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.

My Bank Account was Levied—What Now? How to Stop Bank Levies and Have Levied Funds Returned to You by Filing for Bankruptcy Protection.

Chances are that if your bank account was levied, you were already aware that you owe an unpaid debt and, most likely, were served in the recent months with a judgment entered on a lawsuit. In Minnesota, many—but not all*—bank levies are typically the result of collection on a judgment for unpaid debts owed to the judgment creditor.

*Some creditors such as the taxing authorities, small business administration loans and other government-funded debts are permitted under law to levy bank accounts and garnish wages without having to first obtain judgment in a court of law.

The typical scenario leading up to a bank levy is that a defaulted unsecured debt such as a credit card or medical bill falls into collection and eventually ends up with a local law firm that commences a lawsuit by serving you with a summons and complaint. If that summons and complaint goes unanswered by the debtor, the creditor will typically obtain a judgment within a month or two for the amount owed plus any allowed attorney fees, interest and other costs. This judgment is then docketed in the county you reside and the creditor’s attorney soon thereafter commences collection efforts including wage garnishment and bank levies. You may also be served with post-judgment discovery asking you where you work, bank and for other details of your income that will aid the creditor in collection on the judgment.

Unlike a wage garnishment where prior notice is required, a bank levy can happen at any time without notice as soon as the judgment has been entered. If you are like most people, you probably have a bank account at any of the major Minnesota banks (US Bank, Wells Fargo, TCF, etc.) and/or you previously disclosed where you keep bank accounts when you originally applied for the credit card. All a judgment creditor’s attorney needs to do to levy your bank account is to serve a subpoena on each bank that they think you may own an account and your account is then levied for all money up to the amount that you owe on the judgment. A bank account levy is a serious financial set-back for most families, as it unexpectedly impairs your ability to pay your rent or mortgage due the next month. On some occasions, the levied funds may be returned without the need to file for bankruptcy but only if you can prove to the judgment creditor’s attorney that the money levied came from exempt sources such as social security or other need-based assistance.

For more information on lawsuits and judgment collection, see You’ve Just Been Served with a Lawsuit, Now What? and Collection on the Judgment – What to Know if You Are Facing a Wage Garnishment.

A bank levy is a common precursor to filing for bankruptcy relief. Either chapter 7 bankruptcy or chapter 13 bankruptcy will have the immediate effect of stopping all bank levies and wage garnishments. Additionally—and very importantly from a timing perspective—you may be able to get the levied funds returned to you if you act quickly. The general rule is that levied and garnished funds must be returned to you after you file bankruptcy if the following two criteria are met: 1) the total amount levied is at least $600 or more AND 2) you file bankruptcy within 90 days of the date that the levy subpoena was served on the bank, which is usually a day or two prior to the actual date the funds were levied from your account.  

Contact attorney Lynn Wartchow to discuss your bank levy and what you can do to have the levied money returned to you.

Defaulted SBA Loans: How SBA Loans Differ from other Forms of Credit when it comes to Collection, Personal Guarantees and Discharging SBA Loans in Bankruptcy

Often when a small business obtains bank financing to start-up or expand operations, it does so with a loan that is guaranteed by the federal Small Business Administration (SBA). SBA financing is typically administered through a major bank and is guaranteed by the U.S. Small Business Association, an arrangement that benefits small business owners who may not otherwise be able to obtain personal financing to expand their enterprise. Unlike other forms of business credit such as credit cards and vendor liabilities, the SBA loan will survive the failure of a small business and remain a personal liability of the business’s principal under a principal’s personal guarantee.

SBA loans differ from most other forms of credit in several respects when it comes to the SBA’s recourse under a defaulted SBA loan. First, any default in the payment of the SBA loan may quickly lead to an administrative wage garnishment of the guarantor’s income. Unlike other unpaid creditors, the SBA is authorized under federal statute to immediately order garnishment of the guarantor’s net wages—usually 25%—to satisfy the delinquent SBA loan. In contrast, most other creditors must first initiate litigation and obtain a judgment in a court of law before wages can be garnished, a process which takes several months at a minimum. This means that the SBA can more readily and rapidly force the collection of unpaid SBA loans via wage garnishment of the principal.

