Qualifying for a Mortgage After (or During) Bankruptcy: What does it take and how long will I wait?

It should come as no surprise that qualifying for a new mortgage or refinance with a bankruptcy in your credit history is likely to complicate the process. But while a bankruptcy will stay on your credit report for a full ten years after your case is complete—which means up to fifteen years total for individuals who file chapter 13—bankruptcy takes its biggest bite on creditworthiness in the first two to three years after the case is first filed.

The good news is that bankruptcy does not automatically disqualify a borrower from obtaining a new mortgage or refinance, and the most available product after bankruptcy usually will be a FHA mortgage (as opposed to a conventional mortgage). The bad news is that eligibility for a mortgage will take time, usually two years or more with reestablished good credit.

As a general rule of thumb, a debtor can qualify for a FHA mortgage or refinance either during or after bankruptcy under the following guidelines:

Chapter 7 or Chapter 11 Bankruptcy: At least 2 years have elapsed since the date of discharge of debts and the borrower has a credit score at least a 640. In most chapter 7 cases, the discharge of debts is entered three months after the case is initially filed.

Chapter 13 Bankruptcy: At least 1 year has elapsed since the filing chapter 13 bankruptcy and the borrower has a credit score at least 640, plus the borrower can provide lender with a verified perfect payment history of their chapter 13 plan. Some lenders may also require the chapter 13 trustee’s approval of the loan.

Note: For conventional mortgage products and rural housing, the typical waiting period may be extended to three years or more and often with higher credit score requirements.

If you filed a chapter 7 or chapter 13 bankruptcy, or you are still in an active chapter 13 plan, work now to increase your odds to qualify for a mortgage product by doing the following:

  • Reestablish a good credit score now. The better the credit score, the lower the interest rate will be. While it won’t happen quickly, you do not have to wait until bankruptcy is complete to work on improving a credit score. Pay your mortgage, student loans, vehicle leases and auto loans on time each month so that you get the benefit of the positive credit reporting. If your student loan is in default, get it back on track with an Income Based Repayment program. Don’t let new debts and bills fall into collection. Check your credit report annually for errors that negatively impact your score. And consider a secured credit card or even a traditional credit card with a low limit—use it sparingly, keep the balance below 10% of the available credit limit or, better yet, pay it off in full each month. If your bankruptcy case is already complete, have the state court docket updated to show any pre-bankruptcy judgments were discharged in your bankruptcy case.
  • If you are in an active chapter 13 plan, ensure your monthly chapter 13 plan payment is made on time each month. For debtors with cash flow problems, this may mean that you set up your monthly plan payments to be automatically deducted from your wages or otherwise have your plan payment made via ACH deduction from a bank account.
  • Be prepared and be patient. At a minimum, most borrowers will have to wait at least two years from when a bankruptcy was filed before they will qualify for a FHA mortgage.

As an alternative for homeowners looking to refinance an existing mortgage who do not meet the underwriting requirements for a traditional refinance, the Making Home Affordable program administered through the federal government may offer a better solution. Obtaining a HAMP or HARP mortgage modification essentially provides the benefit of a cost-free refinance with market interest rates however without the strict credit score/financial history requirements or mandatory post-bankruptcy waiting periods. These programs will not exist indefinitely and as of the date of this post, Congress has approved the Making Home Affordable program only through the end of 2016. To identify the various programs and requirements for a mortgage modification, see the official HUD website on Making Home Affordable.

DISCLOSURE: This information is intended as a general guideline only and is not meant to be a definitive response on any individual qualification for a mortgage or refinance. Mortgage underwriting standards change frequently and only a banking institution or loan officer can determine eligibility for mortgage products.

The 2017 Chapter 13 Debt Limits (valid through 2019)

For the 2019 debt limits effective April 1, 219, see here: The 2019 Chapter 13 Debt Limits effective April 1, 2019

Effective April 1, 2016 and valid for all of 2017 and 2018, the debt limits for filing chapter 13 bankruptcy as prescribed by section 109(e) of the Bankruptcy Code are as follows:

Unsecured debt limit:            $394,725

Secured debt limit:                $1,184,200

These limits adjust every three years and the next chapter 13 debt limit adjustment will occur on April 1, 2019.

