Tax troubles become manageable in Chapter 13 bankruptcy. 13 offers powerful alternatives to fighting with the IRS. Or hiding from the IRS.
When you’ve got tax troubles, it’s easy to feel powerless.
After all, you’re confronting a federal agency who wrote the tax rules. And they have hordes of employees with nothing else to do.
Chapter 13 can turn the tables on the IRS (and state tax agencies, too).
Back taxes in Chapter 13
In Chapter 13, you can
- impose an interest free repayment plan for recent taxes
- discharge all unsecured tax penalties;
- eliminate or reduce tax liens;
- discharge older taxes completely.
In contrast to IRS installment plans and offers in compromise, Chapter 13 plans need only to meet the statutory requirements of bankruptcy law to be accepted by the court. The IRS has limited say as to the terms of the plan. So the power dynamic in your tax troubles just shifted.
Chapter 13 is enforced by a judge in the event of disagreements between debtor and taxing authority.
And the bankruptcy discharge is final as to taxes included in the case.
Chapter 13 puts taxes first
The bankruptcy code gives a priority for payment to certain taxes. While priority taxes can’t be discharged in bankruptcy, in Chapter 13 they are paid ahead of all other unsecured debts.
Giving priority to recent taxes reverses the usual IRS rule that tax payments made outside of bankruptcy are credited to the oldest taxes, which may be dischargeable in bankruptcy.
And unlike out of court arrangements, the automatic stay holds all other existing debts at bay until the non dischargeable taxes are paid.
So, you get protection from credit cards and medical bills while your plan payments pay down the priority portion of your tax debt.
Which taxes have priority
Priority taxes are, broadly,
- those taxes for which the return first came due within 3 years of the filing of the bankruptcy;
- those assessed within 240 days of filing or assessible at the date of filing bankruptcy; or
- trust fund taxes of whatever age for which the debtor is liable.
The priority amount includes the tax and the interest to the date of filing on the tax.
Penalties kicked to the curb
Penalties are often the curse of a tax problem. They swell an already troubling total debt and don’t represent the tax actually unpaid.
In Chapter 13. penalties associated with a priority tax are not priority claims.
Penalties get the same treatment as any other unsecured debt, which means they may get little or nothing through the plan.
Interest on tax debt
Interest on all unsecured claims in bankruptcy stops running upon the filing of the case.
Unsecured priority taxes are paid, then, without interest accruing after the filing of the bankruptcy. You do end up paying the trustee’s commission on all sums paid into the Chapter 13 plan,
So the actual cost of retiring priority taxes includes a mark up for the trustee’s expenses of administering the case.
The bankruptcy court also has jurisdiction to decide tax disputes related to Chapter 13 cases.
Discharge of taxes
You get your discharge at the end of the case, when all plan payments have been made.
Priority taxes will have been paid in full through the plan. Non priority taxes, unpaid interest and tax penalties are discharged.
The exception to the discharge of taxes deals with tax years more than three years old for which a return has not been on file for two years. Under the bankruptcy amendments of 2005, those taxes are neither discharged nor paid as priority, unless they were assessed within 240 days of the filing. Which is one of the reasons I harp on filing the tax return every year, even if you can’t pay the tax due.
Just because the IRS has a lien for a tax year, doesn’t mean that the feds have a secured claim for the entire amount of the tax (and interest and penalties>)
Liens in Chapter 13 are valued as of the commencement of the case. The value of the lien is the present value of the equity in the debtor’s assets to which the lien attaches. An income tax lien attaches to property, junior to any other liens already on the property. Tax liens don’t vault to the head of the line.
If the tax lien exceeds the value of the assets available to secure the tax, the portion of the tax exceeding the value of the assets is an unsecured claim. It may be either a priority claim, if recent, or a general unsecured claim, if older.
Thus, tax liens that have grown huge over years can be stripped down to the actual value of current assets, locked in as to value as of the commencement of the case, and paid over 3-5 years through the Chapter 13 plan.
After the bankruptcy discharge, the pre filing lien does not attach to newly acquired property.
Bankruptcy has advantages
The decision to file bankruptcy has to consider lots of factors about your situation, your debts, and your assets.
But don’t swallow the idea that taxes aren’t dischargeable in bankruptcy, or assume that you have to deal directly with the IRS to resolve tax debt.
Bankruptcy, especially Chapter 13, is a powerful tool for tax troubles. And a bankruptcy filed before the return is due can address your taxes for the previous year.