Monthly Archives: November 2015

What Affect Does a Bankruptcy Filing Have Upon an Illinois Real Estate Tax Sale?

The date a bankruptcy case is filed determines a lot.  The filing of the bankruptcy case triggers the implementation of the “automatic stay” provisions of the U.S. Bankruptcy Code.  11 U.S.C. §362(a).  The stay enjoins creditors from taking action to collect debts owed by the debtor.

But how does the automatic stay affect the sale of real estate taxes in Illinois?  The real estate tax sale is actually a multi-step process.  So, the effect of bankruptcy filing depends on the status of the tax sale and whether the buyer is aware of the bankruptcy filing.

An Illinois real estate tax sale has three parts and the bankruptcy case can be filed before or after these parts.  The first part is the tax sale by the county taxing authority and the purchase by a tax buyer.  The buyer tenders money to the taxing authority.  A bankruptcy filing prior to the sale blocks the county from selling the taxes.  Any sale in violation of the automatic stay would be void.

The second part relates to the redemption period assuming the taxes were sold prior to any bankruptcy case.  A bankruptcy filing during the redemption period would not void the sale. However, a bankruptcy filing could effectively extend the redemption period if the homeowner establishes a repayment plan, like a Chapter 13 repayment plan.  The bankruptcy filing does not actually “extend” the redemption period, but it has the same effect.  The redemption period would not expire and the tax buyer would not be allowed to petition the circuit court for a tax deed during a chapter 13 repayment plan if that plan provides for the repayment of the sold taxes.

The third part of the tax sale relates to the petition of the circuit court for the issuance of a tax deed.  A bankruptcy filing after the issuance of the tax deed would not affect the homeowner’s rights because the homeowner would have already lost all legal rights to the property prior to the bankruptcy filing.  In general, a bankruptcy filing stops future action against the bankruptcy filer and preserves the status quo; a bankruptcy filing does not reverse a tax sale or the issuance of a tax deed.

But the bankruptcy court in In re Wilson, 536 B.R. 218 (Bankr. N.D.IL 2015)(Black, J.) had to decide what impact a bankruptcy filing had upon the issuance of a tax deed by an Illinois circuit court when the issuance occurred AFTER a bankruptcy filing but WITHOUT the tax buyer knowing a bankruptcy case was filed.  There, the tax buyer was never informed of the bankruptcy case until after the circuit court had issued the deed.  Both the debtor and the mortgage lender knew of the bankruptcy filing; neither notified the tax buyer.  Consequently, the tax buyer never filed a motion to “lift or remove” the automatic stay prior to petition the circuit court for the tax deed— a motion that the court would have certainly granted.

The Wilson tax buyer filed a motion to “annul” the automatic stay pursuant to 11 U.S.C. §362(d) after the buyer discovered the bankruptcy filing.  The buyer stated that the buyer had no knowledge of the bankruptcy filing prior to the tax deed issuance despite taking steps to investigate.  The court noted that it would be inequitable to punish the tax buyer who acted in good faith while helping the mortgage lender who failed repeatedly to notify the buyer of the bankruptcy filing.  The Wilson court conducted an exhaustive study of the equities between the parties before granting the tax buyer’s motion to annul the automatic stay.  The court also noted that the battle was between the tax buyer and the mortgage lender with the homeowner taking no position.

Practice Pointer:   People who file bankruptcy should make efforts to notify ALL creditors and people who hold adverse interests in any property of the bankruptcy filer.

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

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How Does a Bankruptcy Filing Affect the Sale of Delinquent Real Estate Taxes?

An owner of real property receives protection from creditors immediately upon filing a bankruptcy case pursuant to 11 U.S.C. §362(a), which provides an “automatic stay” or injunction against creditors’ actions against the owner and the owner’s property.  As to real property, the automatic stay prohibits mortgage lenders from foreclosing on delinquent mortgage notes, and it prohibits governmental taxing authorities from selling any delinquent real estate taxes without leave of court.