The secured debt limit of $1,184,200 includes the total of all debt that is secured by personal and real property owned by the debtor including mortgages secured by real estate (i.e., residential homestead mortgages as well as mortgages on rental or commercial properties, if any) and other collateralized debts such as vehicle loans, equipment loans, etc. The secured limit may also include tax liens.

The unsecured debt limit of $394,725 includes the total of all amounts owed on unsecured lines of credit, credit cards, medial debts and other consumer debts, some taxes owed and even disputed debts in most cases. This unsecured debt limit is calculated per person in the event that a married couple files a joint chapter 13 bankruptcy case.

Any individual that is either employed or self-employed in business is eligible for chapter 13 bankruptcy relief provided the individual’s unsecured debts are within these limits of $394,725 unsecured / $1,184,200 secured.

Individuals who exceed the chapter 13 debt limits still have the option to file under chapter 7 so long as their income qualifies under the means test, or otherwise may file an individual Chapter 11 proceeding, particularly for individuals with income-producing assets such as rental properties, valuable business interests and other property holdings that would be liquidated in chapter 7.

If you exceed the 2016 chapter 13 debt limits, read more about alternatively filing under chapter 11 at What is Individual Chapter 11 Bankruptcy and Why Would I file an Individual Chapter 11?

 Contact for a free consultation and more information on all your options available in bankruptcy. 

As an ARAG legal insurance member attorney, Lynn Wartchow assists clients with ARAG legal insurance in filing chapter 13 bankruptcy cases in Minnesota. If you are considering filing bankruptcy and want to know what a chapter 13 plan would look like for you, Lynn offers free consultations and evaluations including how much you can expect to pay into a chapter 13 plan and what debts are resolved for that amount.

2016 Minnesota Median Income effective for bankruptcy cases commenced on April 1, 2016 or later (estimated to be good through at least November 2016)

Median income is a critical measure in bankruptcy upon which the ‘Means Test’ calculation is largely based to determine whether a debtor qualifies for Chapter 7 bankruptcy versus Chapter 13. Essentially, if a debtor’s annualized gross income exceeds the median income for their household size and state of residence, they are generally (but not always) ineligible for Chapter 7 bankruptcy and instead steered toward a five-year Chapter 13 repayment plan.  In Chapter 13, median income also determines whether a debtor is required to do a 5-year plan (when above-median income) or 3-year plan (when below-median income).

It’s also important to note that annualized gross household income is determined by doubling all household income from all sources for the last six full calendar months prior to filing bankruptcy. Chapter 13 bankruptcy is a more likely outcome than Chapter 7when this annualized income is above the applicable state median income. The Means Test calculation and eligibility for Chapter 7 is more complicated than simply a measure against median income and other factors including mortgage payment as well as arrears, taxes owed and domestic support obligations, and a number of other factors also figure into the means test calculation.

As of April 1, 2016, the Median Income in Minnesota is as follows:

2016 Minnesota Median Income per applicable Household Size:         

1 Person          2 People          3 People          4 People          5 People

$51,260           $68,596           $80,900           $98,564           $106,964 

State median income is determined by Census Bureau data and adjusts at least annually. The latest adjustment is effective April 1, 2016 and the next adjustment date is expected November 2016.

To read more about Median Income and the Means Test, see What is the Median Income in Minnesota and How Does is Factor into Chapter 7 Bankruptcy and What is the “Means Test” and Why Does it Matter in Bankruptcy?

Wartchow Law Office is a law firm located in Edina, Minnesota with an exclusive practice in Chapter 7, Chapter 13 and Chapter 11 bankruptcy law, representing individual consumer and business clients throughout the Twin Cities of Minneapolis and St. Paul, Minnesota.

2015 Minnesota Median Income effective for bankruptcy cases commenced on/after November 1, 2015 and through April 2016

Median income is a critical measure in bankruptcy upon which the ‘Means Test’ calculation is largely based to determine whether a debtor qualifies for Chapter 7 bankruptcy versus Chapter 13. Essentially, if a debtor’s annualized gross income exceeds the median income for their household size and state of residence, they are generally (but not always) ineligible for Chapter 7 bankruptcy and instead steered toward a five-year Chapter 13 repayment plan.  In Chapter 13, median income also determines whether a debtor is required to do a 5-year plan (when above-median income) or 3-year plan (when below-median income).

