Logically, you want to know if this debt forgiveness is income and possibly even if they owe this tax on debt forgiven, why did they even file bankruptcy in the first place? The short answer to that question is no, the debt forgiven is not taxable income; however, I should point out that exclusion is contingent on whether the debtor actually received a discharge.

This means that if you filed bankruptcy and received a discharge, even though you might receive a 1099, you are almost certainly excluded from paying taxes on the forgiveness of income.

Regardless of whether the income is taxable to the debtor (and in almost all circumstances in which the debtor received a bankruptcy discharge that year, it is not), it can still be proper for the creditor to send the debtor a 1099. The debtor needs to then fill out the IRS Form 982, which gets the debtor out of paying taxes on the 1099 income due to insolvency.

The very first box of the form, 1a, gives the debtor an exclusion by virtue of a discharge of indebtedness in a title 11 case, which is the bankruptcy chapter.  If the debtor has any questions how to complete the form 982, he/she should consult a qualified tax professional.

This is not to say that bankruptcy is the only reason for someone to fill out the form 982. If you did not file bankruptcy, you still might qualify as “insolvent” for the purposes of avoiding tax liability. Or perhaps you are solvent, but qualify for the Mortgage Forgiveness Debt Relief Act and Debt Cancellation. This act current extends through 2012 and forgives most debt associated with losses on a primary residence.

In other words, the person who short sold their home to avoid bankruptcy might qualify to avoiding taxable income under the Mortgage Forgiveness Debt Relief Act and Debt Cancellation, but the person who filed bankruptcy qualifies for insolvency automatically.

This question came as quite a surprise to me given that I did not remember her reaffirming the debt in her chapter 7 bankruptcy. It had however been almost three years since her case was filed and over two years since it closed, so I was not too sure on the details. I pulled her case docket and sure enough, she had not reaffirmed.

I then took a look at the bank’s state court complaint and noticed that without my knowledge, they had my client sign a new promissory note in the middle of her case. This was not a reaffirmation agreement, since all reaffirmation agreements must be approved by the judge. Under 11 USC 524, a creditor must get the debtor to sign a reaffirmation agreement if the creditor wants to bind the debtor to the debt post bankruptcy, assuming it is for the same collateral as the pre bankruptcy note. This bank had skirted the reaffirmation process by getting the debtor to sign a new note that was not approved by the bankruptcy court.

So what was the end result of the creditor doing things the wrong way? I notified them that they must dismiss their suit, as it is a violation of the debtor’s discharge order. Furthermore, this debtor has grounds to bring an adversary proceeding against the bank for its violation of the discharge order and possible damage to the debtor’s credit.

The point to take away from all this is anytime the creditor does not get the debtor to sign a reaffirmation agreement during the pendency of the Chapter 7, the debt is forever discharged. The creditor still has its lien rights as to the collateral, but the debtor no longer can have personal liability.

Many debtors who are going through the bankruptcy process are intimidated by the idea of attending a 341 creditor meeting, or also called Trustee’s meeting. This isn’t surprising because the 341 creditor meeting is a legal proceeding that requires debtors to review their Chapter 7 or Chapter 13 bankruptcy petitions with a court-appointed trustee.

This meeting can feel intimidating because your creditors can ask you certain questions about your debts. However, you can take the stress out of attending this meeting if you plan ahead. In almost all cases, no creditor is showing up to ask questions. Normally, it is only the trustee and you. The trustee is not a Judge. He is an attorney who often besides of being a trustee handles his own bankruptcy cases and knows that debtors might be nervous at the meeting. In St. Louis, Missouri, for example the trustee’s meeting is held in the Federal Court Building but not in a court room.

Here are some suggestions that can help being prepared for your 341 creditor meeting:

1) Try to meet with your St. Louis bankruptcy attorney or an attorney in your area before you attend your meeting.

It’s a good idea to meet with attorney before your 341 creditor meeting because he can help you review your petition to help you understand possible questions that could be asked about your petition. Your bankruptcy lawyer in St. Louis or your area knows the trustee and questions he will ask about debts, income and your bankruptcy petition in general.

2) Try to watch a 341 creditor meeting in person.

A 341 creditor meeting is a legal proceeding that can be watched in person just like most other legal proceedings in this country. In St. Louis for example, many debtors have the 341 meeting at the same time, the meeting with the trustee takes only a few minutes. He will examine your social security card and picture I.D. to make sure you are the person who is filing bankruptcy and that no one else is using your personal information.

