A recorded tax lien gives the IRS/state a lot of leverage against you and your home. Chapter 13 can gain you back some of that leverage.
Stopping Tax Liens by Filing Bankruptcy
In our last blog post we showed how Chapter 13 can buy you more time and flexibility than Chapter 7. We showed an example how that’s especially true if you owe more than one year of income taxes. Our example assumed that two tax years met the conditions to discharge (legally write off) that debt, while another tax year didn’t.
That example assumed that the IRS/state had not yet recorded a tax lien on your home for either tax year. A bankruptcy filing stops a tax lien’s recording. Then if the tax debt is discharged, the debt is gone so there’s no further basis for a tax lien. Or if the tax debt is paid in full (usually through a Chapter 13 payment plan) again there’s no further debt on which to impose a tax lien.
Dealing with Tax Liens under Chapter 13
But what if the IRS/state HAS already recorded a tax lien on your home?
That can cause all kinds of problems. Two weeks ago we wrote about how a tax lien can turn a completely dischargeable tax debt into one you have to pay in full. Beyond that, any tax lien is terrible on your credit report. It can make refinancing your home much harder. It may even add a problematic hurdle in the selling of your home. Even if you have little or no equity in your home, the tax lien can sit on your title until there’s enough equity to pay it in full.
So if you get a tax lien recorded against your home you need to consider your options. Assuming you want to keep your home, filing a Chapter 13 “adjustment of debts” is one option worth understanding.
Let’s take the same example we used in our last blog post, with a few more facts.
Assume again 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.
The IRS/state has just recorded tax liens on all three tax years against your home. Your home is worth $250,000, and has a $245,000 first mortgage owed on it. So, before the tax liens’ recordings you had $5,000 of equity in the home. Now you have NEGATIVE $19,000 of equity. And you are under the financial risks outlined above from the tax liens.
So on advice of your bankruptcy lawyer you file a Chapter 13 case. You do so because you:
- can’t afford to pay nearly as much as the IRS/state are demanding each month in monthly installment payments
- are afraid of the actions the IRS/state can take against you and your home on the tax liens
- are afraid of the other collection actions they can take on the $24,000 in taxes
- need a plan for taking care of these taxes in a way that you can reasonably manage
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. That is, they would but for the tax liens. Now those two tax debt are “secured” against your home because of their tax liens.
However, under Chapter 13 you have the power to establish that they are secured only to the extent of your home’s equity. So, the 2012 debt of $8,000 is secured by the $5,000 equity in the home. The remaining $3,000 is not secured. The 2013 debt of $8,000 has no remaining equity in the home for it to be secured by. So both that and the remaining $3,000 of the 2012 tax it is treated as a “general unsecured” debt.
This means that this $11,000 ($3,000 + $8,000) would 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 $11,000 would just go into the pot with those other debts, and you’d pay no more than if there was no such $11,000 tax debt. That $11,000 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.
The “Priority” Tax Debt
And how about the third tax year—2014—which doesn’t meet the conditions for discharge? What affect does its tax lien have on it?
It has no effect because all of the home’s equity has already been absorbed by the 2012 tax year. This 2014 tax already has to be paid in full through the Chapter 13 payment plan. It’s a “priority” debt. Had there been equity in the home to cover this lien then you’d also pay interest on this tax. Without any equity this 2014 tax is effectively unsecured. So it’s treated like any other “priority” debt. You have to pay it in full during your 3-to-5-year Chapter 13 payment plan.
So you have up to 5 years to pay the $5,000 secured portion of the 2012 tax and the $8,000 2014 tax. Throughout that payment period you’d be protected from the IRS/state by the “automatic stay.” This usually protects you throughout the years of the case (not for just 3-4 months like Chapter 7). That means no further IRS/state or other creditor actions against your or your house throughout your case.
Your payment plan may or may not include some money to pay towards your “general unsecured” debts. This includes the unsecured part of the 2012 tax and all of the 2013 tax. How much, if any, you’d pay on these would mostly depends on what you could afford to do so, after paying the other taxes. The secured part of the 2012 tax and the 2014 “priority” tax debts would usually get paid in full before the “general unsecured” debts would receive anything.
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 $5,000 secured part of the 2012 tax debt, the unpaid portion of the remaining $3,000 would be forever discharged.
- The unpaid portion of the 2013 tax debt would also be discharged.
- 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 all your tax debts either paid or discharged, there’d be no further risk of a lien against your home from that tax.
- You’d be tax-debt-free, and altogether debt-free (except for long-term debt like your home mortgage).