It’s also important to note that annualized gross household income is determined by doubling all household income from all sources for the last six full calendar months prior to filing bankruptcy. Chapter 13 bankruptcy is a more likely outcome than Chapter 7 when this annualized income is above the applicable state median income. The Means Test calculation and eligibility for Chapter 7 is more complicated than simply a measure against median income and other factors including mortgage payment as well as arrears, taxes owed and domestic support obligations, and a number of other factors also figure into the means test calculation.

As of November 1, 2015, the Median Income in Minnesota is as follows:

2015 and 2016 (through 04/01/16) Minnesota Median Income per applicable Household Size:         

1 Person          2 People          3 People          4 People          5 People

$51,199           $68,515           $80,804           $98,447           $106,547 

State median income is determined by Census Bureau data and adjusts at least annually. The latest adjustment is effective November 1, 2015 and the next adjustment date is expected April 2016.

To read more about Median Income and the Means Test, see What is the Median Income in Minnesota and How Does is Factor into Chapter 7 Bankruptcy and What is the “Means Test” and Why Does it Matter in Bankruptcy.

Wartchow Law Office is a law firm located in Edina, Minnesota with an exclusive practice in Chapter 7, Chapter 13 and Chapter 11 bankruptcy law, representing individual consumer and business clients throughout the Twin Cities of Minneapolis and St. Paul, Minnesota.

 

Minnesota Bankruptcy Courts Now Allow a Chapter 13 Debtor to Compel a Mortgagee Bank to either Foreclose or Take Deed to a ‘Zombie Property’

On September 1, 2015, the honorable Judge Michael Ridgway of the US Bankruptcy Court for the District of Minnesota joined several other jurisdictions nationally in recognizing a chapter 13 debtor’s ability to compel her mortgage bank to either foreclose a property or to take deed to a property for which it had previously refused to foreclose. In so creating this new caselaw in Minnesota, Judge Ridgway has now established the legal procedure for debtors to get out from under a ‘zombie property’, i.e.., a property that the bank refuses to foreclose for financial reasons unknown.

Particularly when it comes to zombie condos and townhomes, mortgagee banks often elect not to foreclose in effort to avoid incurring the homeowner’s association fees, real estate taxes and other accruing costs for a property that may not easily sell to recoup its losses. For such zombie properties, the homes can remain abandoned for years before it is finally either subject to a tax forfeiture proceeding or the toxic mortgage is eventually assigned to a bank who will foreclose. To the homeowner, however, it means years of uncertainty and increasing personal liability for homeowner’s association assessments and other costs of remaining the titled owner to an unwanted home.

For now in Minnesota, chapter 13 bankruptcy offers an avenue of relief in that the debtor can now force a lienholder—i.e., the mortgage bank, the homeowner’s association, or perhaps even the county itself—to either foreclose the property or take deed to the property.

In In re Stewart (Case No 15-40709-MER), the chapter 13 debtor had long-abandoned a condominium property in her former state of residence, Maryland, before moving to Minnesota and eventually filing for bankruptcy relief. For over three years, the condo sat vacant, abandoned and awaiting foreclosure by the bank or any other lienholder for that matter. Yet despite her many efforts to cooperate in a voluntary foreclosure or even deed-in-lieu the property to its lienholders, no one wanted to take deed and ownership to the zombie condo. Even after successful completion of a 5-year chapter 13 plan, she would have emerged from bankruptcy owing tens of thousands of dollars in HOAs and other costs if property continued to not be foreclosed. In essence, the very purpose of her bankruptcy proceeding would have been negated if she could not rid herself of the debts associated with the condo. Therefore, her chapter 13 plan—which was confirmed without objection by any party—provided that the condo unit would vest in its mortgagee bank (One West Bank at that time) in satisfaction of the claim and the deed would so transfer out of her name at long last. Yet over two years after her chapter 13 plan was confirmed, neither the mortgagee bank nor the homeowner’s association made any attempts to foreclose the zombie property. So the debtor and her attorney, Lynn Wartchow, brought a motion to compel the mortgagee bank to either foreclose or take deed to the property once and for all.

