Is Chapter 13 Right For You If You’re Self-Employed In Orange County, CA?

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In this article, you can discover…

• How bankruptcy courts define “self-employed” in California.
• How fluctuating monthly incomes are handled by the Bankruptcy Court.
• Ways to help you manage bankruptcy payments if you have irregular or fluctuating income.

What Does It Mean To Be “Self-Employed” In The Eyes Of The Bankruptcy Court?

Let’s contrast two things. You are working for ABC Industries. You get W-2 income. You’re getting a paycheck each month or every two weeks, or however frequently you’re paid. You are not self-employed. You are employed by an employer. Now, let’s say you have a business and you’re selling widgets. You are self-employed. You’re not working for somebody else.

There are some kinds of work that sort of fit in between. For example, maybe you drive for Uber. Some Uber drivers get what looks like a regular paycheck with deductions. But if you’re not having taxes and social security taken out, then it looks like you’re not an employee, but an independent contractor. There is a very big body of case law in the State of California over this very question. “What is an independent contractor, as opposed to an employee?”

One of the things that we know about employees, is that the employer has to take out of the check payroll taxes, benefits, and so forth. But if you’re an independent contractor, you’re just getting a gross check, and then you’re supposed to pay your taxes and other obligations out of that gross check. So that’s the first thing that we look at: Are you having those deductions from your check?

By the way, this has been the source of a great deal of litigation. People who have been classified as independent contractors, have sued the entity for which they worked based on the claim that they were employees. In the suits these plaintiffs assert that they were supposed to get paid extra for overtime, and were supposed to receive benefits, breaks, and so forth.

There was a California Supreme Court decision a few years ago called Dynamex, something on the order of 150-160 pages long. It laid out the things that the court held were earmarks of being an employee, as opposed to an independent contractor or a self-employed person. The long and short of it is, if your income is not taxed because the entity for which you are working is just giving you a raw check, then you’re probably self-employed.

How Are Fluctuating Monthly Incomes Handled In A Chapter 13 Repayment Plan?

It depends on what sort of fluctuations we’re talking about. Let me give you a simple example of something that comes up fairly regularly in cases where the debtor is a school teacher. Most school teachers don’t work in the summer. They earn income for maybe 10 months of the year, and for two months of the year they have no income.

This is a bit awkward in a Chapter 13 because a Chapter 13 plan is supposed to be structured around regular monthly payments. Of course, you can specify for months M to N this will be the plan payment, and then for months N plus 1 to Q, it’ll be a different plan payment, and so forth, as long as you explain why you are proposing that structure.

However, there is a better, simpler solution. Banks have what are called “Summer Saver” accounts for school teachers. Each time the teacher is paid, part of the check goes into the teacher’s regular checking account, and the rest is put in the Summer Saver account.

Throughout the ten working months the teacher lives on the portion that’s in the regular checking account. Then in the summer when the teacher isn’t working, or is only working part-time, the teacher lives on the money in the Summer Saver account. If the teacher is in a Chapter 13, the plan payment is paid out of the regular account during the ten working months, and out of the Summer Saver account during the summer months.

If you’re not a teacher, but your income fluctuates considerably perhaps seasonally it may make sense to open an account that is similar in spirit to the Summer Saver account, and use it in the same way a teacher uses the Summer Saver account.

In Chapter 13, we use the Bankruptcy Code’s test to determine Chapter 7 eligibility, but for a different purpose. The test is based on your income and expenses for the six months immediately prior to the month you file your petition. If there’s a lot of fluctuation in your income and expenses especially if you’re self-employed – we may also do the analysis based on the twelve prepetition months, and propose a plan that takes into consideration those fluctuations.

How Can My Attorney Help A Bankruptcy Trustee Understand My Self-Employed Repayment Plan?

The Chapter 13 trustee may look askance at a complicated repayment plan. However, I will give the Trustee a clear explanation based on seasonal fluctuations in income. Then if the plan is defensible, the Trustee will probably accept its terms.

If you’re self-employed and your income fluctuations are due to changes in demand, you may be much more at the mercy of the economy than somebody who’s working for someone else. If that’s the case, then we may end up having to periodically file motions to modify the plan.

What Happens If I Have A Very Drastic Drop In Self-Employment Income?

Suppose your plan has been confirmed, you’re making your plan payments, and the demand for your goods or services shot through the floor; making it impossible for you to make plan payments. This change may be a temporary hiccup, or it may be something more permanent. There are several options.

On the one hand, if it’s a temporary hiccup, then we can file a motion to temporarily suspend plan payments until you get past the little rough patch.

