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  Strategies for the Debtor -

     When a consumer or business debtor decides to file bankruptcy, there can be a number of beneficial strategies for those debtors having trouble paying bills. Some of these strategies can be to the debtor advantage or to the debtor disadvantage. These points should be rigorously examined and explained by competent counsel, before the bankruptcy option is executed.

Strategies for the Debtor

Common Strategies

     There are numerous strategic advantages when filing bankruptcy. These can be sufficient to merit a bankruptcy filing. Some of these include: the Automatic Stay, use of "Avoiding Powers, Lien-stripping and the "Race to the Courthouse".

  • Automatic Stay - Under Bankruptcy Code Section 362(a), filing bankruptcy immediately and automatically stops most creditor action against the debtor. It is one of the most powerful weapons in the debtor's defense arsenal against creditor action. The debtor does not have to do anything other than file the case and list his creditors.
  • "Lien-stripping" - "Lien stripping" is a process where a debtor can "strip down" the claim of a secured creditor to the fair market value of the collateral securing the debt. It is generally available in Chapters 11 and 13, subject to certain restrictions on a principal residence.
  • "Use of "Avoiding Powers" - When a case is filed, the trustee and in some cases the debtor are imbued with certain "avoiding powers" under Sections 544(a)(3), 547, and 548 of the Bankruptcy Code. This may let the debtor sue creditors and "undo" certain harmful transactions that fell within certain time periods leading up to the filing.
  • "Race to the Courthouse" - Bankruptcy filing can stop the "Race to the Courthouse": In many situations, a debtor may have numerous creditors who are taking action against him. This is especially true in business cases.

Tax Strategies

     Filing bankruptcy as a strategy to discharge taxes can sometimes help a debtor from a tax perspective. This is a very complex area and should be studied thoroughly by your bankruptcy attorney and tax counsel before the decision is made to file a case for tax purposes. Some of the possible advantages are:

 1).  Some taxes can be discharged, or wiped out, in bankruptcy. These are generally taxes more than 3 years old which meet 4 additional criteria as well. In Chapter 13, taxes can be paid over 5 years with no interest, and the penalties eliminated. In Chapter 11 the taxes need to be paid with interest at the IRS statutory rate, but the payments can be stretched out over 5 years.

 2).  Allowing a foreclosure to occur during bankruptcy while the property is property of the bankruptcy estate, can result in the estate, not the debtor, having the tax consequences. This could keep the debtor from having to pay substantial capital gains taxes, for instance, on a property that had appreciated in value.

 3).  Outside of bankruptcy, forgiveness or cancellation of debt (COD) is considered income, and a debtor would need to report it as such. However, this is not the case when a debtor receives a cancellation or discharge of that debt through bankruptcy.

 4).  The automatic stay stops the IRS and other tax entities from taking debtor's property post-bankruptcy. It "freezes" the lien so that it only applies to the assets the debtor had on the bankruptcy filing date.

Under certain circumstances, the bankruptcy court can rule on a tax dispute and fix the amount of tax that is due, under Bankruptcy Code Section 505.



     There are dozens of strategic considerations involved in making the decision to file as well as when to file bankruptcy. There are differences between the chapters of bankruptcy, and whether the debtor is an individual, partnership or corporation. A true cost-benefit analysis should be performed by the debtor, his bankruptcy attorney, and other needed professionals, including tax counsel, so that the impact of a filing is understood fully in advance. The client should proceed with his case having the best advice available.

Written by Henry Rendler

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