In so deciding in favor of the debtor and enforcing the terms of her chapter 13 “Baxter Plan”, Minnesota is now aligned with several other bankruptcy courts including Hawaii (In re Rosa, 495 B.R. 522 (Bankr. D. Haw. 2013)), Oregon (In re Watt, 520 B.R. 834, 839 (Bankr. D. Or. 2014)), Massachusetts (In re Sagendorph, II, 2015 WL 3867955 (Bankr. D. Mass. June 22, 2015)) and the Eastern District of New York (In re Zair, 2015 WL 4776250 (Bankr. E.D.N.Y. Aug. 13, 2015)).

The full memorandum opinion and order of In re Stewart may be viewed on the bankruptcy court’s website at http://www.mnb.uscourts.gov/sites/mnb/files/opinions/Stewart%2013-40709%20Opinion.pdf.

 

Debt Consolidation vs. Debt Settlement vs. Bankruptcy? What Can You Expect from Each and Which Option is Better?

When facing mounting debts that cannot be repaid according to the regular monthly terms, one should consider all options for debt resolution including bankruptcy relief and non-bankruptcy alternatives. But before you hastily take the most convenient option, consider the benefits and disadvantages for each. In fact, I often encourage my bankruptcy clients to make an apples-to-apples comparison between their debt resolution options—including a list of the pros, cons, risks and costs for each resolution—and often the best and cheapest option quickly becomes clear.

Debt consolidation is a general term for taking out one larger, lower interest loan and using the loan proceeds to pay off any number of smaller, higher interest rate debts. In this way, you are repaying 100% of your debts but potentially saving money on interest over time. While balance transfers and credit card checks with promotional interest rates may be tempting, it’s critical to read the fine print for any hidden fees of balance transfers and the deadlines when the promotional interest rates expire. For example, credit cards and some new loans will charge a small percentage fee on the amount of credit used for the balance transfer or to initiate the loan. Also, the promotional rate expires in only a short time and often any balance remaining after that deadline will revert to the standard interest rate which can be three times higher than the promotional rate. Debt consolidation may work best for people who have regular, predictable income so that they can commit to the monthly consolidated payment and their only issue is the high interest rates. Debt consolidation also assumes that you can obtain financing at a lower interest rate than your current credit cards, which usually necessitates a minimum credit score if not also a pledge of collateral to secure the consolidation loan. Debt consolidation usually will not work well for people who cannot afford a consolidated loan payment (even at lower interest) or for those who cannot obtain new credit due to a low credit score and/or lack of collateral.

Debt settlement (or debt negotiation) is an option that occasionally makes more sense than filing bankruptcy, particularly for higher income individuals, individuals with substantial assets or individuals with access to cash to pay off just a few debts at a reduced balance. Debt settlement involves negotiating a final settlement of the debt and release from future personal liability one-by-one with each creditor. Depending on the number of debts that need to be settled and how far into default each debt is, the debt settlement process can be tedious, expensive and can easily take two or more years to complete with all creditors. There is always the risk that until the debt is fully settled, the creditor can still collect on the full balance and initiate a lawsuit against you. Depending on individual circumstances, debts will typically settle for 25% to 75% of the amount owed and payment is required in either one lump sum or series of payments over no more than six months. Because inevitably some of the debt is repaid and you may end up incurring attorney fees for assistance with the process, debt settlement is almost always more costly overall than a standard chapter 7 bankruptcy proceeding. Finally and unlike what happens when a debt is discharged in bankruptcy, beware that a debt settled for less than the full amount owed often will result in your receiving a Form 1099 for the amount forgiven which is treated as income for tax purposes (with few exceptions, see Received a 1099-Misc on Cancelled Debt? You May Qualify for Exclusion from Taxes if You Were Insolvent or Filed Bankruptcy). For these reasons, debt settlement can be a far more expensive and time-consuming option than bankruptcy.

