Truly NASTY Tax Surprise-Pre Bk Decision

Community Leader
Registered: 03-17-2003
Truly NASTY Tax Surprise-Pre Bk Decision
Wed, 02-01-2006 - 3:25pm

There are a lot of decisions to be made before you decide to proceed with bankruptcy. You can get relief from oppressive debt, and if your debt is hindering your ability to put a roof over your head, food on the table and clothes on your back it is considered oppressive---makes absolutely no difference what the dollar amount is! It is your Constitutional right to proceed with filing and I hope you never let anyone push the emotional buttons to make you feel guilty about it. It's a business decision - pure and simple.

Reaffirming debt is also a business decision. Think long and hard about the sensibility of keeping those cars and their jumbo monthly car payments. Look at the current value of the car and how much you owe. Are you "upside down" on the car, i.e. do you owe more than the car is worth? If so, then consider including it in your bankruptcy, walk away from the car and it's hefty monthly payment and walk away from the tax liability. It is one of the beauties of bankruptcy: you escape an oppressive tax liability!

Yes folks if you go through a repossession or foreclosure you could very well be socked with "income" reported courtesy of your former lender to your and my favorite institution: the IRS.

Let's say you are trying to avoid bankruptcy and you have the gift of gab. You call up and convince your credit card companies that, unless they reduce your debt balances, you're going to file bankruptcy and they will get a big, fat Zero from you. The credit card company says, "Wow don't do that to us!" and they generously lower your balance by say $5,000 so you can pay off the balance over the next year or two. Here's the Nasty Tax Surprise: That $5,000 reduction they "generously" carved off your debt is now ordinary income to you and could cost you as much as $1,750 in additional income tax. You'll find out when you get a 1099 in the mail (miscellaneous income). Bet the debt management companies (who are linked to credit card companies) don't tell you about this "deal."

The same thing can happen after bankruptcy with the car or house. If you are getting back on your financial feet you may find you are still struggling with that car's premium payment and if things go sour and the car is repossessed, you will get hit with a NASTY Tax Surprise too. Every protection you had in bankruptcy won't save you after bankruptcy. The beauty is if you do surrender the car or house during your bankruptcy proceeding, you escape the NASTY Tax Surprise. Plus all the credit card debt that is wiped out won't be reported as income either (as opposed to the above scenario).

These sort of real life financial hits occur every day. Businesses are built on it. So think long and hard about keeping the secured debts like the car or the house - especially if you have your underlying deed of trust and a HELOC (home equity line of credit) or you owe more on the car than it's worth. If you do include these items in bankruptcy and the lenders sell at a loss (less than you owed) you won't get stuck with the NASTY Tax Surprise because it was sheltered by the umbrella of bankruptcy.

It's a business decision. You'll have other cars in your life. You'll have other homes. And at the very least, if you do decide to keep the secured debt, at least you are aware of what can happen should the "worse case scenario" come to pass.

Hope this helps.

Carolyn