When waiting for your case to be called, you will have the opportunity to listen to the questions asked in previous cases. The trustee normally is asking the same or similar questions. You might be able to reduce the stress of attending your 341 meeting because you can see first hand how your meeting will be organized and conducted.

3) Be sure to arrive at your 341 creditors meeting at least 20 minutes early.

It’s a good idea to arrive at your meeting early because you will need to find your attorney who might have other clients scheduled for this time as well. Often, depending on the trustee, you might have to fill out a short questionnaire. In St. Louis, Missouri, for example, the chapter 13 trustee requires a two page questionnaire to be filled out before hearing your case. If that is not filled out, you have to wait until all other cases are heard.

If you don’t understand these rules, or if you need help with the paperwork, be sure to ask your bankruptcy attorney in St. Charles or your area for help. He can help you understand the rules and paperwork in a way that’s easy to understand.

4) Finally, don’t forget to have your Social Security card and picture ID ready for inspection.

It’s important to bring your Social Security card and picture ID to your 341 meeting because Missouri’s bankruptcy regulations require debtors to prove their identities before a 341 creditor meeting can take place. As a result, be sure to place your picture ID and Social Security card in your purse or wallet the night before your meeting. Doing this is the easiest way we know to have these important items with you when it’s time for you to check in for your 341 creditor meeting. If you forget your ID or Social Security Card, the trustee most likely will continue the meeting.

For more information about preparing for a 341 creditor meeting, please ask a bankruptcy attorney in St. Louis or in your area for more details. They can help you find more ways to prepare for your 341 creditor meeting that can help you feel more comfortable completing this important part of the bankruptcy process.

Guest post by Tobias Licker, St. Louis Bankruptcy Attorney

The easiest way to know that would not be correct is the old adage that if it is too good to be true, then it probably is. Think about it, if all you had to do to own your house free and clear was to file Chapter 7 bankruptcy and not reaffirm the mortgage, then a lot of people would do that.

The reason the debtor does not own the house free and clear after not reaffirming the debt is because the lender recorded a lien (often referred to as a security deed) when the debtor originally took out the mortgage. As consensual liens cannot be avoided in bankruptcy, the bank’s lien survives the bankruptcy, even if the debt does not.

Now some of you might have heard that you can get rid of the second mortgage lien in bankruptcy. That actually is true, but there are a couple of key differences. For starters, that can only be done in a Chapter 13 and not a Chapter 7. The second point is this “lien strip” can only be done when the debtor’s first mortgage (which survives the bankruptcy), is worth more than the value of the debtor’s home.

Another point to take out of this lien discussion is that it applies not only to real estate, but also to the car liens, provided the car was taken out with purchase money. Therefore, even if the debtor is in a state where he/she can continue to drive the car without reaffirming, the lender’s lien will still remain valid, and the debtor will have to pay off the lien to ultimately get free and clear title.

11 USC 1329(a) permits the debtor to modify its confirmed plan “upon request.” Therefore, any debtor who is struggling with his/her payment and needs to reduce the monthly payment, can ask the court for a modification.

However, there are a couple caveats to this provision that all debtors need to be aware. This code section also allows a trustee and/or a holder of an allowed unsecured claim to make this same request. Therefore, a debtor who has experienced an increase in income since confirmation could be made to increase the monthly trustee payment.

More importantly however, this provision cannot be used by a debtor to override the fact that there are certain payments the debtor must make to complete the chapter 13 plan and receive a discharge. For instance, the debtor must pay off all child support arrears to complete a chapter 13. Therefore, if the debtor has experienced a loss in income, the debtor cannot get the modification approved if the modified plan does not contemplate for a complete repayment of the arrears over the life of the plan. This is true even if the debtor has a genuine inability to pay.

Let’s compare two scenarios, both of which where the debtor pays the trustee $700 per month and loses his job. In scenario one, the debtor has $50,000 in unsecured debt and is in a confirmed plan that pays it at 100%. In the second example, the debtor has $30,000 in unsecured debt that he pays at 0% and $30,000 in child support arrears that he pays at 100%. The first debtor can attempt to adjust the unsecured pool lower because he does not have to pay the unsecureds a certain percentage, whereas the second debtor must come up with enough money to pay off the arrears on the support obligation.

