LostHead Wonders Where The CtC Savvy Lawyers Are

[Judge Roy Bean]

Let us not forget that the IRS is no more efficient than the average bear.

And the 'net has given opportunists who can and will position themselves to preserve their lifestyle access to the tools to thwart the bear.

[Brian Rookard]

Chapter 13 for me is like the dark side of the Moon.

Here's a Chapter 7 problem:

Individual comes to you, and you decide he needs to file Chapter 7 (let's say, for reasons unrelated to taxes). He meets the means test, etc., etc. Individual has a sole proprietorship business which he has been reporting on his Schedule C (Form 1040) for years and years. For years 2007 and prior, he has generated humongous, unused net operating loss carryovers. Although he does need to file bankruptcy, he had mucho grande net income from his Schedule C business for January thru November 2008. You are going to file his bankruptcy petition on December 1, 2008. What federal income tax advice do you give him for 2008?

Is this some kind of test or something?

Ok, so I am *not* a CPA or "tax professional" in that sense (although I'm thoroughly conversant in the debunking of tax protestor gibberish). And this is an area which frankly I don't have to deal with given our clientele (or maybe its something I just didn't think about until now, but probably should have).

With that qualification ... I'll take a stab at it. If the prospective debtor files for bankruptcy, the "NOLs" are actually property of the estate, and the Trustee can use these tax attributes to maximize the benefit to the estate. In fact, if the taxpayer were to make an election to forgo an NOL carryback, it is possible for the Trustee to set aside that election as a fraudulent transfer! (Holy sh_t ... learn something new every day I'm in bankruptcy). See In re Feiler, 218 F3d 948 (9th Cir., 2000).

Furthermore, when debt is forgiven (as in bankruptcy), the debt forgiven reduces certain tax attributes (such as NOL's). 26 USC 108(b). In fact, NOLs get reduced first.

So, what that means (to me) is that if the debtor/taxpayer files on December 1 (instead of waiting to the end of the tax year), he hoses himself (the bankruptcy estate can use the NOLs to get a larger tax refund which can be distributed to creditors). Furthermore, his forgiven debt will offset the NOLs (effectively meaning that if the Trustee doesn't use them, then they'll likely end up being useless to him later after they're reduced).

Too, I don't know how a spit tax year election under 1398 helps or hurts.

I guess my general suggestion (if it is possible) should be that he wait to file.

That's what I get from the limited research I was able to do in the last hour.

Anyone can feel free to correct me if I'm wrong. This whole "tax attribute" thing and 1398 split year elections is something I've been meaning to learn more about.

[Famspear]

Chapter 13 for me is like the dark side of the Moon.

Here's a Chapter 7 problem:

Individual comes to you, and you decide he needs to file Chapter 7 (let's say, for reasons unrelated to taxes). He meets the means test, etc., etc. Individual has a sole proprietorship business which he has been reporting on his Schedule C (Form 1040) for years and years. For years 2007 and prior, he has generated humongous, unused net operating loss carryovers. Although he does need to file bankruptcy, he had mucho grande net income from his Schedule C business for January thru November 2008. You are going to file his bankruptcy petition on December 1, 2008. What federal income tax advice do you give him for 2008?

Is this some kind of test or something?

Ok, so I am *not* a CPA or "tax professional" in that sense (although I'm thoroughly conversant in the debunking of tax protestor gibberish). And this is an area which frankly I don't have to deal with given our clientele (or maybe its something I just didn't think about until now, but probably should have).

With that qualification ... I'll take a stab at it. If the prospective debtor files for bankruptcy, the "NOLs" are actually property of the estate, and the Trustee can use these tax attributes to maximize the benefit to the estate. In fact, if the taxpayer were to make an election to forgo an NOL carryback, it is possible for the Trustee to set aside that election as a fraudulent transfer! (Holy sh_t ... learn something new every day I'm in bankruptcy). See In re Feiler, 218 F3d 948 (9th Cir., 2000).

Furthermore, when debt is forgiven (as in bankruptcy), the debt forgiven reduces certain tax attributes (such as NOL's). 26 USC 108(b). In fact, NOLs get reduced first.

So, what that means (to me) is that if the debtor/taxpayer files on December 1 (instead of waiting to the end of the tax year), he hoses himself (the bankruptcy estate can use the NOLs to get a larger tax refund which can be distributed to creditors). Furthermore, his forgiven debt will offset the NOLs (effectively meaning that if the Trustee doesn't use them, then they'll likely end up being useless to him later after they're reduced).