Second, the SBA loan may be secured by a lien on the principal’s personal assets including on one’s homestead. In this manner, the SBA loan operates as a mortgage on the principal’s residence and defaulted SBA loans could lead to home foreclosure. While foreclosure in Minnesota entails strict notice requirements and the owner’s opportunity to cure prior to a sheriff’s sale, a completed foreclosure can cause personal upheaval for the owner if they lose their home in addition to the loss of their small business. For this reason, foreclosure is often a precursor to personal bankruptcy in Chapter 13 to cure home mortgage arrears and save one’s home. If the SBA loan is not secured by a lien on the owner’s residence or other personal collateral, then Chapter 7 bankruptcy is often a better solution to simply discharge the SBA loan in its entirety.

The failure of a small business may quickly set in motion personal financial problems for its principal, particularly when the business owner has personally guaranteed an SBA loan and other lines of credit for the business. While the failed business may have simply closed its doors and gone defunct, the owner of the business may be left with residual personal liability long after the business operations have ceased. Particularly if the SBA loan cannot be repaid or compromised in settlement, the principal may consider a personal bankruptcy to discharge their guarantee and protect their personal financial affairs, home and other assets.

For information about how to save your small business, see Intro to Chapter 11 Business Reorganization: The Process, Time and Fees Involved.

To understand if bankruptcy protection is right for you, contact Wartchow Law Office for a free consultation to analyze your circumstances and offer practical guidance on your options in both Chapter 7 and Chapter 13 bankruptcy and bankruptcy alternatives. Located in Edina, Minnesota, Lynn Wartchow represents clients in all Chapters of bankruptcy in Minneapolis, St. Paul, Ramsey and Hennepin County, and throughout Minnesota.

File Bankruptcy to Protect Your Wages and Other Earnings from Garnishment

From the moment that a bankruptcy petition is filed, the “automatic stay” is invoked and this automatic stay of legal proceedings affords many protections from collection activities, including wage garnishment on W-2 income, other income levies such as from 1099 income–usually earnings of self-employed persons or independent contractors–and bank account levies. In other words, the filing of chapter 7 bankruptcy effectively puts all collection activities and legal proceedings on immediate hold due to the automatic stay. Depending on the circumstances, the automatic stay can be lifted for various reasons but rarely, if ever, so that a creditor can continue wage garnishment or bank account levies. (One of the more common reasons for the bankruptcy court to allow the automatic stay to be lifted is for the foreclosure of a homestead that is in default and for which there is no proposal to cure the arrearages, for example through a Chapter 13 plan.)

Wage garnishment is a collection remedy that is usually only, but not always, available after a judgment has first been obtained or at a minimum after you have not responded to a summons and complaint previously served on you several weeks prior. If you have been served with a summons and complaint in a collection lawsuit and/or a judgment has been entered, you are likely also aware that a wage garnishment is headed your way. While most employees will receive notice of the wage garnishment prior to the garnishment taking effect via the next payroll, employers do not always provide prior notice of the upcoming garnishment and availability to claim potential exemptions from garnishment. While a debtor often has advance notice of a wage garnishment, you almost never receive notice of a bank levy until after it has already occurred.

For most people in Minnesota, a wage garnishment means that 25% of your net (“take home”) earnings will be garnished each payroll until the underlying debt is paid off. There are exemptions to wage garnishment available to some individuals meeting certain criteria.

Even if you are a self-employed or contract worker, 1099 non-wage income can still be garnished, especially if the garnishing creditor is aware of such income from previous disclosures made to them including in credit applications.

Bankruptcy puts an immediate stop to wage garnishment and all other collection tactics. In some cases, the last 90 days of wages garnished from you can be refunded by the garnishing creditor within weeks after the bankruptcy is filed.

Located in Edina, Minnesota, bankruptcy attorney Lynn Wartchow represents clients in all Chapters of bankruptcy in Minneapolis, St. Paul, Ramsey and Hennepin County, and throughout Minnesota.

Received a 1099-Misc on Cancelled Debt? You May Qualify for Exclusion from Taxes if You Were Insolvent or Filed Bankruptcy

Generally, when a debt is owed and at least $600 of the debt is canceled, forgiven or settled for less than the full amount owed, this amount forgiven is treated for income for tax purposes. Cancelled debts often arise after a home is foreclosed with a deficiency still owed. Cancelled debts also occur when a credit card goes unpaid for the statutory period or the balance is settled for less than the full balance owed. In these common cases, the person receiving the benefit of the debt cancellation may receive a Form 1099-C or 1099-Misc., requiring them to report income and possibly also pay income tax on the amount forgiven/cancelled.