Therefore, while both debtors had the same trustee payment and maybe even made the same salary, the debtor in example one can get a modified plan confirmed, while the debtor in the second example cannot. Note that creditors could object to the debtors modification in example one, but most likely their objection would be defeated by the debtor if he can show a current inability to pay.

In a Chapter 7 bankruptcy, eligibility is determined, on one hand, by an income-based standard called the Means Test. This mechanism, introduced into the Bankruptcy Code in 2005 by financial industry lobbyists, looks at your household income (including all earners) and compares it to the median income for a household of that size in your state. If your household has a “below-median” income, you are eligible for Chapter 7 according to the Means Test (though, in reality, there are subtleties to the test that this quick explanation does not attempt to capture).

Additionally, however, there is an additional eligibility standard for Chapter 7 bankruptcy. This standard is a “good faith” standard that looks at your average monthly income and compares it to your average monthly expenses (as a household in both cases, not just as an individual). If there is “too much” money left over after those expenses are subtracted from that income, there is a possibility that the Trustees in your bankruptcy case may file a motion to have the case dismissed on the theory that you have money left over at the end of the month with which you might pay your creditors—even if you have passed the Means Test.

In such cases, every legitimate, honest monthly expense that cannot be objected to by the Trustees is of vital importance. Term life insurance with $0 present-day cash-value (benefit only to be paid out upon the demise of the policy holder) is a very useful expense to have on the list in such cases. (Note that whole life insurance, or cash-value life insurance from which the filing individual can draw funds at will at the time that the bankruptcy is filed, can be problematic as an asset requiring exemption or protection in Chapter 7 cases: this post does not address these issues.) Term life insurance is an expense that Trustees do not generally object to and will provide not only a reduction in monthly net income for “good faith” purposes but also will provide your family needed protection should anything unexpected occur.

In a Chapter 13 bankruptcy, this same monthly income vs. monthly expenses formula determines the amount of your Chapter 13 plan payment. Whatever is “left over” at that end of that average, hypothetical month described in the Bankruptcy Petition is the amount that is paid in the Chapter 13 plan on a monthly basis. Obviously, in this case, the term life insurance payment results in a lower Chapter 13 payment.

Some Chapter 13 Plans do require a minimum monthly payment to be made in order to be mathematically feasible and to meet certain criteria of the Bankruptcy Code, but a Chapter 13 bankruptcy is 3-5 years long and, though you are in bankruptcy and whatever the ramifications, life insurance remains a vital and responsible means of ensuring that a sudden tragedy does not result in long-term harm to your loved ones.

Guest Post by John M. Hilla, Michigan Bankruptcy Attorney

Both people had filed Chapter 7 bankruptcy within the previous three years and received a discharge. They kept their respective homes despite filing bankruptcy, but both experienced financial difficulty a few years after their filing which led to the bank sending them each a foreclosure notice. Neither of them were interested in keeping their house anymore, and they both said they were interested in completing a short sale to “solve the problem.”

This situation is all too familiar to some bankruptcy debtors, as their initial bankruptcy filing did nothing to reduce their monthly mortgage payment even though they kept their home. But even as both ladies were encountering a similar problem with foreclosure, there was one major difference between the two debtors which led to them taking vastly different approaches to their situation.

One debtor had reaffirmed her mortgage in her Chapter 7 bankruptcy, while one debtor did not reaffirm her mortgage. Although truth be told, neither debtor was sure whether they actually did reaffirm their mortgage, and I pulled their respective case dockets online to reveal the answer.

Think the decision to reaffirm is not a big one that should not be taken lightly? Consider that the debtor who did not reaffirm did not “need” to complete a short sale to absolve herself of the bank pursuing a deficiency, since her personal liability was extinguished in her Chapter 7 bankruptcy discharge.

Unfortunately for the other debtor, she continued to place herself on the hook for personal liability related to the mortgage even after her discharge, since by reaffirming the mortgage, she voluntarily allowed that mortgage to not be among her discharged debts. This meant that she now was either going to have a short sale or foreclosure on her record, was going to continue to harm her credit by these post-bankruptcy missed payments, and more importantly, was running the risk of the bank pursuing her after foreclosure for a deficiency.