Too, I don't know how a spit tax year election under 1398 helps or hurts.

I guess my general suggestion (if it is possible) should be that he wait to file.

That's what I get from the limited research I was able to do in the last hour.

Anyone can feel free to correct me if I'm wrong. This whole "tax attribute" thing and 1398 split year elections is something I've been meaning to learn more about.

Ah, that's pretty much a Bingo, Brian!

What I would add is that if the taxpayer does not make the 1398(d)(2) split year election, he loses the benefit of the NOL, which goes to the Estate, a separate taxable entity as of the first day of the tax year of the year of case commencement. Since the case is commencing December 1, 2008, he loses the NOL as of January 1, 2008 (edited). The individual's income for the entire year 2008 is post-petition, and presumably if his only income is the Schedule C, he generates a large post-petition tax liability -- with zero NOL deduction to offset that income.

But if he makes the 1398(d)(2) split year election, he has two tax years: One from January 1 thru November 30, 2008. He gets to take the NOL against the income realized for that short period, and the tax liability, if any, is pre-petition. The second short period is of course December 1 - December 31, 2008. The amount of NOL to which the Estate succeeds is computed AFTER the individual has used whatever NOL deduction could use for the short period January 1 - November 30, 2008.

Thus: Very important in this specific situation for the individual to make the 1398(d)(2) election (EDIT: that's assuming he's going to file bankruptcy on December 1, 2008).

Great points on the NOLs and fraudulent transfers. My memory is that the courts have ruled that even though the election to forego the NOL carryback is not "revocable," the Chapter 7 trustee can still avoid the election as a fraudulent transfer, as you stated -- which achieves the same result.

For your excellent answer, you win three lovely nights for two at the Quatloosian Resort Hotel and Casino, at lovely Quatloosian Bay!!!

EDIT: I made a correction; technically, the Estate succeeds to the NOL as of the first day of the current tax year, not the last day of the preceding tax year. In the case of no split year election, the Estate succeeds to the NOL balance as of January 1, 2008, even though the Estate is not created until December 1, 2008.

By contrast, in the case of the split year election, the Estate succeeds to the NOL balance as of December 1, 2008, the first day of the debtor's tax year (Dec 1 - Dec 31, 2008) in which the case commences.

[Famspear]

PS: Brian, if you ask me a Chapter 13 question, I will not do nearly as well as you did on my Chapter 7 question.

[Prof]

Pretty sharp on the split tax year. You would be surprised how many bankruptcy lawyers forget that technique. I recently had a client IGNORE my advice not to pay his 2007 (small) tax obligation when he filed the return in October; the Trustee had enough money to pay that obligation if full, but the client did not want "trouble" with the IRS over about $1200. Then, the Trustee turned around and got the stimulus payment -- which could also have been used to offset taxes due.

(The client in the beneficiary under a spendthrift trust fund, which was/is not part of the bankruptcy estate.)

[grixit]

Hmm. I thought Chapter 7 was where one or more creditors gets a court order to liquidate a failing debtor while there's still something left.

[wserra]

Hmm. I thought Chapter 7 was where one or more creditors gets a court order to liquidate a failing debtor while there's still something left.

And I thought Chapter 7 was "In the House of Tom Bombadil".

Bankruptcy. Arghh.

[grixit]

Hey, i know where Tom Bambadil came from. But bankruptcy is one of the great mysteries of the universe.

[The Observer]

Hmm. I thought Chapter 7 was where one or more creditors gets a court order to liquidate a failing debtor while there's still something left.

Well, Chapter 7 can be filed by the petitioner if they have no assets (and they can file it themselves if they have assets).

Bankruptcy. Arghh.

Is today "Talk Like A Pirate Day"?

[Prof]

Hey, i know where Tom Bambadil came from. But bankruptcy is one of the great mysteries of the universe.

The concepts come from the Old Testament (you can look up the concept of Jubilee or debt forgiveness) and from the Romans via the Venetian Republic. In Venice, if a member of the exchange went broke, he could "break his bench," turn over all of his assets to his creditors, and avoid being sold as a galley slave. The slang expression, "banca rotta" which becomes "bankruptcy."