion about its ability to continue. So to a certain extent, that part is correct.
Another indicator about a company's ability to continue to operate in bankruptcy difficulties is with the insolvency. The traditional test is one looks at liabilities of a company and the assets, and if the liabilities exceed the assets, it could be deemed to be insolvent yet that's not the only definition or alternative. Obviously if they can meet their obligations when they become due, they could have some long-term debt on the balance sheet which could make that happen.
You really got to look into all the factors, especially the company's industry and the customer base in making some of these decisions. Another topic, when I talk about a catastrophic event, I think that COVID-19 is going to be a catastrophic event, and there are going to be a significant number of bankruptcies once the PPP and some of these funds have gone away.
The overview of bankruptcy. Bankruptcy is basically a federal proceeding that you appear, involves a federal judge, and the concept is to protect and preserve the assets of what we call the estate. With all my years of experience, this is much easier said than done. Part of a bankruptcy filing is also the appointment of a judge and then the Office of the United States Trustee, which is a department of the department of justice, which also involves in the financial affairs and monitoring of every bankruptcy case. So there are a lot of hurdles that one has to get involved with.
Now, the ultimate goal of the bankruptcy would be, and the only way to emerge from a bankruptcy filing is to file a plan which hopefully is a plan of reorganization, but there are some other options that we will be discussing shortly. As everyone is aware, there are lots of bankruptcy chapters. Chapter 7 is a liquidation, a Chapter 11 is a reorganization, a Chapter 13 is another chapter for small individuals to reorganize. There's also a Chapter 15 that is foreign bankruptcies that we're not going to talk about in this presentation because we're really keeping it to domestic affairs.
A Chapter 7 is what the majority of the cases that I've worked on in my career. And basically a trustee is appointed for the purpose of closing down a business. A Chapter 7 is the liquidation of a business. The business gets closed. A trustee is appointed, this individual may or may not be an attorney, but the objective is to liquidate and terminate the business. This trustee would have a team of professionals working with them, which would include an attorney, could be special counsel if there's an ongoing litigation or something from a previous part of the case that's warranted.
Definitely most important is financial advisors, tax return, preparers, appraisers, auctioneers whatever he would need, or she would need to take control in order to liquidate the company. After the trustees' appointment, he normally has to first deal with emerging issues relating to closing down of the business. And certain circumstances, unfortunately has to terminate employees, has to vacate the premises, has to tee up for some kind of option sale, if it's warranted, if there's any inventory or machinery equipment that needs to get sold.
So the key responsibilities or functions of the accountants in these situations is really to get control of the financial information, the computer system, the books and records, and any other information that might be warranted in this particular situation for further investigation. A Chapter 11 is really for the protection from your creditors in a bankruptcy court. It's traditionally designed for big companies to restructure, but over the years there has been a lot of creativity and modifications to this, which we can talk about in a little bit.
A debtor is considered a debtor-in-possession and has control of the operations of the business or his personal affairs, if it's an individual case and no trustees involved. But you do have situations where there is a credibility of management, and there are parties in the case have concerns that the management is conducting itself properly in these proceedings, and a trustee can be appointed. And those become very interesting situations to say the least.
The function of the United States Trustee or UST in a Chapter 11 case, it has a lot of responsibilities, is quite involved as far as monitoring every case. The information that's being provided is being provided in good faith to the parties that are concerned and are informed. Debtors are brought up to date, or debtors are kept up to date with their filling responsibilities, reporting. And then there is a collection of a quarterly fee, which is for their interest as well.
Another area or responsibility is the organization of a creditors' committee where on large cases it might be warranted to be invited to participate on the committee for the benefit of creditors. That's what a creditors' committee is. The largest creditors are identified in the outset of the case. And usually the committee has an odd number of members so that no votes can be passed.
To emerge from a Chapter 7 you need to file a plan, which is a very involved, long process, can take many, many weeks of a legal process reaching out to creditors, getting their votes. There's ultimately a hearing. And then a plan when it's approved and all criteria has been satisfied. There's something, what we call an effective date, which is the date that the plan will go into effect.
This is a period between the end of the confirmation hearing to give the debtor and the parties involved time to enter into loan agreements, get documents signed, there's financing involved and any other transactions like that, that need to take effect as well as the effective date is also the date that gap generally accepted accounting principles recognizes the reorganization.
