Will the Mortgage Forgiveness Debt Relief Act be renewed? I wish I knew the answer to that question. Right now, there is a lot of uncertainty about the renewal of the Mortgage Forgiveness Debt Relief Act. According to the IRS website, the Mortgage Forgiveness Debt Relief Act “applies to qualified principal residence indebtedness forgiven in calendar years 2007 through 2012.”

Any time that you owe a debt to someone (or an entity – such as a corporation), and that debt is forgiven or canceled, the IRS says that the amount of debt that is forgiven or canceled is income.  You also usually “get” to pay taxes on that income.

The Mortgage Forgiveness Debt Relief Act provides some homeowners with tax relief. If your home is encumbered by an underwater mortgage and you lost your home to a short sale, deed in lieu of foreclosure, or foreclosure, then the Mortgage Forgiveness Debt Relief Act might apply to you. If it applies to you, then you can exclude certain cancelled debt on your principal residence from your income (and that means you wouldn’t have to pay taxes on that “income”).

Unfortunately, the Mortgage Forgiveness Debt Relief Act expires at the end of this year (2012), and no one knows yet whether it will be renewed. My hope is that it will be renewed, because without its renewal, there could be a lot more former homeowners in serious financial trouble (owing a significant tax debt after losing their home).

If the Mortgage Forgiveness Debt Relief Act is not renewed – or if it doesn’t apply to you – there are still other ways (proving insolvency and bankruptcy) to possibly prevent owing as much in taxes. My advice is that if you are having difficulty paying your mortgage and you think that you may be losing your house to foreclosure, deed in lieu of foreclosure, or a short sale, consult with an experienced CPA or accountant as soon as possible. That way you can do everything possible to reduce the amount that you could owe.

This article in the Detroit Free Press, part 1 of a 3-part series, discusses how Fannie Mae claims that it tries to keep families in their homes, while at the same time pressuring banks to foreclose. Alan White, a law professor at Valparaiso University and a leading national expert on the foreclosure crisis, is quoted in the article:

“Fannie just wants to clean up its balance sheet and get these loans off the books while taxpayers are eating these losses,” White said, referring to the multibillion-dollar federal bailout of Fannie Mae in 2008 and the rising cost to taxpayers.

“And Treasury and the FHFA are letting them get away with it. It’s a huge waste. Wealth is being destroyed, people are losing houses needlessly, and taxpayers are losing money.”

The article also cites examples of banks requesting a delay in the foreclosure process in order to allow short sales or loan modifications to occur, and Fannie Mae declining those requests and insisting that the banks proceed with foreclosure.

From the ELHP Minnesota website:

The Emergency Homeowners’ Loan Program (EHLP) can provide eligible homeowners with a 0% interest, forgivable loan that pays past-due mortgage payments (principal, interest, taxes, insurance, attorney fees), as well as a portion of the homeowner’s FUTURE mortgage payment for 24 consecutive months (up to a $50,000 limit) provided that certain eligibility requirements are maintained.

If you are eligible for EHLP, you have a very tight timeline during which you must apply – you must apply by July 22, 2011. For more information on how to apply, visit the official EHLP website.

The Minnesota Home Ownership Center and Fannie Mae have entered into a partnership “to accelerate the response time for struggling Minnesota families with loans owned by Fannie Mae.”

If your loan is owned by Fannie Mae, and you are struggling with your mortgage payments, you should contact the Minnesota Home Ownership Center ASAP.

If you are unsure about whether Fannie Mae owns your mortgage, here is a link to a blog post that explains how to find out who owns your mortgage.

It is very common for people in dire financial situations to borrow money from relatives. A lot of times, Debtors feel nervous about not paying back their relatives before filing bankruptcy. If a Debtor pays back a relative before filing bankruptcy, they could very likely end up regretting that decision. This is because of the definition of “preferences” under Section 547 of the Bankruptcy Code.

There are 2 kinds of preferences with which Section 547 is concerned. The first type of preference is payments totaling $600 or more to any one creditor made during the 90 days before you file bankruptcy.

The second kind of preference is any payment made to “insiders” in the year before you file bankruptcy. What is an “insider”? The term “insider” includes but is not limited to: relatives of the debtor; general partners of the debtor and their relatives; corporations of which the debtor is an officer, director, or person in control; officers, directors, and any owner of 5 percent or more of the voting or equity securities of a corporate debtor and their relatives; affiliates of the debtor and insiders of such affiliates; any managing agent of the debtor. 11 U.S.C. § 101.

Whether certain payments qualify as preferences is something that you will need to discuss with your bankruptcy attorney.  Payments that may be considered preferences must be disclosed on your bankruptcy petition, on the Statement of Financial Affairs.

If you are at a point where you are thinking that you may have to file for bankruptcy, you should contact an attorney before paying back any insiders. Otherwise, if you do end up having to file bankruptcy, the bankruptcy trustee may be able to avoid those preference payments. That means that the trustee can demand those payments from your relative – and the trustee may even sue  them to get the money back from them. That could lead to an awkward Thanksgiving dinner or family reunion.

