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Bankruptcy and the Holidays: File in Early 2014 to Cover More Income Taxes

As soon as 2014 arrives, your Chapter 13 case can cover, and protect you from, more tax debt.  


Discharge of Tax Debts vs. Protection While Paying Tax Debts

Filing bankruptcy can help you deal with tax debt(s) in two main ways.

First, the most direct way bankruptcy can help is to discharge—permanently write-off—some or all of what you owe in taxes. Without going into all the requirements, generally you can discharge older income taxes: the bankruptcy filing must be at least 3 years after the pertinent tax return was due (plus any time for extensions), AND the bankruptcy filing must be at least 2 years after the tax return was actually sent to the IRS or state tax agency.  (There are other requirements but they seldom come into play.) Taxes which meet all the requirements can be discharged under either a Chapter 7 “straight bankruptcy” or a Chapter 13 “adjustment of debts.”

The second way bankruptcy can help, for tax debts that don’t meet the requirements for discharge Chapter 13 gives you time to pay them while you are being protected from the collection efforts of the IRS and the state. This can be a huge advantage, as described below.

The Benefit of Filing Bankruptcy in 2014

As of January 1, 2014 you most likely can’t discharge any more taxes. But if you expect to owe taxes for 2013, after the turn of the year you can include that tax debt under the protection of a Chapter 13 case. That can be extremely helpful.

Usually interest and penalties stop accruing as soon as your Chapter 13 case is filed, enabling you to pay off the tax debt faster. The taxes must be paid off before your Chapter 13 is completed, but you can often pay other even more urgent debts before the taxes, such as back payments on a vehicle, mortgage, or child support. In some cases you don’t pay any more into your Chapter 13 plan because of what you pay in taxes simply reduces how much you would otherwise been required to pay to your other creditors.

But often more important than all this, covering your 2013 income taxes by filing in early 2014 stops the IRS and/or state from pursuing you on that debt. It’s included in your overall package for dealing with your debts. The 2013 tax debt won’t come back to haunt you a few months. It’s especially helpful to avoid getting hit with a new tax debt if you are in the midst of a Chapter 13 case dealing with your earlier debts.

An Example

Let’s bring this to life with a hypothetical example.

Imagine a person who owes $50,000 in “general unsecured” debts—credit cards, medical bills, personal loans, and such. She also owes $5,000 to the IRS for each of the following tax years: 2009, 2011, 2012, and 2013 (totaling $20,000) for underpaying tax withholdings and/or estimated quarterly payments. Assume she filed all tax returns on time. Also that if she started withholding and/or paying estimated quarterlies appropriately in 2014, she could afford to pay $500 per month into her Chapter 13 plan. Her income amount requires her to pay into a Chapter 13 plan for three years instead of five.

Her 2009 tax debt is dischargeable, since it’s more than 3 years since it’s tax return was due (on April 15, 2010), and more than two years since it was filed (the same date).  The 2011, 2012, and 2013 tax debts cannot be discharged, under either Chapter 7 or 13; even the oldest one, 2011, could not be until April 16, 2015 (three years after its April 16, 2012 filing date—the 16th since the 15th is a Sunday).

If this person had filed a Chapter 13 case in the middle of 2013, she would have paid $500 per month for 36 months, a total of $18,000. That would have been enough to pay off the 2011 and 2012 taxes (a total of $10,000), with the remaining $8,000 going (after the Chapter 13 trustee’s fees and any unpaid attorney fees) to pay a portion of the 2009 taxes and the general unsecured $50,000.  She could not include the 2013 tax in her Chapter 13 case because it was not yet a legal debt at the time the case was filed.

If this same person had waited until after the beginning of 2014 to file her Chapter 13 case, that would enable her to include the 2013 tax debt of $5,000. (Although it is not due to be paid in full until April 15, 2014, the debt is continued a legal debt as of January 1.) So paying for her 2011, 2012, and 2013 taxes would have taken $15,000 of the $18,000 paid into her plan. With the Chapter 13 trustee likely taking at least 5% (seldom higher than 10%) of the $18,000, or about $1,000, with any attorney fees not paid up front likely taking some or all of the remaining $2,000 or so, there would be very little or none left available to go towards the 2009 dischargeable $5,000 tax debt or to the $50,000 in general unsecured debts.

The benefits of waiting until the beginning of 2014 for this person include that she would not pay interest and penalties on the 2013 income tax, and she would not need to worry about IRS collection efforts on that debt, which would be handled in one convenient package with all her other debts. And perhaps best of all, the money paid for that 2013 tax debt was virtually “free money”: the money that would have gone to the 2009 income tax and other general unsecured debts had she filed earlier in 2013 is now instead going to pay the 2013 taxes. 

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