So if prior to that date, there was $10 million of unsecured debt on the books, and there's a 15% distribution over time. That $10 million should be reduced to a million and a half dollars. And that's the date that would be coming into the play. The pipes of Chapter 11 plans, there are some variations. I mean, in the old traditional school, a plan of reorganization was giving a company or an individual a fresh start, give an opportunity to repay creditors at a reduced rate over time and basically redevelop and re-emerge their business.
Over the years, there have been plans put into place to establish other criteria and other objectives such as a plan of liquidation, which the management liquidates the company versus the Chapter 7 trustee. If you know you're going out a business, if it's just the only objective, management might have better connections with the industry to liquidate the assets. So it's a much smarter situation if the situation's warranted and there's credibility and everything else that needs to be involved.
There's also very, very popular is the 363 sale of assets. Basically the assets of the company are sold. It could be all the assets, it could be some of the assets. The valuable components that have some value and they're sold free and clear of debt. So basically they get the assets and then there's a remaining bankruptcy shell of the bankruptcy case that usually spins off into something called the liquidating trust.
And usually the trust comes into existence if there's pending litigation or litigation yet to be filed or pursued for the benefit of the creditors. And this is the tool that's used, it's accepted by the IRS, the tax returns are filed et cetera. And it's the way the two of them work together as a subsequent event to the Chapter 11 filing. The fourth item on the list is, or convert to Chapter 7.
It's not really a type of plan, but if you don't have any other ways to emerge from bankruptcy, by filing some kind of plan, you are ultimately going to be converted to Chapter 7. And it's just unfortunately after a period of time, that's what has to happen with the process. And one of the interesting things that have come into play this year is the sub-Chapter 5. It's really a Chapter 11, sub-Chapter 5. It's designed for small companies and individuals with an opportunity to reorganize.
So if you looked at Chapter 11 and Chapter 7, either you liquidate, or you're a big company you can't be able to emerge. This seems to be a very logical alternative. It's a lot less expensive on the debtor. There's no committee, there's no US trustee fees. You can maintain ownership without putting any new value or any money in, so actually it's an excellent tool. It's an excellent tool, and I think there's going to be a lot of people utilizing this coming forward, if they meet the criteria and the key factor is the amount of debt.
But fortunately, the CARES Act has extended the debt to seven and a half million dollars, for your secured and unsecured debt. So there seems to be a lot of leverage and opportunities there if you meet the criteria. A trustee is appointed but it's very different than a Chapter 7 trustee. This trustee basically works with you and assists you through the process of filing a plan and some of the other criteria is of what you're going to do to emerge from your case.
So it's something definitely to be looked out, looked for. In the future it's going to be the hot potato in the bankruptcy industry. As part of Chapter 11, there's also the creditors' committee, which is as I mentioned earlier, it's a committee that's formed by the United States Trustee's Office to investigate the affairs of the company, the relationships with creditors, and someone looking out on the other side for larger cases, the debtor does bear the cost.
There's a lot of beneficiary and a benefit to working on the committee with a debtor can provide a lot of benefits to the debtor based on relationships. And obviously the committee consists of their creditors in the first place. Large cases and they bear the cost and it's definitely another responsibility obviously as well to maximize the distribution to the unsecured creditors. A creditors committee can investigate the debtor's affairs, including the avoidance actions, litigations, et cetera. They kind of work in a hand in hand tool.
Chapter 7, I'm just going to give a little story isn't as easy as you always think. I was once involved in a case that it was a nursery for wedding flowers and right around Memorial Day with lots of weddings going on, and the trustee actually got permission to the court to operate and be able to provide the flowers. But there's also a more famous one of the trustee with wedding dresses that the wedding shop was closed down and the trustee actually tracked down the people and helped them get their wedding dresses. So it's not always as easy as we think.So if determines that the amount you're receiving in a Chapter 11 distribution is greater than the amount you would see if the company was liquidated under Chapter 11. But claims analysis is the correct answer because that's really something that a Chapter 7 trustee would ask you to assist them with.
Okay. Chapter 13. This is a mechanism for individuals to reorganize based on their ability to pay with cash or funds that they have available. There is a means test involved, and that determines the ability to repay based on a calculation of disposable income, usually for a five-year period. There are limitations about $395,000 of unsecured debt and a million, 184 secure debt. But these amounts are significantly less than a Chapter 11, sub-five requirement, so it might work.
There is a trustee involved, but he's basically there to collect and distribute the money. So if you had excess disposable income of a thousand dollars a month, $12,000 for five years is $60,000. You would repay 60,000 of your debt. If you had a quarter of a million dollars' worth of debt, you'd give everyone 25 cents in the dollar give or take. So that's basically how the Chapter 13 process works.
