Good Reason to Delay Filing Bankruptcy until Now: Pay Less Income Taxes AND Shorten Your Chapter 13 Case
If you owe income taxes, with wise timing you may be able to be in Chapter 13 for much less time.
Our last blog post showed how smart timing in filing a Chapter 13 “adjustment of debts” case can result in you paying less of the income taxes you owe. This happens because with the passage of time older income taxes can be discharged—legally written off permanently. Often these older taxes are paid nothing in a Chapter 13 case, or else they do not add to the amount that you would otherwise pay to your creditors if you did not have those tax debts.
In today’s blog post we show how that can result in a Chapter 13 case that takes less time to complete. Getting out of a Chapter 13 case earlier—potentially a year or two earlier—has a number of benefits, including getting your remaining debts discharged sooner, and allowing you to rebuild your credit faster.
What Determines the Length of Chapter 13 Case
You may have heard that a complete, successful Chapter 13 case generally takes three to five years. Although that may seem like a long time—especially compared with the four months or so that an ordinary Chapter 7 “straight bankruptcy” usually takes—the relatively long length is actually often a benefit because it gives you more time to spread out payments that you want to or need to make—to catch up on a mortgage or child support arrearage, for example—thus reducing the amount of your monthly Chapter 13 plan payment. The lower monthly payment can make it possible to accomplish what would otherwise be impossible.
But what determines whether your case will take three years or five, or something in between?
Two main considerations: your “income” and your budget.
Your “Income” Determines Whether Your Case Must Last 3 Years or 5
Whether your “income” is below or above the published median income for your state and family size determines whether your “applicable commitment period” is 3 years or 5 years.
We put “income” in quotes here because the legal meaning of “income” for this purpose is unusual, quite different than most conventional meanings of that word. There is more to it than this, but essentially “income” is calculated by combining all income and funds that you received from virtually any sources (except through Social Security) during the last 6 FULL calendar months before the date you file bankruptcy, then doubling that amount.
Without going into this any deeper here, let’s assume that your “income,” like the majority of people who file bankruptcy, is below the median income for your state and family size. That means that your “applicable commitment period”—the minimum length of your Chapter 13 case—is 3 years.
Three-Year Chapter 13 Cases Voluntarily Lasting Longer Based on Your Budget
Just because your “income” determines that you have a 3-year “applicable commitment period” does not mean that your case can’t last longer if your budget requires it. If you must pay a certain amount in mortgage and/or vehicle loan and/or support arrearage or other debts, but doing so over a period of 36 months will result in a monthly Chapter 13 plan payment that is too large for your budget, almost always your plan payment can be lowered by stretching your plan out over a longer period, up to a maximum of 60 months (5 years).
Income Taxes to Be Paid in Full vs. Those Paid Only to the Extent You Can Afford to Do So
At the beginning of this blog post we referred to older taxes being paid little or nothing in a Chapter 13 case. Newer income taxes must be paid in full—although usually without any further interest and penalties and with a bunch of other advantages. But once any of your tax debts meets a number of conditions—most of which are based on the age of the tax—it changes from a “priority” debt—one that has to be paid in full in a Chapter 13 case—into a “general unsecured” debt—one that only has to be paid to the extent that your budget allows within your “applicable commitment period.”
The two main conditions, BOTH of which must be met, for this change into “general unsecured” status are:
1) the tax return for the income tax in question must have been due more than 3 years before your bankruptcy case is filed, plus any extra time granted for extensions to file that tax return; and
2) the tax return must have been received by the IRS or state tax authority more than 2 years before the bankruptcy case is filed.
(There are some other conditions, but in most cases these two are the only ones that matter.)
To illustrate, if you owe the IRS $5,000 for personal income taxes for the 2010 tax year, its tax return was due—assuming no filing extension—on April 15, 2011. If you did send in the tax return on that date, you could file a Chapter 13 case at any time starting April 16, 2014—more than 3 years later—and that $5,000 would be treated as a “general unsecured” debt. But if you did not send the tax return to the IRS until June 30, 2012, then the bankruptcy must be filed more than two years after that date, so on or after July 1, 2014 instead for the same result. If your Chapter 13 case was filed any earlier, then that $5,000 tax debt would be a “priority” debt to be paid in full.
A Shorter-Lasting Chapter 13 Case
Simply put, filing your Chapter 13 case right after an income tax debt converts from a “priority” debt into a “general unsecured) one enables you to have a shorter case because you have that much less that you have to pay.
Using the example above, assume again that your “income” is under the median amount so that the minimum length of your Chapter 13 case is three years. If you filed your case when the $5,000 income tax for 2010 was still a “priority” debt, that $5,000 would have to be paid in full before your case could be completed. Assuming a monthly Chapter 13 plan payment of $250 per month (and keeping it simple by disregarding any trustee fees), that would take 20 months of your Chapter 13 case. Also assume that would push your case out to a full 5 years.
But once that 2010 IRS tax debt turns into a “general unsecured” one, it would only need to be paid to the extent your budget allowed. That $5,000 would be lumped in with your other “general unsecured” debts—credit cards, medical bills and such. You may be able to pay nothing—0%–on those debts (if that is allowed in your jurisdiction) if, as in this example, all of your available money is going to pay “priority” or secured debts. If so, that saves you $5,000, reducing the length of your Chapter 13 plan by 20 months. The 5-year (60-month) case would get shortened to only 40 months—3 years and 4 months.