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Does Filing for Bankruptcy Affect Your Retirement Accounts? Thoughts on IRA’s, 401(k)’s, 403(b)’s, etc. with Estate Planning in Mind

Alex Moretsky


It should be reassuring to know that most retirement accounts are protected in bankruptcy from seizure by the bankruptcy trustee because either they are not property of the bankruptcy estate or are exempt. If they are considered property of the estate, federal and state law typically provide exemptions to protect such accounts.

Congress created the Employee Retirement Income Security Act (ERISA), whereby virtually all retirement and pension plan funds are excluded from the bankruptcy estate, including 401k, 403b, 414, 567, Roth IRA, Keogh, profit sharing, money purchase plans and defined benefits plans. The reason is ERISA-qualified retirement accounts have certain transfer restrictions which protect them from creditors. These restrictions are enforceable in bankruptcy. The only limits to the broad rule involves traditional and Roth IRAs where the exemption is limited to $1,245,475.00 (as of the writing of this article) per person for all retirement plans combined. Most individuals are unlikely to surpass this amount. Further reassurance comes in the form of roll overs. If you were laid off or changed jobs and rolled over your 401(k), for example, into an IRA, 100% of the account balance is protected in bankruptcy.

If you have retirement accounts exceeding the threshold amount, the law provides investors an incentive to keep IRAs funded with rollover salary deferral contributions separate from IRAs funded with annual contributions as the former has unlimited protections and the latter only limited.

The Bankruptcy Abuse Protection and Consumer Protection Act (BAPCPA), which made several substantial changes to the Bankruptcy Code in 2005, reinforced the fact that IRA assets from rollover of employer funded IRAs are protected without limit as are any rollover distributions. It does not, however, protect required minimum distributions. BAPCPA also added small businesses and self-employed retirement vehicles to the list of exceptions, including SEP-IRAs, Simple IRAs and Keoghs.

It is important to remember that funds withdrawn from retirement plans lose their protection, unless rolled over within 60 days into other IRA or retirement accounts. Once any portion of retirement funds are taken out prior to filing for bankruptcy, that portion is no longer off limits to the trustee. An inherited IRA is not considered a retirement account and is therefore not protected, except if inherited by a spouse and rolled over into the spouse’s IRA. But if it is not rolled over, it is considered an inheritance and therefore unprotected.

As previously mentioned, not all plans qualify for bankruptcy protection. Those that do not include the following:

  1. Employee stock purchase
  2. Improperly funded plans
  3. Plans not qualified as retirement plans under the tax code
  4. IRA inherited by someone other than a spouse
  5. Plans rolled over or transferred into a new fund not in compliance with the tax code
  6. Plans not receiving favorable determination by IRS

Before deciding to liquidate your retirement account to pay off debts, talk to a Montgomery County bankruptcy attorney to determine if you have other options. You may be able to eliminate your debts AND keep your retirement funds.

Offer in Compromise: How the 2012 Change in Guidelines Will Help You Settle Your IRS Debts

Alex Moretsky

An Offer in Compromise (OIC) is an agreement between you, the taxpayer, and the IRS that settles a tax debt for less than the amount owed. It offers a way to pay off your debt and get a fresh start. In 2012, the IRS changed the guidelines and liberalized the rules making it easier to afford and qualify for an OIC. That, in turn, resulted in a dramatic increase in the acceptance rate. In the last two years the number of offers accepted has risen from 24,000 to 31,000, a percentage change of 38% to 42%. This is a dramatic improvement from a decade ago when less than 25% of applications were accepted. It also represents a welcome change from an agency that has placed substantial roadblocks to those seeking to compromise their tax obligations. These changes will help some taxpayers resolve their tax problems in as little as two years compared previously to four or five years.

The financial analysis used to determine which taxpayers qualify for an OIC has also changed. It now includes:

  • Revising the calculation for the taxpayer’s future income.
  • Allowing taxpayers to repay their student loans.
  • Allowing taxpayers to pay state and local delinquent taxes.
  • Expanding the Allowable Living Expense allowance category and amount.

When the IRS calculates a taxpayer’s reasonable collection potential, it will now look at only one year of future income for offers paid in five or fewer months, as opposed to four years and two years of future income for offers paid in six to 24 months, down from five years.
The most recent changes also allow taxpayers larger discounts on their assets from prior rules. As an example: before the recent changes, a taxpayer’s investment account with a value of $100,000 would have required the taxpayer to fully account for that amount in their offer. Under current rules, the taxpayer can discount the value of the account by 20%, thereby reaching a valuation of $80,000. In fact, the IRS uses the concept of discounting by 20% for almost all taxpayer assets, whether tangible like real estate and vehicles, or intangible.