On the other hand, if it looks like your income is going to permanently be reduced, then we have other options.

We can file a motion to modify the plan due to a change of circumstances to reduce plan payments. Of course, you’re have to provide good evidence to convince the judge and the Chapter 13 Trustee of the correctness of your assertion. You can’t just say, “Well, you know, I’ve had a little rough patch, and it looks like my income is down, so lower my plan payments.” Nobody’s going to take your word for something like that. We have to have good solid admissible evidence. If you do have the necessary evidence, then we can get the plan payments reduced on a longer-term basis.

If things really have tanked and you simply cannot proceed any further and it’s not your fault, maybe the vicissitudes of the economy just hit you really hard, such as, for example, when we had the pandemic mess. Then you have another couple of options.

You can either convert to Chapter 7, usually not the preferred direction to go, because now you’re in a new Chapter 7. If you have non-exempt assets, that Chapter 7 trustee will seize and liquidate them, and you’ll lose those assets in the Chapter 7.

In the alternative, you can move the court for what’s called a hardship discharge under Chapter 13.

How Does A Hardship Discharge Work, And How Can I Obtain One If I’m Self-Employed?

With a hardship discharge, you’re getting a Chapter 13 discharge and your possessions are not in any jeopardy, but you do have to satisfy a few requirements.

Number one, the plan has to have been confirmed. You can’t do this if the plan hasn’t been confirmed.

Number two, whatever this change of circumstances is that’s rendered you unable to make any more plan payments, you cannot be justly held accountable for.

Number three, you must have satisfied the Chapter 7 liquidation requirement: You’ve already paid your creditors what they would have gotten in a Chapter 7.

Number four, there is no practicable way to modify the plan.

If you have that scenario, then you can get a hardship discharge. The hardship discharge has several benefits over the Chapter 7 discharge.

Number one, none of your nonexempt assets are in any jeopardy.

Number two, if, God forbid, you have an adverse change of circumstances in the future, then you don’t have to wait as long to go into another bankruptcy case as you do if it’s a Chapter 7.

I will say, if this happens and you’re my client, let me know, because I cannot take any action about something that I don’t know anything about. It’s always a rude shock if I get a motion to dismiss a case for failure to make plan payments, and I had no inkling that there was a problem. If the client had just contacted me and said, “My hours have been cut, something’s happened, I can’t continue,” maybe we could have taken action and solved the problem. Don’t be a stranger. I’ve got a phone. You’ve got my number. If you’re my client, call. Let’s see if we can work something out.

What Financial Documentation Does A Self-Employed Person Need To File Chapter 13?

One of the things I ask for is a P&L spreadsheet for the last 12 months on a month-by-month basis, not just an aggregation, so that I can see the patterns. I also need it because I have to submit it to the Court in the initial filing, and to the Chapter 13 trustee. I also need documentation of large expenses to establish their legitimacy.

For the most part, Chapter 13 Trustees are reasonable if the facts are reasonable. But trustees are not fools. Indeed, the Chapter 13 Trustees and the Chapter 7 Trustees are very sharp people. Occasionally, I have people who contact me and I get the impression they think they’re going to pull a fast one: “Oh, these trustees don’t know anything.”

Actually, they know a lot. This is what they do, and they’ve been at it for a long time. And they can see through this sort of stuff. At the very least, we need P&Ls for the last year. We need bank statements for the last year, because the Chapter 13 trustee is going to do a fine-tooth combing through those bank statements to see what’s going on, to see if what you put in that P&L list really agrees with the P&L spreadsheet.

There are other documents I need. It’s sort of on a case-by-case basis. It depends on the nature of your business. Finally, the business is not filing the bankruptcy, you as an individual are filing. Businesses are ineligible for Chapter 13 protection.

Are Tax Debts Owed By Self-Employed Individuals Eligible For Repayment Or Discharge?

That’s a little bit more complicated to answer.

First, all debts have to go into the Chapter 13 plan. You do not get to pick and choose. There are no little side deals that you’re going to have.

Second, tax debts fall into several categories: secured, unsecured priority, and unsecured nonpriority. There are income tax debts, payroll tax debts, sales tax debts, and property tax debts.

Some income tax debt is dischargeable in bankruptcy. What that means, in practical terms, is in a Chapter 13 case, those tax debts do not have to be paid in full. They’re paid at whatever percentage you’re paying to the general unsecured debts: Credit card debt, medical debt, and so forth.

Other tax income tax debts are what are called “priority tax debts.” Those have to be paid back 100%. This gets to be a bit complicated because priority status for a tax debt is not necessarily the same as dischargeability. There are three requirements for an income tax debt to be dischargeable, which I will discuss in the next section.

