If you have an income tax debt that qualifies for discharge and also some tax debt that doesn’t, Chapter 13 is often your best option.
Stopping Tax Liens through Chapter 13
In our last blog post we showed how Chapter 7 might prevent an income tax lien from hitting your home. It stops the recording of the tax lien through the power of the “automatic stay,” which stop virtually all creditor collection activities. And then you get a discharge (write-off) of the tax debt. But then we added a twist: owing one or more additional tax years’ of debt which does not qualify for discharge. What if you have a tax that meets the conditions for discharge and one or more years’ that don’t? We showed how sometimes Chapter 7 can deal with this effectively, if the still-remaining tax debt is manageable.
But what if the taxes you still owe are not manageable? In a Chapter 7 case the protection of the “automatic stay” ends as soon as the case ends, usually just 3-4 months after it’s filed. So after that you could easily get a tax lien recorded against your home for the still-owed taxes.
Last time we ended by saying a Chapter 13 “adjustment of debts” could be a better option in these situations.
Let’s show how Chapter 13 could be a better option with an example.
Assume that you owe income taxes of $24,000—$8,000 for the each of the 2012, 2013, and 2014 tax years. The 2012 and 2013 taxes meet all the conditions for discharge. The 2014 one doesn’t, mostly because it hasn’t yet been 3 years (as of when this is being written) since the date its tax return was due on April 15, 2015.
On advice of your bankruptcy lawyer you file a Chapter 13 case. You do so because you:
- couldn’t reliably pay into a monthly installment plan with the IRS/state for the remaining $8,000 tax owed for 2014. That’s because you have some other important debts that would also survive the Chapter 7 case. In particular you’re behind on your home mortgage and child support payments. Support enforcement is getting very aggressive, and you don’t want to lose your house. Chapter 7 would not help with these.
- don’t qualify for Chapter 7 under the “means test.” Your income under that test is too high, and your allowed expenses leave you with too much disposable income. You don’t have Chapter 7 as an option.
- need to file a Chapter 13 case for its other benefits. You want to get lots of protected time to catch up on your first mortgage and your child support. Chapter 13 gives you strong tools for dealing with these special debts (and many others).
(Note that any one of these reasons may well be enough to make Chapter 13 worthwhile or appropriate. The particular combination of facts here would very likely make Chapter 13 the right choice.)
The Example’s Chapter 13 Plan
In this example the $16,000 of 2012 and 2013 tax debts would be treated as “general unsecured” debts. This means that they’d be paid—if at all—to the same extent as your other ordinary debts with no collateral. In most Chapter 13 cases there’s only a set amount available to pay to the entire pool of “general unsecured” debts. This means that usually that $16,000 would just go into the pot with those other debts, and you’d pay no more than if there was no $16,000 tax debt. That $16,000 tax debt just reduces how much other “general unsecured” debts get paid, without increasing how much you pay. In fact, in many bankruptcy courts you’re even allowed to pay nothing to the “general unsecured” debts. That happens if all your money during the life of the plan goes elsewhere.
Speaking of money going elsewhere, you’d pay the remaining $8,000 for the nondischargeable 2013 tax during the course of your 3-to-5-year Chapter 13 payment plan. It’s a “priority” debt, one that you have to pay off during your case. Throughout that 3-to-5-year period you’d be protected from the IRS/state by the “automatic stay.” That’s because it usually protects you throughout the years of the case (not for just 3-4 months like Chapter 7). That means no tax lien being recorded against your house throughout your case.
Your payment plan would also include money to catch up on your home mortgage and on your child support. These two debts could be paid ahead of or alongside the “priority” tax debt.
The End of the Chapter 13 Case
At the end of your successful Chapter 13 case the following would happen:
- Having by that point paid off the $8,000 “priority” tax debt, any interest and penalties that would have accumulated on that tax would be forever waived.
- With that tax debt gone there’d be no further risk of a lien against your home from that tax.
- To the extent that the $16,000 in older taxes would not be paid, they’d be permanently discharged. (This would usually be most, or sometimes even all, of the $16,000.)
- Your home mortgage and child support would be caught up as well.
- You’d be tax-debt-free, and altogether debt-free except for the on-time first mortgage.