Another one of my cases that was very interesting regarding the largest creditor, never perfected his position so he became the chairman of the Unsecured Creditors Committee. And he worked with the committee and the professionals and confirmed the plan. It's about 20 cents on the dollar and everybody was really happy. And then he went and pulled the plug on the product line. So in bankruptcy, you never know what can happen.
The first day orders and motions are key as far as payroll and rent and certain are the key liabilities that need to be paid expenses, critical vendors, as well as the provision for professionals to get paid on a monthly basis, following the filing of a monthly fee application. The statement of schedules and SOFA is something that's really full financial information. A bankruptcy schedules do include components of the trial balance. So the most up-to-date records a debtor has at the date of the efficient date would be very helpful.
And there's also the statement of financial affairs, which is just a wealth of information about the history of the debtor, a lot of critical information over the past couple of years regarding income and other sources of information involved with the company that it's definitely worth looking at the responsibility of preparing the monthly operating reports is something that needs to be done on a monthly basis.
Key including cash flow and really the debtor is compiling liabilities or certain things like that, that might give rise to some kind of concern in the case for the parties involved. The claims bar date, that's the cutoff date the claim should be filed. Everyone should be aware of your practitioner, non-practitioner. If anyone ever filed bankruptcy and you receive one of those notices from the court, you should file it, and make sure it states your claim properly.
When in doubt, just file it. It's better to be safe, than lose the opportunity to collect some kind of claim. So definitely very important. There is what we call the disclosure statement. That's this file at the same time as a plan and a sub-Chapter 5, you'll actually do them all together. And a traditional bankruptcy is spread out over a little bit of time and just explains all the criteria and everything that's going to happen with the plan, and how's the debtor is planning to emerge from Chapter 11, if they're following the plan and there's a confirmation hearing that include testimony.
This depends if there's a consensual plan, if all the parties are in agreement if all the votes have been cast, if any impaired class issues. And then there's the effective date, which I talked about earlier, but it's a very key time, the bankruptcy is over, as far as filing issues, et cetera.
There are alternatives to bankruptcy. I mean, for a Chapter 11 is any kind of out of court settlements or restructuring or modification of some kind of banking facility or something clearly would be a better way to go. And I'm sure a lot easier on your pocketbook, but the 11 is there, the new sub-five, obviously I mentioned a few times might meet the criteria. A Chapter 7, there is something called an assignment for the benefit of creditors, there's an alternative to check the seven.
And that's a state level proceeding of liquidation. It is different in every state and you have to file all the local rules of the state, but in New Jersey, for example, it is very lucrative. There are numerous businesses that have been successfully liquidated under the assignment for the benefit of creditors. And sometimes if there's too many complex issues, you're going to need the file, the bankruptcy, and sometimes if there's things that easily can get brushed under the rug.
You might be able to work that aspect out as well. So definitely a very good tool to keep in mind as well. Some of the other services that financial advisors or practitioners provide, we discuss the schedules, monthly operating reports is almost like a financial statement with a lot of detail, files on forms designated by the office of the United States Trustee. The claims analysis, which was the correct answer on the polling question would go back and look at the claims file and determine if the claims really are valid. And I would see if it points in your case.
When distributions would be made, you wanted to take that in consideration and you've got to get the right numbers so you can make fair distributions to all the parties. In a reorganization of a Chapter 11, the key financial information provided by the financial advisors is needed. Liquidation analysis would be a liquidation of the assets as it would turn into cash for potential distribution, forecast or projections with realistic assumptions.
I have many a times heard bankruptcy judges really say, a good set of projections with a good liquidation analysis really goes a long way in making the decision of the viability and see the ability of a company trying to emerge from bankruptcy. So that's something to keep in mind. And that would be really where you want to focus if you are working with a Chapter 11 debtor or a client of that nature.
I do want to briefly just talk about avoidance actions and payments in the 90 days and insiders. Basically all payments in 90 days are subjects to fallback or a preferential treatment, which would be allocated to the other creditors. In recent times, it's required to have your defenses before actually you file your preference claims. That's a very key factor these days about what's the new value and ordinary course might be, that might adjust the value of the claim or really make it more realistic of what the preferential transfer is about.
There's also the fraudulent conveyances that financial advisors and practitioners are quite often involved with in their go back on whatever potential litigation or fraud that might be deemed to be worth investigating. And that falls on the state statutes that there's a four-year look back period in New York, excuse me in New Jersey, but six years in New York. So depending on your case, you might've been in a business in New York years ago, and now you're operating in New Jersey that might have a six year look back. So you really want to keep everything in perspective as far as that goes.