In bankruptcy, most unsecured debts are discharged in full and the majority of chapter 7 debtors pay nothing more than the attorney fee and filing fee. In chapter 13, some percentage of the debts is repaid but the total paid into a chapter 13 plan can still be significantly less than what a debt settlement may cost.

For help in assessing of your debt resolution options, contact Wartchow Law Office located in Edina, Minnesota.

Fairness for Struggling Students Act of 2015: Bankruptcy Relief may be on the Horizon for Private Student Loans

A legislative proposal is finally pending with Congress as a first step to help ease the student loan crisis. Sponsored by Sen. Durbin of Illinois in conjunction with Sen. Franken of Minnesota, the Fairness for Struggling Students Act was proposed in March 2015 to remove the Bankruptcy Code’s exception from discharge of private student loans. Short and simple and to the point, the full text of the bill can be read here.

Private student loans account for as much as 20% of the total $1 trillion student debt load in the U.S. And just as with the more common federally subsidized loans, currently there is no relief in bankruptcy for private student loan principal or interest. For borrowers in default, the effect of reversely amortized interest on private student loans can quickly multiply the balance in only a few years.

According to the U.S. Department of Education, between 13% and 15% of all student loans are in default. This is almost triple the low default rates of the early 2000s. And with student loan borrowing on the rise and income rates not keeping pace with inflation, the default rate can only be expected to increase. Unlike other unsecured debts, student loans currently are almost never discharged in bankruptcy except in very rare circumstances of total and permanent inability of the borrower to repay.

While federal student loans are subsidized by the federal government–common examples are Direct Loans, Parents PLUS Loans and Perkins Loans–private student loans are funded by banks, credit unions and other private lenders or even the school itself.  Because private loans are not guaranteed by the government, these loans typically carry higher and variable interest rates, may require repayment during enrollment, often demand a certain credit rating and cosigner, and are not eligible for consolidation or loan forgiveness programs for public servants. To say the least, private student loans have similar repayment conditions as credit cards (noting that credit card companies factor the possibility of bankruptcy into the high interest rates charged), yet private student loans have none of the relief options in bankruptcy that one has for their credit card debt.

Prior to October of 2005, it was possible to discharge private student loan debts in chapter 7 and chapter 13 bankruptcies while federal student loans have historically remained non dischargeable. However with the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), essentially every type of student loan–both public/federal and private– cannot be discharged in bankruptcy.

If passed, the Fairness for Struggling for Students Act will effectively reverse the 2005 changes to the Bankruptcy Code and once again make private student loans dischargeable in a bankruptcy proceeding. Under the Act, private student loans would be treated the same as credit cards, i.e., bankruptcy would discharge private student loan debts same along with most other general unsecured debts such as credit cards and other unsecured loans.

Be sure to read more about student loans and relief options at the Wartchow Law’s Student Loan Blog.

More on the National Crisis of Defaulted Student Loans: the Income Based Repayment (IBR) Program is One Option to Avoid Wage Garnishment

The student loan debt predicament is to the 2010s what the foreclosure/subprime lending crisis was to the 2000s. Student loans are a massive consumer debt issue that reaches every economic earnings level, from the underemployed recent graduates unable to find a career in their chosen profession, to the experienced professionals earning a median income. Student loan debt service is simply expensive, even for the average employed professional. And little relief is currently available from the federal government or otherwise.

(Read more of my continuing student loan debt blog: The Student Loan “Debt Bomb”: With Student Loan Debt Out of Control, What Can Bankruptcy (and Congress) Do to Help?)

According to Forbes.com in late 2014, the total student debt load in the U.S. is over $1 trillion dollars, a number which comparatively represents about 10% of the amount of outstanding mortgage debt in America. As of early 2015, the interest rate on Stafford is presently 4.66% for undergraduate loans and 6.21% for graduate loans.

As a practical example, a recent graduate from a 4-year public university with an average student loan debt of $30,000 will repay their student loans at $272 per month for at least 10 years. Add a graduate degree to the calculation with the additional average debt of $57,600 and that monthly student debt expense jumps to $917 per month for ten years.