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

Cancelled debts are reported on a Form 1099 and not always in the year that the debt is cancelled. Form 1099s can be sent up to three years after the debt was cancelled, which may result in your having to amend that year’s tax returns. Once reported on a 1099, you are required by law to report this income on your tax returns and both the IRS and state includes the amount of cancelled debt as taxable income. Accordingly, this additional taxable income may result in taxes owed at the same rate that income is taxed.

However, there are exceptions to being taxed on cancelled or forgiven debt if you were insolvent immediately before the debt was cancelled or otherwise if you received a discharge in a Chapter 7 or Chapter 13 bankruptcy proceeding. While both insolvency and a discharge in a bankruptcy proceeding may provide an exception for some types of cancelled debts (particularly regarding residential mortgages), insolvency by the IRS standards does not require that you actually file bankruptcy. You can be insolvent according to the IRS without actually filing bankruptcy. If you qualify as “insolvent” according to the IRS standards, you must still report the Form 1099. income on your tax returns however you can separately file Form 982 is you qualify to exclude this income from your taxable income

A common example of cancelled debt is when a credit card balance is settled for less than the full amount owed, thus resulting in an amount which is “forgiven” or cancelled by the credit card company. Under federal law, the credit card company is required to report the amount of the cancelled debt as taxable income to the credit card holder.

As another example, if a personal vehicle was repossessed and then later sold by the lender after repossession, the amount owed on the loan would be reduced by the sale proceeds however usually a “deficiency” is still be owed. In this case, your lender may send you a 1099 for the difference owed which is “cancelled” by them. Unless you file bankruptcy or were insolvent immediately before the cancellation of the deficiency, you may owe income tax on that deficiency.

You should not receive a Form 1099 on debs that were previously discharged in a bankruptcy occurring prior to the issuance of the 1099. In fact, bankruptcy is usually an all-inclusive exclusion from taxes for cancelled debts, however you must still report the 1099 income on Form 982 and attach to your federal tax return. Note that the IRS Form 982 refers to a bankruptcy discharge as a “discharge of indebtedness in a title 11 case” since the Bankruptcy Code is under title 11 of the United States Code.

More information on the taxation of cancelled debts is available at www.IRS.gov and in the IRS Publication 4681.

Also see Received a Form 1099 on Foreclosed Home? You May Qualify for the Mortgage Forgiveness Exclusion to Cancellation of Debt Income.

Located in Edina, Minnesota, attorney Lynn Wartchow represents clients in all Chapters of bankruptcy in Minneapolis, St. Paul, Ramsey and Hennepin County, and throughout Minnesota.

 

The Fair Debt Collection Practices Act and How It Protects You

The Fair Debt Collection Practices Act (“FDCPA”) is pro-consumer legislation that was originally enacted in 1978 for the purpose of protecting consumers from the aggressive and sometimes abusive collection tactics often used by third party collection agencies. Among the its lengthy list of prohibited acts and conduct, the FDCPA makes it illegal for debt collectors including collection agencies, lawyers, forms writers and other third party collectors to do the following:

  • State information that is false, deceptive, or misleading
  • Threaten to take any action that cannot legally be taken or that is not intended to be taken
  • State that a legal process such as a lawsuit has begun when in fact it has not
  • Represent that collection documents have been authorized or approved by a court, official, or an agency of the government
  • Threaten to unlawfully repossess property
  • Claim that the consumer has committed a crime
  • Incessantly call on the phone or engage in repeated telephone conversations
  • Call the consumer at their place of employment when the collector knows that the employer prohibits such communications
  • Discuss the debt with a third person, such as an employer or family member
  • Call the consumer if they know they are represented by an attorney

There are several requirements that must be met before a consumer’s claim for an FDCPA violation arises, including that the underlying debt must have been incurred for personal, family or household purposes as opposed to for business reasons. Damages for successful FDCPA violations include up to $1,000 plus the cost of attorney fees for bringing the action. Additional damages may be available if the consumer can prove emotional distress or that they suffered an out of pocket expense due to the violation.

If you believe that you may have a claim under the FDCPA, you should tell your bankruptcy attorney about the claim as this could be a potential asset in your bankruptcy case.