And the one last comment I'm going to make before I turn it over to Dan is the 505(b). That is a prompt determination, which is an action you will make when you file a tax return. It's in the bankruptcy, as far as a taxing authority has 60 days to decide if they want to order that particular tax return. Now, it really is for an entity that has a tax liability, like a corporation or an individual verse partnerships and liquidating trusts that really have no tax liability.
But a lot of practitioners that I've worked with over the years, we always file them. You get back a letter, the IRS has decided not to order this return, if they accept the prompt determination, or you get some letters with other language, but it is a letter from the IRS but it's signed off by someone that the return was received with a date and all kinds of other confirming information. So it is a very valuable tool and I suggest using it. Now I'm going to take you from the bankruptcy code. I'm going to turn it over to Dan. Who's going to talk to you about the IRS code and thank you.
Dan Gibson:Thank you, Jay. And as you can see Jay is a wealth of knowledge when it comes to the bankruptcy area. And he works with his clients attorneys, other practitioners working and helping them through the process. And just so you know, a little inside baseball. One of the things that we get involved from the standpoint of the other tax departments, we assist Jay in preparing personal returns, corporate returns and liquidating trust that need to be done. And obviously that stuff doesn't go away.
There's still those filings. Even though you're in bankruptcy, those filings still need to take place. So, as Jay said, we're going to bridge over now to the tax effects in bankruptcy. Just a couple of comments and Jay's mentioned some of this stuff from a financial planning strategy. You don't want to take bankruptcy lightly because it is a big step, but it's not something you want to overlook as far as strategies, especially in a tax resolution area.
One product warning I guess like you'd see on a package or on a commercial, there's no DIY's in this, no do it yourselfers. Make sure you're getting experienced bankruptcy attorney advice in something like this, you don't move forward with someone who's doing some other part of the law somewhere. You want to make sure you have someone who really understands this area. And one of the goals here and my part here for the practitioners that don't deal in bankruptcy evidence, just give you an awareness, so that you can discuss some proficiency with your clients with the bankruptcy attorneys that you may interact with.
The effects of bankruptcy, one of the different options that you can go through. Because again, one of the benefits of bankruptcy in this planning strategy is particularly when it comes to tax and tax resolution is you can bring a dead halt to collection activity with a bankruptcy filing, give you some room to breathe, get your thing together. At the beginning of the collection activity, it took onto the IRS and the taxpayer is a thing that has just gotten out of control.
This is a way of putting that to a halt and giving the taxpayer some room to breathe. It does give you an opportunity to do reduce and in some cases even eliminate taxes, penalties, and interest. And other cases, when you need to get into some sort of a payment plan and the government is not willing to give it to you, the bankruptcy court can kind of shove it down their throats whether they like it or not, but they've come up with a payment plan.
And just a recap of some of the bankruptcy chapters. Jay, I can't do it any more justice than Jay has done already, but the ones that most of the practitioners on this call are going to see is Chapter 7, which is basically a liquidation for individuals and businesses. Chapter 11, Chapter 13 are really restructuring reorganizations for the most part. Most people will go into Chapter 13 unless they've got significant amount of debt and then they're thrown back into a Chapter 11, which is where the businesses primarily are.
And again, just be aware of one thing that Jay mentioned also is that you can try to get into Chapter 7, but you have to go through a mean test to stay there and if you're not, that's what pushes you back to Chapter 13?
I did see one question here, Jay; you could jump in if you want. But someone was asking about what is discharge in terms of bankruptcy. In my definition, I would say discharge simply is getting rid of I guess a part or all of the data at one point. Well, that's my definition.
Very good. The right answer is Chapter 7, which the majority of people got, very good. The other thing I mentioned a little bit was the ability to be able to basically stop collection activity. This is under section 362(a) of the bankruptcy code. There's an automatic stay on any collection activities that take place. And this usually includes the IRS and all state tax departments. What ends up happening from a tax standpoint, the cases is most likely somewhere within the collection division, whether it be automated collections or a revenue officer, or maybe even an appeal for that matter.But it's transferred out of their hands into the IRS insolvency unit to take care of it from there. If there's any ongoing audits or criminal investigations going on with respect to tax during that period of time, those are not protected when you file bankruptcy. And what ends up happening and again as Jay has mentioned, there's bankruptcy of estate that is created made mostly of a property that was owned at the time of bankruptcy.