These examples illustrate the point that reaffirming real estate is always a shaky proposition at best, particularly if there is no equity. Unfortunately most debtors do not realize that it is a myth to think they cannot keep their home if they file bankruptcy or if they do not reaffirm their mortgage in the bankruptcy.

Finally, it is important to note that if you find yourself in a similar situation as either of the above-described debtors that you must check your case docket. You might not remember exactly what happened in your case, and it’s always important to review the official case docket to determine what transpired in your case. As these fact patterns revealed, the proper approach for both debtors could not be known until the case docket was reviewed.

Therefore, if you have not filed your most recent or any prior year’s tax returns, the return must be filed prior to the filing of your bankruptcy petition. If the Trustee has not received the returns required prior to the 341 Meeting, the Trustee will likely, at best, adjourn the hearing, or, at worst, file a motion requesting the dismissal of your bankruptcy case.

What if you have filed for an extension, however, or if there was an inaccuracy in a prior return?

If you have filed for an extension, the outcome of reaching the 341 Meeting without having provided a full return depends greatly upon the good will of the Trustee assigned to your case. Ultimately, however, the returns must be provided and the fact of an extension having been filed is very likely not going to be very persuasive to the Trustee. You should proceed with the filing of your bankruptcy, if this is the case, with the understanding that your accountant may have to work faster than originally anticipated to get that return filed.

If there was an inaccuracy, or, worse, some level of lack of full disclosure, in any prior filed return for the income earning years that must be reported in your bankruptcy petition, this is a larger and more complicated issue.

Bankruptcy and tax reporting are both Federal processes but are not interlinked. However, you must by law report all income earned from all sources for a number of past years in your bankruptcy petition regardless of whether you disclosed or involuntarily or voluntarily failed to disclose the income in your tax return. While there is no obligation for the Trustee to do so, there is nothing preventing him or her from notifying the IRS of any discrepancy.

The income must be disclosed, period. “Attorney-client privilege” does not mean that your attorney can or will assist in a continuing failure to properly disclose income to the IRS by violating those independent ethical obligations with regard to the disclosures required in your bankruptcy petition.

If there has been any error or impropriety in a prior filed return, that error should be corrected with an amended return prior to the filing of the bankruptcy. If there is a debt to a Federal or local taxing authority as a result of the correction, this will, at the very least, enable your attorney to give you the best advice for addressing the debt along with the rest of your debt-load in your bankruptcy case.

Guest Post by John M. Hilla, Michigan Bankruptcy Attorney

If I receive a question on this subject it is usually something like can I keep my house if I dont sign a reaffirmation agreement? However, more often than not, its not a question I receive, but rather a definitive statement such as I want to sign a reaffirmation agreement so I can keep my house. I also get an offspring of that comment, which goes something like this: but I wont own the house anymore if I dont reaffirm the mortgage.

Aside from a rare minority ruling on this subject, the debtor can be assured that he/she does not need to reaffirm the mortgage to stay in the home. What the debtor must do to stay in the home is to continue to pay on the mortgage. However, this is true whether or not the debtor filed bankruptcy or not. The bankruptcy debtor should in fact be well acquainted with this concept, as the foreclosure notice the debtor might have received prior to filing bankruptcy would attest to.

In other words, the debtor who does sign a reaffirmation agreement but continues to fall behind in payments is in a much more grave threat of foreclosure after bankruptcy than the debtor would did not reaffirm, but made timely ongoing mortgage payments since the bankruptcy case was filed. With a signed reaffirmation agreement, the creditor can not only take the house back, but also ding the debtors post bankruptcy credit and pursue the debtor for a deficiency balance.

Touching on another misconception noted above, the title to the property does not change whether the debtor reaffirms or not. Reaffirmation is about the debt, not the title. The debtor will remain on title whether or not the debtor reaffirms, subject of course to any subsequent foreclosure, should it happen.

So are there times when a debtor would want to reaffirm a mortgage? Although I would argue the debtor almost never needs to reaffirm the mortgage, there are times when the debtor can somewhat comfortably reaffirm the mortgage. Where the mortgage payment is reasonable and the debtor has some equity in the home, the debtor might certainly want to reaffirm the mortgage, as timely payments can help rebuild the debtors credit.

However, it is very atypical that the debtor has enough equity to justify reaffirm the mortgage but not such an asset that the debtor is not over his/her allowed exemptions for the property. As such, the problems with reaffirming a mortgage often outweigh the benefits.