Wartchow Law Office provides free bankruptcy consultations to discuss options in Chapter 7 and Chapter 13 bankruptcy in Minnesota as well as non-bankruptcy debt relief alternatives. Located in Edina, Minnesota, Wartchow Law Office represents clients throughout the Twin Cities of Minneapolis, St. Paul and surrounding areas.

Received a Form 1099-C on Foreclosed Home? You May Qualify for the Mortgage Forgiveness Exclusion to Cancellation of Debt Income.

If you receive a Form 1099-C reporting ‘debt cancellation’ income after a home foreclosure, you may qualify for the Mortgage Forgiveness exclusion. As if the distress of home foreclosure isn’t enough, homeowners may receive a Form 1099-C from their former mortgage lender reporting the deficiency owed as income to the homeowner. The income reported on the Form 1099-C is what’s referred to as “Cancellation of Debt Income” or “Discharge of Indebtedness Income”, both of which generally must be reported as taxable income on an individual’s Form 1040 federal and state tax returns. When the 1099 relates to foreclosed real estate, the amount of cancelled debt can be significant and can consequently result in a substantial increase in tax liability for that year, loss of tax refunds or even additional tax liabilities owed to the IRS and Minnesota Department of Revenue.

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

Typically, cancellation of debt is an income realization event that must be reported on one’s tax returns. The idea is that any amount of principal or interest that a person legally owes but does not have to repay is considered taxable income in the year that such debt is cancelled. As an illustration, if you owe a commercial lender $15,000 between interest and principal due on a loan but that creditor agrees to accept $5,000 and cancel the other $10,000 in satisfaction of the full amount, that creditor is required by federal law to issue an IRS Form 1099-C, which reports the $10,000 cancelled debt as taxable income to you. Depending on the circumstances, the amount reported on Form 1099 must be included as personal income unless a statutory exclusion applies. Most of the IRS’s income exclusions are conditioned upon insolvency of the taxpayer—i.e., total debts exceed total fair market value of all assets—however bankruptcy is not necessarily required to qualify under certain IRS insolvency exclusions. Even in the absence of insolvency, a homeowner may still qualify for the Mortgage Forgiveness exclusion.

The Mortgage Forgiveness exclusion is provided under the Mortgage Debt Relief Act of 2007, which allows most taxpayers to exclude 1099 income resulting from the discharge of debt on their principal residence. The key to qualifying for this exclusion is that the debt must have been incurred to buy, build or substantially improve your principal residence and the debt must have been secured by your principal residence. Most traditional mortgages on homestead properties would meet this criteria. Currently, the Mortgage Debt Relief Act only applies through 2012, after which it may be extended by additional act of Congress.

When an individual files for bankruptcy, Section 108 of the Internal Revenue Code automatically excludes any debt that was discharged in the bankruptcy from taxable income. This is why consumer debtors who receive a discharge in a Chapter 7 or Chapter 13 bankruptcy proceeding rarely receive a 1099 regarding any of the discharged debts (and if you do, you should talk to your tax preparer about your options to dispute the 1099).

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.

For more information on The Mortgage Forgiveness Debt Relief Act and Debt Cancellation, see IRS Publication 4681 and IRS Form 982 available on the IRS website at www.irs.gov. You should always ask your tax professional for tax advice and not rely on information found online. This information is intended for entertainment purposes only and use of any information from this site or any other web site referred to is for general information only and does not represent personal tax advice either express or implied. You are encouraged to seek professional tax advice for personal income tax questions and assistance.  

Collection on the Judgment – What to Know if You Are Facing a Wage Garnishment

A frequent impetus for a Chapter 7 or Chapter 13 consumer bankruptcy filing is when a person is being actively collected on—usually in the form of a wage garnishment and/or a bank account levy—pursuant to a money judgment entered against them. Once a judgment is entered, the party owing money is called the “judgment debtor”. The entry of a judgment against a judgment debtor should come as little surprise, as it comes after that person has already been served with a summons and complain in a lawsuit claiming monetary damages owed to the judgment creditor. If the judgment debtor did not file a response within the prescribed time periods, which is a common scenario, the judgment creditor obtained a default judgment. Regardless of whether the judgment was entered by default or after hearing on the matter, the judgment creditor can take any numbers of actions to collect the amount owed pursuant to that judgment.