Before an OIC will be considered you must do all of the following:

  1. File all tax returns that are legally required through the tax year;
  2. Make all required estimated tax payments for the current year; and
  3. Make all required federal tax deposits for the current quarter if you are a business owner with employees

OIC qualifications are based on computation of a taxpayer’s ability to pay debt before the IRS runs out of time to collect (collectible statute expiration date). This decision is not subjective, but predicated on formulas.

To qualify for an OIC:

  1. You must prove you cannot pay the total balance owed before the collection statute expires
  2. There is doubt whether the IRS can collect the full amount owed from you, known as “doubt as to collectability”
  3. Alternatively, you can show that due to exceptional circumstances, payment would cause economic hardship or be unfair or inequitable

The OIC process is a formal process. It begins when you file Form 656 and pay a $186.00 fee (exempt if you are below poverty guidelines). In addition, you must send the first month’s payment with your completed application unless paying in 5 payments or 5 months, in which case you must send 20% with your application. If taking longer than 5 months to pay, you must continue to make all proposed payments while the offer is pending.
Even if you are rejected you should try again. Two reasons for rejection are your offer was too low, in which case the IRS will tell you what amount is acceptable or you are a notorious character. After finding out why you were rejected, re-submit. If the financial circumstances have not appreciably changed or the new offer is not different from the old, consider writing a letter offering more cash.

Innocent Spouse Relief Alternatives

Alex Moretsky

When Valarie Stephenson tried to leave her husband in 2003, he put a gun to her head and threatened to kill her. She was so terrified that she remained in the marriage until 2007. She then contacted an attorney and filed for divorce. After the divorce was finalized in 2008, she learned that she was liable for more than $77,000 in unpaid taxes stemming from a joint tax return filed in 1999. During their marriage, Valerie’s husband controlled the finances and Valerie was in the dark.

Unfortunately, Valerie’s situation, though extreme, is not the exception. According to one study, approximately 50,000 individuals each year become responsible for their spouse’s debts through marriage. When filing a joint federal income tax return, existing law states that spouses are jointly and severally liable for taxes assessed on the joint return, even after divorce or the death of one spouse.

Prior to 1998, the IRS allowed innocent spouse relief, but the requirements were so stringent that very few spouses qualified. Congress, concerned that the IRS was seeking taxes from the wrong spouse, expanded relief for “innocent” spouses in 1998. It created exemptions to help relieve wives who were unfairly left oppressive tax burdens by divorced or deceased spouses. There are two main, but distinct, arguments to attain “Innocent Spouse Relief”:

  1. Limited equitable relief for those meeting statutory requirements, or
  2. General equitable relief provided by the Secretary of the Treasury, taking all relevant facts into consideration.

For someone that does not qualify under other forms of relief, “Separation of Liability Relief” is an alternative form of relief. It is available to divorced or separated spouses who filed a joint return during their marriage. This alternative determines the liability of each person separately by allocating income and deductions from the joint return to each spouse, effectively amending a joint return to a separate one.

To qualify for “Separation of Liability Relief” you must show the following:

  1. Filed joint returns for the relevant year(s)
  2. At the time of filing Form 8857, the “innocent” spouse is no longer married or is legally separated, or is not a member of the same household for the last 12 months
  3. Relief does not apply to items spouses knew to be erroneous but signed off on willingly, and
  4. There was no transfer of property to the “innocent” spouse for the main purpose of avoiding taxes

If you do not qualify for “innocent spouse” or “Separation of Liability” you might still qualify for Equitable Relief. The requisites are as follows:

  1. A spouse must have an unpaid, understated or underpaid tax liability and not be eligible under the other Innocent Spouse subsections
  2. It would be unfair to hold spouse liable for understated/underpaid taxes
  3. There was no transfer of property to another party as part of a scheme to avoid taxes, and
  4. The income tax liability from which relief is sought by one spouse is attributable to a tax item or omission of the other spouse

There are also preventable measures and alternative avenues you can take to avoid being in the situation where you need to avail yourself of these remedies. First, you can file separate rather than joint tax returns, especially when you believe your spouse’s financial or business activities are questionable. Second, you can take advantage of a CDP – collection due process – hearing whereby the taxpayer challenges a tax liability or workout an alternative collection arrangement. And finally, if the IRS has levied on taxpayer property you can seek release of the levy and return of the property if it creates an economic hardship whereby the taxpayers cannot pay for reasonable living expenses.

To help you determine your eligibility for Innocent Spouse Relief, contact a Philadelphia, Pennsylvania lawyer who will take the time to discuss your options.