In a consumer bankruptcy case,  a person’s gross income is used to calculate whether the debtor is above or below the median income for means test purposes.

People often confuse gross and net (or “take-home”) income, and that is understandable, because most people’s household budgets operate according to their take-home pay. However, when you are trying to determine whether your household income is above or below median income, it is determined according to your gross income – not your take-home pay.

If you have self-employment income, in order to determine your income for means test purposes, you will need to have an up-to-date profit and loss statement. It is also very important for self-employed people to keep good records and documentation (think: bank statements, receipts, etc.).

In 2005, BAPCPA (Bankruptcy Abuse Prevention and Consumer Protection Act) was passed. For more information about BAPCPA, through the lens of the U.S. Trustee Program, see this website.

One of the most “fun” parts of BAPCPA is the application of the means test in a consumer case (Form B22 in a bankruptcy petition).  Here is an example of Form B22A. If your household income (for the last 6 months before you file your bankruptcy petition) is below the median income for your household size in your state, then the means test is pretty easy. If your household income is above the median income, then the means test becomes more complicated.

How do you know if your household income is above the median income for your state? Here is a link to the numbers as of November 1, 2010. The numbers change pretty regularly, so it’s also a good idea to check here and make sure that the numbers you are accessing are the most recent numbers. If you are filing a consumer Chapter 7 Bankruptcy and your income is over the median income, Form B22 becomes a bit more complicated for you. Depending on the results of your Form B22, you may not qualify for a Chapter 7 Bankruptcy, and may be required to file a Chapter 13 bankruptcy instead.

As of February 1, 2011, more than half a million HAMP modifications have been made permanent. Read more about it here. What do people do when they don’t receive a permanent HAMP modification? Some people, who may not qualify for a modification under the HAMP program have been able to obtain an in-house modification through their bank. Generally, the application process for an in-house modification is the same as the application process for the HAMP program, but the banks have more leeway in deciding whether to grant an in-house modification. The process for obtaining an in-house modification is not really any less frustrating or time-consuming than obtaining a HAMP modification. It is, however, another option for a struggling homeowner who would like to save his or her home.

Homeowners who are not able to save their homes sometimes participate in the Home Affordable Foreclosure Alternatives (HAFA) Program – by doing a short sale or a deed in lieu of foreclosure.

Sometimes, a homeowner who is unable to obtain a modification chooses to let their house go into foreclosure. A homeowner who chooses this option should be sure that they understand their state’s laws regarding deficiency judgments and foreclosure. Here is a link to my blog post about Minnesota’s laws regarding deficiency judgments.

One common issue in a bankruptcy case is whether the person filing bankruptcy will be able to keep their tax refund (many times it’s a refund that they haven’t yet received). Depending on what assets you have and which exemptions you are using (Minnesota state exemptions or the Federal exemptions) you may be able to keep your entire refund. I know that a lot of people like to receive large tax refunds, because it is a forced savings plan. However, if you are regularly receiving large tax refunds, and you are also thinking that you might have to file bankruptcy, you might be providing the IRS with a nice interest-free loan to the detriment of your personal finances. If you don’t want to receive a large tax refund, you will need to change your withholdings. The IRS has a withholding calculator on its website. To see if you are withholding the right amount from your paychecks, start out by using the withholding calculator. It is also a good idea to double-check your results with an accountant or a CPA. If you change your withholdings so that you won’t get a tax refund, you won’t have to worry about exempting a large tax refund from the bankruptcy estate – and that means that you won’t have to worry about keeping your tax refund.

It is quite common for prospective clients to call my office and tell me that they are considering taking out a loan from their retirement account, or withdrawing money from their retirement account, in order to pay some of their creditors. I’ve also had people hire me to file their bankruptcy a year or so after doing this. Usually they took out that loan or withdrew that money in order to pay their creditors (and avoid filing bankruptcy). Yet, even after doing that, they are finding themselves in a situation where filing bankruptcy makes sense for them.

My first piece of advice is: don’t do it! For most people, it’s usually not a good idea to take money out of their retirement accounts to pay their creditors.

If you are going to withdraw money from your retirement account (even though I just told you it’s probably not a good idea) it is in your best interest to consult with an accountant or CPA first. I have seen people “cash in” their 401(k) or their IRA, and use all of that money to pay off some  of their creditors. Then, when tax time comes, they end up getting hit with a big tax bill. Usually they have not been withholding at a high enough rate to cover that tax bill, and they have spent all the money that they withdrew, so they end up owing the IRS and the MN Department of Revenue a nice chunk of change – never a fun thing.

Another downside to taking out a loan against your retirement account or withdrawing money from your retirement plan in order to pay your creditors is that the money in your retirement accounts is generally protected in a bankruptcy. It makes me really sad to see people cash in their retirement, only to end up filing bankruptcy. Also,  a loan that you take out against your 401(k) isn’t the sort of debt that can be “wiped out” in a bankruptcy, so that loan against your 401(k) doesn’t disappear.

This article provides a nice discussion about considering alternatives to withdrawing from your 401(k). Here’s a link to another interesting article about the increase of people withdrawing from their retirement plans.