For the average single income earner in Minnesota with a graduate degree and carrying the national average student debt load, this means that approximately 28% of their take-home pay will be devoted each month to student loan debt service alone. Try affording a mortgage, credit card payment or child care with that much income devoted to student loan debt service.

The result is widespread student loan default. A defaulted student loan, like any other unpaid debt, can aggressively force repayment via wage garnishment of 15% of one’s take home income. When this happens, the defaulted borrower may not be able to afford their other basic living expenses such as housing, utility and food expenses. Thus the defaulted student loan can snowball into a series of unfortunate events including accumulation of credit card debt used to purchase such basic expenses, to eviction, foreclosure and even bankruptcy. And while bankruptcy usually provides relief from other debts, it will not discharge student loan obligations so that the crisis continues during and after a bankruptcy is filed. All the while, interest continues to accumulate on both the unpaid balance and the unpaid interest—resulting in reverse amortization that can easily double the balance due in a matter of several years. (Forbearance or an allowed temporary suspension of payments may also result in reverse amortization of the loan balance, and often this option is best avoided for this reason.)

One of the few forms of relief available for student loans is the federal Income-Based Repayment program, also called the “IBR” program. Under the IBR program, student loan repayments are capped at 15% of one’s discretionary income. Discretionary income is calculated as the difference between one’s most recent adjusted gross income (AGI on the last federal tax return Form 1040), less 150% of the applicable poverty line for your state and family size. Additionally, you must be able to demonstrate a financial hardship and meet other personal and loan eligibility requirements. Parents PLUS loans are almost never eligible for the IBR program however most other federal student loans will qualify.

For more information on the federal Income-Based Repayment program, see the IBR page of the Federal Student Aid website operated by the U.S. Department of Education.

For assistance with applying for the IBR program and other debt resolution, contact Wartchow Law Office for a free consultation to discuss your options.

The Archdiocese of St. Paul and Minneapolis Files Chapter 11 Bankruptcy: A Review of the First Day Filings

For more detailed discussion on chapter 11 procedure, common issues and more, be sure to read Wartchow Law’s Chapter 11 Blog.

On January 16, 2015, the Archdiocese of St. Paul and Minneapolis filed a petition for relief under chapter 11 of the United State Bankruptcy Code. The partially complete chapter 11 filing today in the United States Bankruptcy Court for the District of Minnesota lists, among other claims, the contingent and unliquidated claims of at least twenty-one individual personal injury plaintiffs identified only as John Doe and in amounts unknown as of the date of the commencement of the bankruptcy proceeding. In its filings, the Archdiocese states its intent “to move this case forward as quickly as possible in order to minimize professional fees and to maximize the recovery to victims in this case.”

The first day filings also make mention that the 187 parishes within the Archdiocese of St. Paul and Minneapolis are separate and distinct legal entities which manage their own property and assets, and which have not otherwise sought bankruptcy protection as part of this proceeding.

As of the time of this post, the Archdiocese has yet to indicate on public record with the bankruptcy court what, if any, transfers of assets or cash it made outside the ordinary course of its business affairs in the past two years. Under federal law, preferential and fraudulent transfers and transactions made by a debtor within certain proscribed periods prior to filing bankruptcy may be avoided, essentially undone and “clawed-back” into the bankruptcy estate for the benefit of the creditors. Under the Bankruptcy Code, a preferential transfer is typically a payment or transfer made within a specific period of time prior to filing bankruptcy which conferred an unfair benefit on one creditor over other creditors of the debtor at that time. See 11 U.S.C. § 547. Fraudulent conveyances are defined as done with the actual intent to hinder, delay or defraud one’s creditors while insolvent, or for which the soon-to-be debtor received less than equivalent value in exchange for such transfer while insolvent, or for which the transfer was made to or for the benefit of an insider of the debtor. See 11 U.S.C. § 548.