An order granting relief from the automatic stay is typically granted in a bankruptcy case if the secured party is not receiving adequate protection, or the owner has no equity in the property and the property is not necessary for an effective reorganization. See 11 U.S.C. §362(d).

But what do taxing authorities do about delinquent taxes when a homeowner files bankruptcy?  It depends when the bankruptcy case was filed in relation to the sale of the delinquent taxes.  First, let’s assume a sale is imminent but did not occur prior to the bankruptcy filing, then let’s assume a sale occurred prior to the bankruptcy filing.

Imminent Sale:  The filing of a bankruptcy case automatically prohibits the sale of the delinquent real estate taxes.  In a Chapter 7 case, the taxing authority typically stands-down and postpones the tax sale  until after the bankruptcy case is concluded.  The taxing authority could file a motion to lift the automatic stay to allow the tax sale, but typically does not file such a motion because of the cost to do so.  A Chapter 7 case typically lasts only 100 days or so.  Thereafter, the taxing authority thereafter conducts the tax sale.

A Chapter 13 case is different because it could last 5 years.  The filing of the Chapter 13 stays the sale of the delinquent real estate taxes just like a Chapter 7 filing.  However, the owner of the real estate must make a decision whether the owner wants to retain the real property or surrender it.  If surrendering the real estate, the owner’s Chapter 13 plan should expressly provide for the surrender of the real estate pursuant to 11 U.S.C. §1325(a)(5)(C) and treat any secured creditor’s deficiency claim as an “unsecured” claim by reason of the surrender.  If retaining the real estate, then the owner’s Chapter 13 plan should provide to cure mortgage arrearage and maintain the mortgage payments, and provide for the full repayment with interest of any delinquent real estate taxes.

Post Sale: The issues are more complicated when a real estate owner files a bankruptcy case after the delinquent real estate taxes have already been sold.  Some states allow an owner to “redeem” the sold real estate taxes within a certain statutory time period.  The Bankruptcy Code allows a Chapter 7 trustee to exercise the homeowner’s redemption rights by paying the delinquent taxes (plus interest) provided the bankruptcy case was filed prior to the redemption period expiring.  Similarly, the Chapter 13 bankruptcy laws allow the home owner to repay the sold real estate taxes over the 5 year period provided the bankruptcy case was filed prior to the redemption period expiring.  Unfortunately, a homeowner cannot save real estate sold for delinquent real estate taxes by filing bankruptcy after the redemption period has expired.

Violating the Automatic Stay:  Sometimes a real estate tax buyer who properly purchased delinquent real estate taxes unknowingly violates the automatic stay by foreclosing a homeowner’s equity of redemption despite a bankruptcy filing.  Such was the case in In re McCrimmon 536 B. R. 374 (Bankr. D.MD. 2015). The tax purchaser bought the delinquent real estate taxes before the homeowner filed bankruptcy.  There was no automatic stay violation at the time of purchase because the bankruptcy case had not yet been filed.  Maryland law required the tax purchaser to give certain notice to the property owner and lienholders at least two months prior to filing an action to foreclose the right of redemption.  The tax purchaser conducted a title search and gave proper notice to the owner and known lienholders prior to filing the foreclosure action in the county court.

Later, the McCrimmon homeowner filed bankruptcy but failed to provide any notice to the real estate tax purchaser.  Subsequently, the tax purchaser filed suit in the county court and foreclosed the homeowner’s right of redemption in accordance with Maryland law.  The mortgage lender objected to the tax purchaser’s foreclosure because it violated the Bankruptcy Code’s automatic stay protections because the foreclosure occurred after the bankruptcy filing and without leave of the bankruptcy court.

The tax purchaser filed a motion to “annul” the automatic stay.  The McCrimmon court granted the tax purchaser’s motion because: (1) the tax purchaser was not noticed and had no actual or constructive knowledge of the bankruptcy filing; (2) the court would have granted a motion to lift the automatic stay had the tax purchaser filed such a motion prior to the foreclosure sale; and (3) the equities favor the tax purchaser because the financial loss to the purchaser by denying the motion to annul far outweigh the financial loss to the mortgage lender by granting the motion to annul.  Therefore, the court annulled the automatic stay so that it had no effect upon the tax purchaser’s foreclosing of the homeowner’s right of redemption.