Now should the debtor reaffirm a car note? This one is a little different for a variety of reasons and why reaffirm a car note should be much more common than reaffirming a mortgage.

Unlike a home, which is considered real property, a car is personal property. The code is much more clear that personal property liens must be reaffirmed for the debtor to retain the property under federal bankruptcy law. That being said, many states have ipso facto clauses that prevent a creditor from repossessing a car that the debtor is current on payments even in the absence of a note. Additionally, even in states where the creditor can pick up a vehicle in which the debtor is timely on payments due to the fact the debtor did not reaffirm, some car lenders will not pick up the vehicle as long as the debtor continues to make timely payments.

It should be noted that the bankruptcy stay expires as to personal property during a Chapter 7 case, while it never expires as to real property during a Chapter 7 case (unless the lender has won a Motion to Lift Stay). Therefore, a debtor can lose a car during a Chapter 7 bankruptcy without an Order of Lift Stay, whereas the same is not true of a home. That is another reason why a debtor might want to reaffirm a car note in a Chapter 7.

Finally, it is important to remember that one of the primary goals of Chapter 7 bankruptcy for a debtor should be to emerge with as few debts after bankruptcy as possible. Therefore, whereas reaffirm a car note is often for many debtors only obligating themselves to $5,000 or so worth of debt, that makes signing that reaffirmation agreement a lot less risky than reaffirming that $250,000 mortgage.

The most common questions I get are Will I lose my house if I bankruptcy? or Will I lose my car if I file bankruptcy? While it is possible a debtor would lose those items in bankruptcy, it is important to note that you will almost always not lose those items because you filed bankruptcy.

The only scenario that you can lose an item because you filed bankruptcy is when you file a Chapter 7 bankruptcy and lose an asset (i.e., your house or your car) to your Chapter 7 trustee through a liquidation of the bankruptcy estate. It is imperative the debtor understands that any asset with negative equity is not going to be taken by their Chapter 7 trustee. The trustee has no interest in selling the debtors $300,000 house if the debtors mortgage on it is worth $325,000 or the debtors $10,000 car that has a $14,000 note attached to it.

The attorneys role prior to the case is to evaluate the likelihood that the Chapter 7 trustee would find an asset of sufficient value to liquidate, and if so, inquire from the debtor whether he/she wants to risk a liquidation of that asset. If the debtor does not want to take that risk but still wishes to file bankruptcy, the debtor should then consider Chapter 13 bankruptcy. Unlike in a Chapter 7, the debtor must make a monthly payment to creditors in a Chapter 13. However, also unlike a Chapter 7, the debtor cannot involuntarily be forced to surrender any property.

Therefore, if the debtor has a $300,000 home with a $50,000 mortgage, the debtor is likely to see that property liquidated in a Chapter 7 by the trustee (note: this will depend on the debtors applicable exemptions). If the debtor absolutely does not want to lose the house, the debtor would file a Chapter 13 to retain the house, while in exchange repaying at least a portion of its debts to its creditors.

While we just discussed when the trustee liquidates the debtors property, the next question to answer is Will my lender take my house if I file bankruptcy?  The answer to that is no, with a caveat. The bank will not take back your house through foreclosure (and your car lender will not take back your car) because you filed bankruptcy. They are prevented from doing that because the debtor gets The Automatic Stay when the bankruptcy is filed.

The lender could take back the car or the house during the bankruptcy if they get the bankruptcy courts permission through a Motion to Lift Stay. And why would the court grant a motion to lift stay so that the creditor can get at the debtors collateral? A motion to lift stay is granted when the debtor is not current on its payments (when in a Chapter 7) or not making its post bankruptcy filing date payments (when in a Chapter 13).

Therefore, it is not the act of filing bankruptcy itself that would cost the debtor use of its collateral to its creditor, but rather the non-payment on the collateral, which could have taken place partially or entirely before the bankruptcy was filed. The bankruptcy will actually keep the debtor in possession of the collateral longer than if the debtor had not filed bankruptcy, which at worst gives the debtor more time to work out other options to potentially retain the house or car.

However, as I always tell my clients who are in arrears with their house or their car, there is no chapter of the bankruptcy code that lets you use someone else’s collateral forever without paying them.