If I’m Self-Employed, What Types Of Tax Debts Are Dischargeable?

First, trust fund tax debts are never dischargeable. The classic example is payroll tax debt. It is called a trust fund tax because it arises from your duties as a trustee. If you have an employee, before you pay that person you deduct money from that person’s paycheck to pay that person’s income tax. That money is never yours. You are holding it in trust for the taxing authority. If you fail to send that money to the taxing authority, you have breached your duty as a trustee. The consequences can be dire, and can include imprisonment and fines. Conclusion, never, never, never fail to send payroll taxes to the taxing authorities.

Other types of tax debts can be dischargeable. The most commonly occurring is income tax debt.

For an income tax debt to be dischargeable, it has to satisfy three and all three requirements.

Number one, the tax return for the given tax year must have been due, with extensions if you got them, at least three years before the day you file the petition. For obvious reasons this is called the three-year requirement. Notice that it focuses on when the tax return was due. It does not look at whether or not you filed a legitimate, nonfraudulent tax return.

Number two, you must have filed a legitimate, nonfraudulent tax return for the given tax year, at least two years before the day you file the bankruptcy petition. By the way, it’s down to the day. If you’re off by even one day, there is no mercy. It’s like dealing with the Terminator. You are just out of luck. There’s no bargaining. “Oh, well, look, I was one day off!” Too bad, you’re out of luck.

Number three, the tax that you’re seeking to discharge cannot have been assessed or have been assessable during the 240-day window, immediately prior to the day you file the petition. 240 days is eight 30-day months. You can convince yourself of that by just thinking eight times three is 24, so eight times 30 is 240.

If a tax debt satisfies all three of those, then it’s dischargeable. What that means in practical terms is that in the Chapter 13, if you don’t pay that tax in full then at the completion of the plan, the unpaid portion is discharged.

A priority tax is one that fails to satisfy the three-year and 240-day rules. The two-year rule doesn’t come into play. Thus, an income tax could be nondischargeable because it fails to satisfy the two-year rule, but it could still be a nonpriority debt because it satisfies the three-year and 240-day rules for dischargeability.

What Happens To My Nondischargeable Tax Debt During Bankruptcy?

If a tax is nondischargeable, is a priority tax debt, it must be paid in full over the life of the plan, even if the other creditors get chump change. If it is a nondischargeable nonpriority tax debt, then it doesn’t have to be paid in full, but at the completion of the plan you will still owe the unpaid balance.

Trust fund tax debt must be paid in full over the life of the plan.

What Strategies Can Help Self-Employed People Succeed With A 3- To 5-Year Repayment Plan?

The key is budgeting because if you’re going to be in a Chapter 13 plan, you’re going to need to set aside each month the money necessary to make the Chapter 13 plan payments. If you’ve got a lot of debt, it may be that you haven’t been efficiently budgeting. A benefit to Chapter 13 is that it forces you to do some budgeting. In fact, as part of preparing the petition, we come up with a budget that will help you manage your finances.

You’re going to need to make sure, right off the top, every month you’ve got money set aside for Chapter 13 plan payments. You also need to make your secured debt payments. Otherwise, your case may be dismissed or converted to Chapter 7.

The long and short of it is in one word: Budget. You need to do careful budgeting and stick to the budget.

By the way, my insistence on budgeting does pay off. We were contacted a couple of months ago by somebody that we did a Chapter 13 for, who got his discharge ten years ago. He and his wife, very nice people. He said, “You know, you gave me this budget, and I decided I was just going to stick to the budget, and I stuck to the budget, and stuck to the budget. Now I just sold a business for more than a million dollars. We were doing very well because we stuck to the budget you gave to us”.

So budgeting is a key thing here and it can produce really good results.

What Types Of Expenses Are Considered “Necessary” For A Self-Employed Filer?

That is a fairly open-ended question. I can maybe come up with some examples of things that are necessary, but it’s going to be an open-ended list. I think we can all agree that food is necessary. I could probably cut back on the carbohydrates myself. I’ve had a love-hate relationship with them, more love than hate. But certainly, you’re going to need to have a food budget.

Does that include regular king crab and prime rib meals? I have a medical condition that requires a minimum amount of king crab and prime rib each month. If you don’t have that medical condition, you’re probably going to need to budget for a less luxurious diet.

Actually, I’m kidding on that, obviously, because, who can afford to have king crab and prime rib every night? It’s probably not good for you. I’d like to prove that to myself, but in any event… So you’ve got to have a reasonable food budget.