Practice Pointer:  An individual who files bankruptcy should give notice of the bankruptcy filing to all creditors, including a real estate tax purchaser.  Creditors who violate the automatic stay protections could “annul” the stay if the equities are in their favor.  This is a factual determination.  Annulling the automatic stay would not have occurred in the McCrimmon case had the tax purchaser been given notice of the bankruptcy case and chose to ignore that notice.

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

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Can the IRS Intercept a Tax Refund to Pay Non-Tax Debts Owed to Other Federal Agencies?

Absent bankruptcy, the federal Treasury Offset Program (“T.O.P”) allows the IRS to offset a non-tax debt owed by a taxpayer to a federal agency against a federal income tax refund owed to the taxpayer.  See 26 U.S.C. §6402.  The right of offset (aka “setoff”) allows entities that owe each other money to apply their mutual debts against each other, thereby avoiding the absurdity of making party A pay party B when party B owes party A.

The IRS’ Treasury Offset Program authorizes the Secretary of the Treasury to intercept a taxpayer’s tax overpayment and apply it to preexisting debts.  Section 6402(a) of the US Tax Code provides that the Treasury “may” credit a taxpayer’s income tax overpayment against any tax liability.  Whereas, §6402(d) provides that Treasury “shall” credit a taxpayer’s income tax overpayment against a non-tax debt owed to another federal agency other than the IRS.

However, a taxpayer objected to the IRS intercepting a tax refund in the bankruptcy case of In re Addison, 533 B.R. 520 (Bankr. W.D.VA 2015).  There, the taxpayer argued that the US Bankruptcy Code’s automatic stay provisions of 11 U.S.C. §362(a)(7) prohibited the IRS from offsetting the tax refund against the non-tax liability owed by the taxpayer to the US Department of Agriculture, which related to a mortgage foreclosure deficiency.  The IRS countered and argued that §362(a)(7) did not apply because it was superseded by 11 U.S.C. §362(b)(26)’s negation of the automatic stay for setoffs by the IRS.

The Addison court rejected the IRS’ argument and held that §362(b)(26) did not apply to the facts of this case because §362(b)(26) only applied when the IRS was setting off tax debts owed to the IRS.  In the Addison case, the IRS was setting off non-tax debts owed to the US Department of Agriculture.  Specifically, the court stated §362(b)(26) constrains the reach of the automatic stay by excepting from violating the automatic stay the setoff under applicable nonbankruptcy law of an income tax refund…against an income tax liability.  (emphasis added).

Practice Pointer:   The IRS has broad tax intercept powers to collect debt on behalf of the federal government.  However, these powers are not unlimited.  In the bankruptcy concept, the IRS has the power to intercept tax refunds to offset tax liability relating to a taxable year that ended before the bankruptcy filing date, but the IRS does not have the power to intercept tax refunds to offset non-tax liability owed to other departments of the US Government.

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

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Can a Taxpayer Discharge Loan Debt Incurred to Pay an Otherwise Non-Dischargeable Tax Debt?

Yes and no, depending on what type of bankruptcy case is filed.  Sometimes a taxpayer has a tax debt that the taxpayer cannot afford to pay, but it cannot be discharged in bankruptcy because of the dischargeability prohibition of 11 U.S.C. §523(a)(1).  So, one strategy is for that taxpayer to obtain a bank loan to acquire capital and then tender the bank loan funds to the taxing authority to pay off the tax debt.  Then, that taxpayer files bankruptcy in an attempt to discharge the non-tax bank debt.

Such a taxpayer who files chapter 13 bankruptcy would have an easy time discharging the bank debt as long as the taxpayer waits a sufficient period of time.  The Bankruptcy Code does not expressly prohibit the Chapter 13 discharge of debts incurred to pay non-dischargeable tax debts.  However, an immediate bankruptcy filing after acquiring the bank loan would trigger issues of bad faith and fraud with a bank alleging the taxpayer had no intention of ever repaying the bank loan.  See 11 U.S.C. §§523(a)(2) or (a)(4). So a taxpayer should wait a period of time before filing bankruptcy, and make the required monthly payments on the loan until the bankruptcy filing to show good faith and act as a prophylactic.