And the trustee has to go through and make certain judgements on those properties as to what's liquid. And obviously if you're in a situation where someone has a car, but they have more debt on it than the car's worth and debts secured that's probably not something that you're going to even worry about trying to liquidate. So you really have to make a judgment in there. What is worth something, consideration that debt that's associated with it and to the creditors.
Most retirement plans in bankruptcy are not included. Though the IRS can still go after the 401k. And depending on the states you have to be concerned about what properties are excluded. Most people's value is in their real estate and when we talk about depending on what state you're in, really looking at the homestead exclusion there. As most of you've known, if you're in Florida or if you're in Texas there's an unlimited exclusion for the most part, for those states, when it comes to home.
Then we go over the 10 rules to Chapter 7. And the first three on this page are probably for us practitioners that work with clients that maybe in this sort of a situation. If you've turned out for a bit, I would turn back in for these first three. Because these are probably the most important, because in a lot of people's opinion they don't think taxes can be discharged in bankruptcy, but they can, but you do have to follow these certain roles. All right?
Rule number one is there's a three-year-old, which is really triggered on the due date of the return and it's the due date including the extension. So for individuals, it's going to be April 15th or October 15th. Doesn't matter when you file a return. But whenever that due date is, it has to be more than three years prior to the filing of the bankruptcy. Rule number two was 240 days. They'll say a return has been filed and it's being amended or it's under examination and there's an assessment, that assessment has to be 240 days prior to the filing.
240 days is proximately eight months and rule three is the two-year rule. So in the event that a return is filed late it has to have been filed to two years before the filing of the bankruptcy. I'm going to go through a couple of things here. There is some controversy regarding late filings. There are some federal circuit courts that, if you're late filing by a day, they consider that not to be a return and the taxes associated with that are due to be dischargeable in bankruptcy.
Substitute returns in the cases where the late filings are okay, the substitute returns are normally not counted. But if they're signed, they can be counted. But again, you have to be careful about the federal circuit that you're dealing in. What their restrictions are with respect to late filings. And these three rules are commonly called the three, 240 rules for getting taxes discharged in bankruptcy.
I'm just going to go through a couple of examples here on the three, two, 240 rules. You have the three-year rule, Joe files for and receives an extension of time in which to file his 2008 taxes to October 15th, 2009. The tax returns due is now October 15th, 2009, rather than the original date of April 15, 2009. Joe wishes to discharge these taxes. He must wait to file bankruptcy until October 15th, 2012, as you can see that's the three-year rule.
And the two-year rule. Jill's 2008 income tax returns are due on April 15th. She doesn't get an extension and she doesn't get around to filing a return to June 1, 2010. If Jill wants to discharge her 2008 taxes, she can't file bankruptcy until June 1st, 2012, two years from the date she filed the return and more than three years from when the return was due.
The 240-day rule, Jill files 2008 return on April 15th and assesses her taxes shortly after that. However, the IRS audits Jill's taxes and finds Jill made mistake, unbeknownst to Jill she owes a few hundred dollars more on the amount on a rate of return. The IRS assesses the additional tax along with some penalties and interest on March 1st. If Jill wants to discharge the newly assessed tax penalties and interest, she'll have to wait until October 27th, 2012, that's 240 days until she files for bankruptcy.
When you deal with these rules the three, two, 240-day rules, you really have to be also cognizant of any tolling that may take place. And tolling means during those periods of time where the IRS is prohibited from doing any collection activities, the three-year rule is tolled. So if there's some sort of collection activity that's tolling it for say six months, your three-year rule becomes three-and-a-half-year rule at that point.
So certain things like if you're in the middle of doing offers in compromise, or if there's a collection due process request coming in, or if there's a taxpayer advocate that's been worked for the taxpayer if you previously filed bankruptcy. If you're actually in a payment arrangement, if you're in an installment arrangement that does not toll the statute at that point. So it's really important.
I think this is probably the case with anything. And then I've mentioned in the past with tax resolution, you want to get a transcript and you really do want to sit down with an experienced bankruptcy attorney and go through that transcript to make sure that you're not going to file a bankruptcy prematurely and knock out certain tax returns that you've wanted to get the taxes discharged. So again, you would just want to check that.
And then again, just to note here, the late filing of returns, again depending on what federal circuit you're in, you may not be able to discharge any late filed returns. So just be aware of that. So back to the rules. Rule four. Fraudulent return rule, the returns can't be considered a fraudulent return. IRS has the burden of proof there. They have to show knowledge of falsehood of the return and an underpayment of tax.
