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Good Reason to Delay Bankruptcy until Now: To Include 2013 Income Tax Debts

If you owe income taxes for 2013, filing a Chapter 13 “adjustment of debts” would enable you to pay that tax under very favorable terms.


Paying Taxes Under Chapter 13

Chapter 13 is a very good tool for dealing with debts, particularly unusual debts, the kind that can’t be simply discharged (legally written off) under Chapter 7 “straight bankruptcy.” It is a particularly handy tool for attacking income tax debts, particularly if you owe for more than one tax year or owe a substantial amount.

Discharging Income Taxes Under Chapter 7

If the only taxes you owe are older ones, you may be able to simply discharge those tax debts with a Chapter 7 case. To do so they have to meet a number of conditions, but in most situations just these two:

1) the tax return for the pertinent income tax was due more than 3 years before the Chapter 7 case is filed, plus any extensions;

2) the tax return was actually delivered to the IRS or Department of Revenue more than 2 years before the Chapter 7 case is filed.  

Paying Taxes Under Chapter 13

If any of the income taxes you owe do NOT meet these conditions, then the choice is usually between making payment arrangements directly with the tax authorities, or paying the debt under the following advantages provided by Chapter 13:

  • Usually no further interest or penalties are added to the tax from the time the Chapter 13 is filed, reducing the total amount to be paid.
  • Penalties accrued before the Chapter 13 filing often do not need to be paid, or usually for only pennies on the dollar.
  • The timing and amount of the payments on the taxes that must be paid are based not on what the IRS and/or state tax authority would demand but rather on how much you can afford to pay.
  • Other even more important debts—child support arrearage, a vehicle loan, for example—can often be paid ahead of the taxes.
  • Tax liens can often be handled much better than under Chapter 7, by fixing the extent to which the lien attaches to your assets, preventing the tax authorities from using the lien as leverage to make you pay after the bankruptcy is finished.
  • The tax authorities can’t take any collection action against you while you are in the Chapter 13 case–can’t contact you (except for sending you very specific notices), can’t garnish wages and bank accounts, can’t levy on anything you own, and can’t record a tax lien on your home, car, or other possessions.
  • Tax debts that meet the conditions for discharge are treated like “general unsecured” debts, generally paid only to the extent there is money in the budget to do so within the required length of the plan, often not increasing at all the total amount you need to pay.

Income Taxes Due for the 2013 Tax Year

Because of these advantages, if you expect to owe taxes for the current tax year it may make sense to wait to file your Chapter 13 case until immediately after the year is over. So if your tax year is the same as the calendar year—as it is for most consumers and small business owners—and you expect to owe income taxes for 2013, early 2014 may well be a good time to file a Chapter 13 case.


Here’s an example of how this would work.

Jerry operated a one-person business for several years, until closing it and starting a job as an employee in early 2013. Because of financial obligations related to closing down the business and his initial desire to avoid filing bankruptcy, he arranged to have his new employer not withhold taxes through the first three quarters of 2013 so he could afford to pay some pressing creditors, resulting in an anticipated unpaid income tax of about $6,000 for the year. He also owes income taxes of $3,000 for each of 2009, 2010, 2011, and 2012 incurred while his business was struggling. He has $40,000 in credit cards he incurred while he tried to keep his business afloat and $25,000 in medical bills because he could not afford health insurance.

In September of 2013 Jerry met with a bankruptcy attorney and decided that the best way for him to solve his debt problems was by filing a Chapter 13 case, mostly because of his tax debts. There was no immediate urgency so he was advised to wait to file his case at the beginning of 2014 in order to be able to include the anticipated $6,000 of 2013 taxes in his Chapter 13 plan.

His attorney filed Jerry’s Chapter 13 case during the first week of 2014. His income dictated that his plan would run for 36 months, and his allowed expenses showed he could afford to pay a total of $550 per month to all of his creditors. That $550 per month times 36 payments meant that Jerry would pay a total of $19,800 into his plan. Excluding attorney and trustee fees for the sake of simplicity, this is where that money would go:

  • The 2010 through 2013 taxes do not meet the requirements for discharge, so must be paid in full. That takes up the first $15,000 ($3,000 + $3,000 + $3,000 + $6,000).
  • The remaining $4,800 ($19,800 minus $15,000) would be divided among the rest of the debts. That includes $3,000 for the 2009 income tax, $40,000 in credit cards, and $25,000 in medical bills, a total of $68,000. $4,800 paid on $68,000 of debt means that these debts would be paid about 7% of their total.

 So after filing in early 2014, assuming that Jerry’s plan is approved by the bankruptcy court, and his income and expenses do not significantly change during the following 36 months, Jerry can expect that after 36 months of $550 payments, his remaining debts will be discharged, and he will be completely tax-free and debt-free.

If instead Jerry would have filed a Chapter 13 case during 2013 he would not have been able to include the 2013 income tax in his plan. At least not without some extraordinary and potentially risky maneuvering. He would have started payments on a plan that did not include that large $6,000 debt, and then after filing the 2013 tax return he would have had to make special payment arrangements for that tax outside his Chapter 13 case, and then revise his original budget and plan to account for these changes. In addition, he would have to pay ongoing interest and penalties on that 2013 income tax, and would risk collection action against him if his circumstances changed and he could not keep up payments on that tax. It’s clearly must simpler and safer for Jerry to have waited to file in early 2014 so that he could deal with all his debts in one clean package. 


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