One of the really, really important things people don’t know about filing bankruptcy is how bankruptcy relates to federal income tax. In earlier blogs, I spent some time discussing debt settlement agencies and credit counseling bureaus, and why I don’t think either of those places is where you want to go first when you have debt issues. One of the most important reasons I think that way is that, if you make an agreement with a creditor to settle up with you for less money than you really owe them, income tax comes right into the picture, that very tax year. In other words, the portion of the debt you don’t pay back to your creditors has to be included on your tax return as taxable income, just as if you earned that money! Then, depending upon how much the amount is that is “forgiven”, your tax bracket could be bumped up higher and you could be paying a higher percentage tax on all your income! (Talk about a double whammy!)

Now, the truly interesting fact is that if debts are discharged (actually “forgiven”, but in this case through the court system), there’s no taxable income. There are actually other factors besides tax considerations in favor of filing bankruptcy rather than negotiating a settlement with the creditors, but avoiding the tax “double whammy” has to be near the top of the list!

Even though more than one million Americans file bankruptcy each year, there’s a myth floating around that bankruptcy is for deadbeats.  With me being a bankruptcy attorney in Indiana, I see hundreds of different people in my office every month, and I can certainly attest to how big a myth that is!  Still, I like to read what other bankruptcy attorneys from other states are saying about their bankruptcy clients. 

    One article I read recently comes from a Pennsylvania attorney named Mr. Otto.  Otto talks about all the negative feelings that debtors tend to have about themselves when it comes to using bankruptcy services.  Some of these negative feelings are caused by the real financial problems people are facing, but very often the bulk of the negativity comes from this myth about being a deadbeat. 

     In fact, many people have been responsibly handling their money for many, many years, and then – boom!  An extended illness or a layoff just came in and wrecked all their carefully-laid plans.  Now they’ve got creditors making their lives miserable, and they themselves are letting negative self-talk and blame make their own lives even worse.

      Mr. Otto suggests that debtors deal directly with their own feelings about bankruptcy, rather than repressing them.  Once a person has faced up to his own feelings, he can be ready to let go of those feelings and move on with the rest of his life.  One of the main things he advises is to stop laying blame – stop blaming others, and most important, stop blaming yourself, he says.  Have self-compassion, he tells people going through a bankruptcy.

     You know, that might just be good advice for everybody!

The more I think about that old country song “Looking For Love In All The Wrong Places”, the more it reminds me about how people overwhelmed by money problems try to get help in some of the wrong places.  As a bankruptcy attorney in Indiana for so many years, I know these poor people are merely postponing and avoiding facing up to their problems, rather than taking the action steps to turn things around.

In a former blog I talked about Debt Settlement Agencies, and why these are almost never a good solution or even a good first stop.  A second type of place many people turn to when they need debt help is a credit counseling  service.  In fact, whenever I tell someone at a social or business gathering what I do for a living, namely that I’m an Indiana bankruptcy attorney , the next question out of their mouths is often “Isn’t it better for someone to first try a credit counselor before filing bankruptcy?”

I need to remind you that I never deal in absolutes, saying one solution fits all people who need debt help. And so, rather than getting all excited about why one course of action is “the best”, I always stop and realize that the person asking the question probably doesn’t understand what credit counseling actually is.  Credit counseling agencies are supposed to offer education about good financial habits, advising folks on sticking to a budget, being faithful about paying bills on time, and the like.  What is supposed to be secondary, but often is the main kind of advice offered (for a fee, I might add), is negotiating with creditors in the same way that debt settlement agencies do.  In other words, the counseling agent talks to the credit card company to try to get that company to settle for a lower monthly payment or even a lump sum that is less than the amount really owed.

It’s important to know, by the way, that credit counseling agencies were examined recently by the IRS (you can read about this on the IRS website at www.irs.gov) and largely found to have failed to do the public enough good to qualify as tax-exempt agencies.   The investigators found that many agencies were too closely tied to for-profit credit companies and were more interested in benefiting them than the clients.  However, even if a credit counseling service does a good job, it may still not be the best place to go, for two reasons:

First, people with serious debt problems need to know all their options, and that includes legal options which only a bankruptcy attorney is qualified to discuss!  An experienced bankruptcy attorney can offer counseling on managing money and budgeting, but a credit counseling service is not allowed to offer legal advice.  They can’t talk about Chapter 7 or Chapter 13, about lawsuits people are facing or even about foreclosure on a home.  Only attornies can offer complete bankruptcy information and bankruptcy services.

The second important reason is time.   When late fees and penalties are piling up by the day and creditors are calling you at home and at work, time is of the essence.  It’s crucial that you get legal advice quickly and select a course of action.  This may or may not include filing a bankruptcy petition, but if you had gone first to a credit counselor and paid a fee, precious time would have elapsed, closing off some options.

Real life statistics bear out what I’m saying about avoiding delay.  The majority of people in Indiana who come to me considering bankruptcy are not financially irresponsible people. They never have been.  “Life happened” to them.  Either a serious illness in the family occurred, with tens and sometimes hundreds of thousands of dollars in hospital and treatment bills, a breadwinner was laid off from work, and sometimes there is an unexpected and expensive divorce going on.  Very often it’s a combination of more than one of these things.  Counseling on how to manage a budget isn’t really going to help in these cases, and meanwhile, the bills are mounting every day.

So, what I really want to say to people is this: Don’t look everywhere before coming back to where you should’ve started in the first place.  As bankruptcy attorneys in Indiana, I and the other attorneys in my office are first and foremost counselors. That’s precisely what we do every day of the week.  But, unlike debt settlement agencies or credit counseling bureaus, we can help you look in all the right places for a plan that fits you and the situation you’re in, and we can help you do it right now!