Sometimes, I’ll have a chat with a prospective Chapter 13 client, who says, “I’m just not going to have anything?” That’s right. You’re just going to be on a diet of one hot meal a day: a bowl of steam. (I’m still kidding.) In reality, the Court is reasonable. Yes, you’ll have a reasonable life. You need food. You need housing. You need transportation. You need utilities.

There may be other things, especially if you’re self-employed. You need to cover business expenses, which may include transportation, materials, and tools. Perhaps you have lease payments on the building where you conduct your business, and you have utilities requirements. This sort of analysis is done on a case-by-case basis.

What kind of expenses does your business have? Which expenses are for things that are fun, but aren’t needed, and which expenses are for things that you really need. When looking at business expenses I ask, “Can I justify this expense to the judge?”

The conversation with a client may proceed as: “I’ve got to have meals.” Well, yeah, you have to have meals, but they’re already part of your personal food budget. “No, but you see, it’s client development. I’ll take a client out for a meal and then that produces business.” Well, that might be a legitimate expense.

You can have a personal entertainment budget and that’s certainly reasonable to have. We’re not supposed to just be automata with no entertainment whatsoever. There may be legitimate entertainment that you need to do to generate business for your business.

On the other hand, in that entertainment budget, do you really need to have season tickets to the Lakers games? I suppose it depends on the kind of business you have. Maybe there is some compelling reason for that sort of entertainment. This is why I started my answer to this question with the statement: It’s sort of open ended.

Much of the answer to this question is the answer to a lot of questions in life; it’s context. So much of life is dependent on the context. The reasonableness of a business expense is contextually driven.

What Are Signs Chapter 13 May Be The Better Choice Over Chapter 7 For A Self-Employed Debtor?

First, if your income is too high to qualify for Chapter 7, then Chapter 7 is simply off the table.

There’s a way to make that precise. Congress has given us a three-part test that looks at income and its interaction with expenses. It is designed to answer the question, if you didn’t have these debts how much money would you have left over each month to cover your reasonable living expenses? If the answer is nothing, then Chapter 7 is the appropriate chapter. Otherwise, you must consider Chapter 13 or Chapter 11.

Second, if you have nonexempt assets, the Chapter 7 trustee will seize and liquidate them and have money to pay creditors. In a Chapter 13, you keep all your stuff. You will not lose assets. The trade-off being, you’re going to be making payments through the Chapter 13 plan, which will pay the creditors at least as much as they would have been paid in a Chapter 7 liquidation. In sum, if you’ve got non-exempt assets and you don’t want to lose them, then Chapter 7 is not for you.

Unfortunately, if your income is insufficient to fund a feasible plan, Chapter 13 may also be off the table, even if you have nonexempt assets.

For example, let’s say you have $35,000 worth of priority tax debt and you have $500 a month in disposable monthly income. If you propound a plan that’s going to pay back $500 a month for 60 months, the judge will not confirm it because it is infeasible. It is infeasible because the priority taxes of $35,000 have to be paid in full, but the $500 a month for 60 months only pays $30,000.

Sometimes, it’s better just to do the Chapter 7, even if you have nonexempt assets. Just wipe the debts out, dust yourself off, and start fresh.

Once again, context is everything. The analysis is done on a case-by-case basis because there are many moving parts in determining whether Chapter 7 or Chapter 13 is the appropriate chapter.

Ending Remarks:

If you’re in another state besides California, and you’re watching this video, I’m really pleased. I hope you found it helpful. I hope you enjoy it. However, I cannot give you legal advice. I am only licensed to practice law in California. If I give legal advice to somebody in another state, I will be committing a crime, and that crime is practicing law without a license.

So, please don’t call me and ask for legal advice. I don’t mind little emails with nice encomiums. I got an email recently from a very nice person, who is in another state. The person wrote that the videos are very helpful, and she really enjoyed them. She didn’t ask for legal advice. Two thumbs up. I don’t have any objections to getting a nicely worded email like hers. But I cannot give you legal advice.

On top of that, even if you’re in California, if you’re up in the Bay Area and watching the videos. I’m pleased that you like them. I don’t take cases up there. It’s just too far. I’m here in the Los Angeles Area. So, if you’re in Orange County or Los Angeles County, I’m happy to help out. Although I do not take Chapter 13 cases in San Bernardino and Riverside Counties, I will do Chapter 7 and Chapter 11 cases there. If you’re in the Central District of California, give me a call. I’m happy to see if I can help you.

Still Have Questions? Ready To Get Started?

For more information on being self-employed Chapter 13 Orange County and filing for bankruptcy protection, an initial consultation is your best next step. Get the information and legal answers you are seeking by calling (562) 777-9159 today.