While treatment of the alleged victims’ claims can hardly be gleaned from the mere first day filings in this chapter 11 case—as in most chapter 11 cases, first day filings seek to establish the procedure by which the case will proceed in the coming weeks and months—the Archdiocese’s papers do provide some indication that this purpose behind its reorganization proceeding will “focus on the creation of a mechanism for the payment of fair compensation to abuse victims… similar to bankruptcy cases commenced by other dioceses in the United States.” Such other cases may include the bankruptcy proceedings previously filed by the archdiocese in Portland (filed July 2004), Tucson (filed September 2004), Davenport, Iowa (filed October 2006), San Diego (filed February 2007), Milwaukee (filed January 2011), Gallup, New Mexico (filed November 2013), and most recently in Helena, Montana (filed February 2014). These cases also involved sex abuse cases whose aggregate compensation payments to date have totaled in the billions of dollars. (Source: http://en.wikipedia.org/wiki/Settlements_and_bankruptcies_in_Catholic_sex_abuse_cases)

In addition to the three-page petition, the list of Creditors Holding the 20 Largest Claims, and the Statement of Authority to File Petition signed by Joseph F. Kueppers, member of the Board of Directors, attorneys for the Archdiocese also filed several motions seeking expedited relief, including a motion authorizing certain documents and pleadings to be filed under seal to maintain the anonymity of uts alleged victims. The expedited motion essentially seeks to limit public access to several portions of the bankruptcy schedules and creditor matrix that would otherwise identify the names and addresses of potential and alleged victims of sexual abuse by clergy or other members of the Catholic entities, including both individual claimants already represented by counsel in Ramsey County actions as well as other potential claimants known to the Archdiocese who may still assert claims of misconduct. Section 107(b) of the Bankruptcy Code authorizes the protection by seal of documents containing such individuals’ identities due to the “scandalous or defamatory” public exposure that may be caused by naming them in the otherwise public bankruptcy filings. The Archdiocese has also requested that the deadline for filing proofs of claim to be established at a later date rather than within the standard one or two days of commencement of the case.

Additionally in its first day filings, the Archdiocese seeks for the court to waive the United States Trustee’s standard requirement mandating the closure of all prepetition bank accounts in favor of establishing new “debtor-in-possession” bank accounts. Instead, the Archdiocese seeks court authorization for it to maintain its various pre-petition accounts held at US Bank, Wells Fargo, Premier Bank and Bremer Bank, citing reasons of both administrative convenience in payment of future expenses, accounting and for investment purposes as well as “to protect the safety and integrity” of such accounts.

Unless and until such time that a trustee is appointed to administer its financial affairs, a chapter 11 debtor continues to possess its assets and operate and manage its business affairs as a debtor-in-possession of its own affairs. This means that the Archdiocese’s assets and operational income are at least temporarily protected from liquidation, attachment or execution to satisfy claims of its creditors while, simultaneously, the automatic stay confers protection from the continuance of most other legal proceedings and actions against it.

The Archdiocese is represented in its chapter 11 proceeding by the law firms of Briggs and Morgan and Lindquist & Vennum, LLP. As of the date of this post, the case has been assigned to Judge Robert J. Kressel of the U.S. Courthouse located in Minneapolis, the local Minnesota Office of the U.S. Trustee has yet to appoint an attorney to the matter and no trustee has been appointed.

Congress Extends the Income Exclusion for 1099 ‘Forgiven’ Mortgage Debt to Tax Years 2015 and 2016

For a more detailed discussion on tax debt and other tax resolution issues, be sure to read Wartchow Law’s Tax Blog.

On December 18, 2015, Congress extended certain tax breaks to apply for both tax years 2015 and 2016, including the income exclusion for forgiven mortgage debt on a qualified principal residence. “Forgiven” or “cancelled” mortgage debt on a Form 1099-C occurs usually after a homestead is foreclosed, short sold or otherwise a defaulted mortgage goes unpaid for the statutory period of time. Upon the occurrence of these events, banks are required to treat the unpaid balance as “forgiven” and issue a Form 1099-C to the homeowner for the balance that is cancelled. (The term “forgiven” is a gross misnomer since, in fact, the mortgage balance remains lawfully collectible in full—more on that later in this article).

As of October 20, 2015, the Mortgage Debt Relief Act had not yet been extended to tax year 2015. However since President Obama approved an extension of the tax relief for the next two tax years (i.e., 2015 and 2016), this means that homeowners receiving a 1099 for mortgage debt will not be required to declare mortgage debt as taxable income on their federal income tax return. In past years, Congress has typically waited until December to extend the Act’s tax relief to homeowners (better last minute than never).