The two most common avenues to collect on a money judgment are to garnish either the debtor’s wages or the debtor’s account at a bank or other financial institution. Garnishment of a bank account is also referred to as “levy”. The process for each collection tactic is different. In order to garnish wages under Minnesota statute, the judgment creditor must serve notice of garnishment on the debtor’s employer (also called the “garnishee”), shortly after which the employer is required to withhold 25% of the debtor’s income for remittance to the judgment creditor.  While some government benefits such as emergency and medical assistance and other money such as child support and social security benefits are specifically exempt from garnishment, a judgment debtor’s wages and other earnings usually can be garnished up to 25% per pay period and until the judgment amount is fully satisfied.

Similarly for bank account levies, the judgment creditor serves a garnishment summons on the debtor’s bank to levy upon bank accounts in the debtor’s name up to the total amount owed on the judgment. This process usually transpires without any prior notice to the judgment debtor, who receives the opportunity to claim a portion of the levied funds exempt only after the funds have already been removed from the account. Unlike wage garnishment, a judgment creditor can take 100% of funds in the bank account up to the amount owed on the judgment. The judgment creditor may levy on the same bank account multiple times and also levy on multiple accounts in order to satisfy the amount owed.

Bankruptcy can provide relief from collection on a judgment, whether wage garnishment or bank account levy, in several ways. First and most immediately, the filing of a bankruptcy petition and schedules with the Bankruptcy Court invokes an automatic stay protection against continued collection. This means that as of the moment the bankruptcy petition is filed, no further wages or bank account funds can be legally garnished or levied. Second, it is also often possible to have returned any money that has been garnished or levied from a judgment debtor within 90 days of their filing for Chapter 7 or Chapter 13 bankruptcy relief. Only the actual filing of a bankruptcy proceeding will provide the protection of the automatic stay and ability to have garnished funds returned. The quicker a judgment debtor acts to obtain advice of a bankruptcy attorney, the better the odds are to reverse the detrimental effects of a garnishment or levy or, better yet, to avoid it altogether.

Lynn Wartchow is the founding attorney of Wartchow Law Office and has represented clients in Chapter 7 and Chapter 13 consumer bankruptcy proceedings since 2005.

You’ve Just Been Served with a Lawsuit, Now What?

It’s common for people who have consumer debts such as credit cards and medical bills to be sued and have judgments entered against them prior to filing bankruptcy. The first thing to realize is this is all very normal. In fact, lawsuits are so common that the threat of wage garnishment stemming from a judgment is one of the leading motivations for people to file bankruptcy sooner rather than later.

The second thing to realize if you have been sued is that lawsuits move fast and your money and earnings are at risk. In Minnesota, lawsuits are generally initiated when the plaintiff serves the defendant with a summons and complaint stating the basis for the lawsuit and amount owed. For lawsuits involving the collection of debt such as credit cards, the complaint typically will set forth the outstanding balance owed as well as tack on accrued interest and attorney fees. From the date that a summons and complaint are served, the defendant has 20 days to submit an answer or the plaintiff can quickly ask the court for a default judgment. Once a judgment is entered, the creditor is now a  judgment creditor” and has additional remedies available to collect on the amount owed, including garnishment of wages and levying any bank account that is linked to the “judgment debtor”.

Bankruptcy stops a lawsuit the moment a bankruptcy petition is filed with the court. If
the lawsuit is still pending at the time the bankruptcy is filed, a judgment cannot be entered. However if the lawsuit has already been reduced to a judgment, the judgment can still be discharged by bankruptcy. In some circumstances money that has been garnished from wages or levied from a bank account prior to the bankruptcy can be returned to you. There is a process to remove judgments post-bankruptcy discharge, which is advisable to help restore credit quicker after bankruptcy.

If you have been served with a lawsuit, you may wish to act fast to consult your bankruptcy options within the first couple weeks. While it’s generally best to head off a lawsuit before it gets to the point of judgment, you still have options even after a judgment is entered. A bankruptcy attorney can clearly explain what you can expect as far as the lawsuit, judgment and the return of any garnished or levied funds are concerned. Just remember that the legal process moves quickly and prevention is the best defense.

Lynn Wartchow is the founding attorney of Wartchow Law Office and has represented clients in Chapter 7 and Chapter 13 consumer bankruptcy proceedings since early 2005.