Removing Judgments on Real Estate through Bankruptcy

Alex Moretsky

A judicial lien in Pennsylvania is a non-consensual (without your agreement) lien that attaches to your property, such as a house or a car. It happens when someone, usually a creditor, sues and wins a lawsuit and gets a monetary judgment against you. The judgment is then recorded against your property, which creates a lien. The lien attaches to property you own that is located in the county in which the judgment was entered. The judgment can easily be transferred to any other county in Pennsylvania in which you own property and would attach to that property, as well.

When filing either Chapter 7 or Chapter 13 bankruptcy, the judgment lien can be eliminated or reduced by filing a Motion to Avoid Judicial Lien requesting that the lien be removed from the real estate. Two key factors must exist in order to remove the lien. First, the judgment debt must be listed on the bankruptcy petition. Second, the lien would impair some or all of the exempt equity in your property. Let’s assume you own a house with a fair market value of $250,000. You have a single mortgage with a balance of $260,000 and a judgment lien of $20,000. Given this set of facts, you could eliminate the entire $20,000 judgment lien. If we change the facts by reducing the mortgage balance to $220,000, you would be able to reduce the judgment lien by about $14,000 ($250,000 [FMV] – 220,000 [Mortgage balance] – 24,000 [exemption limit on real estate] = $6,000. Thus, $14,000 of the $20,000 judgment lien would be eliminated, while $6,000 would still exist. Changing the facts one last time, assume that the mortgage balance is $150,000. In this situation, you would not be able to eliminate or reduce any portion of the judgment lien because there is enough equity in the house to cover the lien, even when the exemption is accounted for.

While the order of discharge is effective immediately in Chapter 7 bankruptcy cases, Chapter 13 cases typically last three to five years. In some jurisdictions, once a lien is avoided in a Chapter 13 bankruptcy case, it becomes effective immediately rather than years later when the debtor receives a discharge. The reason this distinction is important is because the majority of chapter 13 cases do not make it to discharge for one reason or another. If the chapter 13 case is not discharged, then the lien remains intact, despite the bankruptcy court’s order to the contrary.
To determine whether you may discharge your liens by filing bankruptcy, contact a Montgomery County bankruptcy lawyer.

The Tax Consequences of Debt Forgiveness

August 11, 2014

Alex Moretsky

Settling a debt for less than the full amount owed seems like a blessing when you are burdened with lots of it. Unfortunately, the Internal Revenue Service and Pennsylvania Department of Revenue takes a different view of your good fortune.

When a creditor writes off or reduces a debt, it usually reports the amount written off as lost income to reduce its own tax burden. The IRS treats the forgiven amount as gained income for you and wants to collect a tax on this phantom income. For example, if you owe VISA $15,000.00 and the company decides to reduce your debt to $5,000.00, the difference of $10,000.00 is considered income and, consequently, taxable.

Any financial institution that forgives or writes off a debt of $600.00 or more will send a 1099-C to the IRS. It is incumbent upon the debtor to list the income on his tax return to avoid any discrepancies between him and the creditor.

The rule even applies after your property has been foreclosed or repossessed, provided the lender forgives the difference between what you originally owed and what the property sold for, otherwise known as a “deficiency”. This problem became especially acute during the Great Recession. In view of the toll the recession was taking, Congress passed the Mortgage Forgiveness Debt Relief Act. The Act forbids the IRS to tax the deficiency on homes foreclosed between the years 2007-2014. But it applies only to one’s primary residence. Vacation and investment properties are not eligible for debt forgiveness and monetary limits apply. Read More…

Defenses to Mortgage Foreclosure

August 11, 2014

Alex Moretsky

During the economic downturn of 2008/09 that saw record numbers of homeowners in Philadelphia and across Pennsylvania lose their homes and put others in jeopardy of losing theirs, consumer advocates found evidence that the real estate industry was riddled with fraudulent and predatory lending practices. This led to a change of heart within the courts who began viewing homeowners with some sympathy and mortgage companies with suspicion.

Foreclosure laws vary from state to state due to state law. However, there are defenses common to most states when it comes to fighting a mortgage foreclosure. Here are some of the more common:

  1. Terms of the mortgage are unconscionable – You cannot just claim unfairness. You must provide a specific justification previously recognized by a court. One such justification is a principle known as “unconscionability”, that is the terms or circumstances of the mortgage are so unfair as to shock the conscious of the reasonable person. There is also a branch of law called “equity” used to defend against foreclosures. Equity focuses on fairness where legal statutes don’t provide relief.
  2. You are a service member on active duty – There are special protections for active duty service members. Federal law prohibits foreclosure proceedings while the service member/homeowner is on active duty. Violation of this protection may be enforced with sanctions.
  3. The Foreclosing Party did not follow state procedures – You can challenge the foreclosure and if successful the foreclosing party must begin the process again. For example, Pennsylvania law requires certain notices be provided to the homeowner in default. If they are not, the foreclosure process may be stopped.
  4. The Foreclosing Party cannot prove ownership – If your mortgage has been sold and bought by many different banks and lending institutions, appropriate documentation of who owns the mortgage must be presented. This has become a hot topic.
  5. Mortgage servicer made serious mistakes – Mortgage servicers are entities who contract with the banks and lenders to receive and disburse payments, and enforce the terms of the mortgage. They make mistakes by crediting payments to wrong parties, imposing excessive fees or fees not authorized by the lender, or substantially overstating the amount you must pay to reinstate the mortgage. This is especially serious because an overstated amount might deprive you of the main remedy available to keep the home.
  6. Original Lender Engaged in Unfair Lending Practices – There are two federal laws that protect against unfair lending practices associated with residential mortgages and loans: Truth In Lending Act (TILA) and the Home Ownership and Equity Protection Act (HOEPA). Lenders violate TILA when they don’t make certain disclosures in mortgages documents such as: annual percentage rate, finance charges and payment schedules. You have the right to retroactively cancel or rescind the loan if laws are violated, provided you do so within the stated period.
  7. Standing – Sometimes the entity bringing foreclosure proceedings does not have standing to do so because they do not actually own the mortgage. If the alleged mortgage was not assigned, transferred or sold to plaintiff or assigned, sold or transferred each and every time it was sold or conveyed, the plaintiff may not have standing to bring a foreclosure.
  8. Statute of Frauds – The Pennsylvania statute of frauds applies to invalidate any and all transfers of a mortgage not memorialized in writing at the time of transfer. And if the documents memorializing the transfer of the mortgage/note were not executed until after the date of commencement of action, plaintiff lacks standing to bring the action.

Many large banks have acknowledged unorthodox, unacceptable or even illegal practices in the area of mortgages, loan modification and foreclosure which has given homeowners additional ammunition. Speak to an experienced mortgage foreclosure attorney in the Montgomery County, Pennsylvania area to discuss your options.

Post-Holiday Financial Blues: How Chapter 7 or 13 Bankruptcy Will Help

August 11, 2014

Alex Moretsky

Holiday time brings enormous pressure to join in the collective spirit of gift giving and indulgences. If your financial situation was already precarious this festive spending might put your monetary resources over the edge. Bankruptcy might very well be your best option. I am not advising you to purchase a 65” HDTV or top-of-the-line washer/dryer on credit with the intent of filing for bankruptcy. But if circumstances are such that you have been fighting to stay afloat for some time then the pressures of the holiday season might be the proverbial straw that breaks your financial back. Bankruptcy can help by greatly reducing or even eliminating unsecured debts such as:

  1. Revolving credit cards bills
  2. Medical bills
  3. Past due utility bills
  4. Past due rent
  5. Unsecured personal loans
  6. Debts in collection
  7. Other “open account” debt

Read More…

How Chapter 13 Bankruptcy May Save Your Home

August 11, 2014

Alex Moretsky

December 12,2014

Evidence suggests that nearly all debtors filing Chapter 13 in Pennsylvania are homeowners wishing to save their homes. Filing a Chapter 13 bankruptcy is particularly helpful to people behind on their mortgage payments who need time to catch up on those payments, but cannot afford to pay the arrearage in a lump sum. Chapter 13 provides an opportunity to delay or prevent the foreclosure on your home and pay off back debt from future income. In some cases, second and third mortgages can be eliminated. It is an opportunity to adjust financial affairs without having to liquidate your assets.
Read More…

Chapter 11 for a Small Business

August 11, 2014

Alex Moretsky

November 7, 2014

When is it appropriate for a small business to file for Chapter 11 Bankruptcy protection in Pennsylvania? Although Chapter 11 is normally associated with large corporations it is available to small businesses.
A small business is defined as a company having under 500 employees, although 96% of such businesses employ 50 or less. These small companies make up the majority of Chapter 11 filings. Small businesses, as defined by the American Bankruptcy Institute, are determined by:

  1. Whether they are closely held
  2. Whether it is owner operated
  3. The liabilities are backed by personal guarantees
  4. Have a lack of ability to afford professional fees
  5. Have less than $10 million in debt and $5 million in annual revenue

Read More…


August 11, 2014

Alex Moretsky

September 23, 2014

Since I last wrote about this topic, there has been some slow but steady progress in expanding discharges for student loans. As a general rule, student loans are not dischargeable in Chapter 7 or Chapter 13 unless they pose an undue hardship. Commonly referred to as the Brunner Test, the case from which the name is derived, you must show that repayment would create a hardship upon you, your family and/or your dependents. The three criterion for meeting this test are as follows:

  1. Based upon your current income you cannot maintain a minimal standard of living;
  2. Your financial situation is unlikely to improve during the repayment period; and
  3. You have made a good-faith effort to repay the loans.

Read More…