The Internal Revenue Service and state taxing authorities treat the 1099’d mortgage debt as taxable income unless an exclusion is claimed by the taxpayer on Form 982 for the tax year for which the 1099 is issued. This means that a 1099 received on even a mortgage balance of $30,000, for example, can result in significant federal and state income tax liability upwards of $5,000 or more for just a middle-income taxpayer. For higher income earners, this 1099 could result in massive tax consequences into the tens of thousands. The exclusion operates to exclude the 1099 from taxable income if the amount forgiven was “qualified principal residence indebtedness”. For current information on this and other income exclusions, see IRS Publication 4681.

This income tax exclusion for forgiven mortgage debt dates back to 2007 and Congress’s then-response to overwhelming consumer need for protection against tax liability contained in the Mortgage Foreclosure Debt Forgiveness Act. This most recent bill passing by Congress now allows for homeowners to claim the income exclusion on their 2015 and 2016 tax returns (assuming the 1099-C is issued for 2015 or 2016).

Tax year 2017 is currently without any extension of the mortgage debt income exclusion–look for that decision to be before Congress in December 2017. Other income exclusions may still be available however, for example the insolvency exclusion or the exclusion for a discharge received in bankruptcy.

This income tax “relief” for forgiven mortgage debt is not to be taken without a heaping measure of caution, however.

First, a 1099 does not actually denote that the mortgage balance forgiven and, in fact, the homeowner still owes the entire amount to the bank which can be collected upon via lawsuit and other means. Wait, back that up. The bank declares the mortgage forgiven and takes their tax benefit, the homeowner is personally responsible for the resulting income tax on the forgiven amount, but yet the homeowner can STILL be held accountable for the mortgage balance owed? Yes, actually. Practically, this means that the bank may still lawfully report the entire balance as due, owing and in default on a homeowner’s credit report, potentially ruining their credit. More significantly, perhaps, this also means that a homeowner can be sued for the forgiven balance and, if judgment is obtained, their wages garnished and bank account levied.

There are many state courts around the country—including here in Minnesota—that have declared that issuance of a Form 1099-C does not alone operate to legally extinguish a debt and, therefore, the full balance remains outstanding absent some operation of the law, such as a discharge received in a bankruptcy proceeding. These courts rely on an IRS Information Letter dated December 30, 2005, which explained: “The Internal Revenue Service does not view a Form 1099-C as an admission by the creditor that it has discharged the debt and can no longer pursue collection.” See I.R.S. Info. 2005-0207, 2005 WL 3561135 (Dec. 30, 2005). How’s that for deceptive wording?

Second, the timing of asserting the exclusion on your income tax return is tight to say the least. Assuming a homeowner timely receives the 1099-C following the end of the tax year for which it is issued, they still have time to report the income and claim the exclusion via IRS Form 982. But for homeowners who did not timely receive the 1099-C from the bank, the deadline to amend their tax return to claim the exclusion is six months from the date the return was originally due, which is usually April 15th of the following year. As an illustration, if a homeowner was in an active bankruptcy proceeding when the bank declared the mortgage forgiven on a home foreclosed prior to filing bankruptcy, the bank may have issued a 1099-C to the IRS yet simply never sent the 1099-C to the homeowner due to their being in bankruptcy at the time (or instead of bankruptcy, perhaps the 1099 was lost in the mail or the bank sent it to the wrong address). In this example, the homeowner may not find out about the 1099-C until years later when the IRS sends a collection letter for the additional income tax due on the forgiven mortgage—and all in spite of the bankruptcy. The result is that the homeowner is outside of the 6-month deadline for amending their 2013 tax returns to claim the income exclusion and is now strapped with the additional tax debt and a battle against both the bank and the Internal Revenue Service. Try unwinding that tax debacle.

For more about 1099s and the insolvency exclusion, see Received a Form 1099-C on Foreclosed Home? You May Qualify for the Mortgage Forgiveness Exclusion to Cancellation of Debt Income.