Rule five is the tax evasion rule. Taxpayers must not have willingly attempted to evade taxes. Again, the IRS has to establish there was a duty pay the tax, the taxpayer was aware of that duty and the taxpayer deliberately avoided that tax. Rule six, obviously, if there hasn't been any assessed tax, the tax is not going to be dischargeable, the tax has to be assessed prior to the petition. And again, it has to be in consistent with the three, two, 240 rule that we talked about previously.
Rule seven. Important to note here, payroll withholding sales and other trust fund taxes are not dischargeable. These are usually taxes that are required to be collected by the taxpayer and then remitted by the government. Most of you are familiar with those. Those are withholdings from employees. The employees' portion of social security state sales tax. These are not dischargeable. All right? And in fact you have to be careful with those because the owners of the businesses that get involved in these sort of things, the IRS can go after them personally for these things.
Property taxes have to be assessed at least a year before the filing in order to get those discharged, and the excise tax or custom duty tax, they must be imposed at least three years before the filing. And if you have any gap claims, if the taxpayer is forced into involuntary bankruptcy by the creditors, the trustee appointed, before the trustee appoint any tax claims that might arise in between the forcing into the involuntary bankruptcy and the appointment of the trustee will not be dischargeable.
This is a good illustration of what I'm talking about, with the amount of time that has to expire before filing a bankruptcy. In this case, you have a non-filing, hasn't filed for a number of years. And all of a sudden they file in 2013 with all these returns and they want to file bankruptcy August 2008. The return that falls out of here is the 2012 return. All right? That's due in 2013. He's extended all his years.The 2012 return will be due in 2013, October 15th of 2013. So the years that would have expired if he had only done it in August of 2016 to 2012 would have dropped out, he would have to really hold off filing a bankruptcy until October 15th, 2016, in order to effectuate and get the bankruptcy for all the years that he's filed.
Okay. All right. So again, it's the 2008 through 2011, years that we're talking about, that would be discharged from bankruptcy. So the different types of tax debt that we have. When you're going into bankruptcy, you have a general unsecured and non-priority tax debt. These are ones that meet the three, two, 240-rule and that aren't already priority or security debt. These are usually dischargeable. The priority debt are those that don't meet the three, two, 240 rules, those are not dischargeable debts.And then you have the security tax. The IRS has a lien on the property of the taxpayer in the lien. But the lien is limited to the property that you have. The remainder goes to the general unsecured tax that I have a short example here. The IRS files a tax lien against Mike's personal and real property to $200,000 for back taxes. Mike only has 30,000 in equity in his home after subtracting the mortgage and his personal property he's only worth $20,000.
Mike files bankruptcy. The total value of his real and personal property is obviously $50,000. So the secured debt is $50,000. The remainder of the $150,000 becomes the general unsecured debt or priority debt depending on whether or not it falls within the three, two, 240 rules. Just be aware that even though you've gone through bankruptcy, the federal tax liens do not go away, they do attach to any future property interest and then obviously the IRS is looking for the big stuff when it comes to that. So if you're paying any real estate and you still have the federal liens still enforceable, that could stir up an issue with you.
And penalties, interest and liens. Penalties are meant to punish taxpayers or normally dischargeable. And these are the accuracy failure to file, failure to pay penalties. Penalties that are meant to repay the government is not dischargeable, namely the trust fund recovery. That's a penalty that's charged against which we talked about before. The trust funds not being dischargeable and the owners possibly beginning now put on the hook for those withholdings or employer social security portions, they'll be assessed a tax fund recovery penalty and that is not dischargeable in bankruptcy.
Interests follows the tax. So taxes interest associated that will be eliminated. Again, loans normally pass-through bankruptcy, they remain on any assets or any future assets that are purchased. The IRS does tend to stay away from seizing personal residence and retirement accounts, even though they could and they do when cases are egregious and the taxpayers are not being very cooperative.
Normally what we advise clients to do when they go through bankruptcy is after it's done, give it about 60 days and then call up the IRS insolvency, they have the phone number there, to confirm that the discharges and to address any releases of any liens. Because a lot of times the IRS at that point, they just want to clean up their books. All right? So we might be able to work up a deal at that point and pay a certain percentage of the dollars to get the taxes of your lien released at that point.
So that ends our presentation. I thank you for all attending and I see there's a number of questions here. We'll definitely get those answered and out to you as soon as possible.
Transcribed by Rev.com
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