A taxpayer who files chapter 7 bankruptcy would be out of luck and find non-dischargeable pursuant to 11 U.S.C. §§523(a)(14) or (a)(14A) the bank debt incurred to pay off the tax debt.  These Bankruptcy Code sections except from Chapter 7 discharge debt incurred to pay a non-dischargeable tax owed to the United States or any other governmental unit.

These issues were addressed in Brown v. Link (In re Link), 2015 Bankr. LEXIS 3248 (Bankr. E.D.MO 2015).  In Link, a restaurant seller owed delinquent state sales tax at the time the restaurant was sold.  The seller sold the business to the buyer (and the buyer ultimately filed Chapter 7 bankruptcy) for an amount sufficient to pay the seller’s state sales tax obligation.  The buyer did not have sufficient capital so the buyer secured a loan.  The lender tendered funds to the buyer in the form of three checks: (1) a check made payable to the state sales taxing authority in the exact amount of the sales tax debt owed by the seller; (2) a check made payable to the state sales taxing authority in an amount the buyer was required to pay the state taxing authority as a bond for prospective sales taxes; and (3) a check made payable to the buyer for additional capital. Ultimately the restaurant failed and the buyer filed bankruptcy seeking to discharge the loan provided by the lender that had been used to pay money to the state sales taxing authority.

The first issue the Link court had to address was whether the 11 U.S.C. §523(a)(14A) non-dischargeability exception applied to loans incurred to pay tax debts owed by someone other than the person filing bankruptcy.  In Link, this issue related to the buyer’s loan incurred to pay the state sales tax owed by the seller.  The Link court held that the 11 U.S.C. §523(a)(14A) non-dischargeability exception applied to the payment of all non-dischargeable tax debts and was not limited to just the tax debts owed by the person filing bankruptcy.  Therefore, the buyer’s loan was deemed non-dischargeable because the court found a direct connection between the loan incurred and the immediate application of those funds to seller’s tax obligations.

The second issue the Link court had to address was whether the 11 U.S.C. §523(a)(14A) non-dischargeability exception applied to loans incurred to pay a bond for prospective sales taxes.  The court found that buyer’s use of the loan to pay the sales tax bond resulted in the loan being rendered non-dischargeable.  This issue appears more complicated than the first issue and the court’s analysis is debatable.  The Link court interpreted expansively the non-dischargeability statute’s language of “a tax required to be collected or withheld and for which the debtor is liable in whatever capacity.” 11 U.S.C. §523(a)(1) incorporating 11 U.S.C. §507(a)(8)(C).  This interpretation appears to be overly expansive and subject to an appellate attack because the buyer’s bond was not a “tax,” but merely collateral to be used by the state sales taxing authority in the event the buyer fails to pay to the taxing authority the required sales tax in the future.  If the buyer pays the appropriate sales taxes in the future, then the bond would be returned to the buyer.  As such, the bond may be interpreted by an appellate panel as not “a tax required to be collected or withheld and for which the debtor is liable in whatever capacity.”  11 U.S.C. §523(a)(1) incorporating 11 U.S.C. §507(a)(8)(C).  Under this alternative interpretation, the loan proceeds used to pay the bond would not be deemed a payment of a “tax” and would therefore be dischargeable. But, the buyer never appealed the decision so the issue has to wait for another case.

Practice Pointer:   A taxpayer should file Chapter 13 bankruptcy instead of Chapter 7 bankruptcy if that taxpayer is attempting to discharge a loan incurred to pay otherwise non-dischargeable taxes owed to the IRS or another taxing authority.  Chapter 7 is a poor choice.  Instead, a Chapter 13 bankruptcy with a limited dividend to unsecured creditors would be a better strategy.

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

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