Here’s an illustration how you could save your home if you were behind on your mortgage and property taxes, as well as income taxes.
In our last blog post (a couple days ago) we showed an example of how a Chapter 13 “adjustment of debts” can protect someone who was behind on income taxes, particularly income taxes that would not qualify for being discharged (legally written off) in a Chapter 7 “straight bankruptcy” case. We showed there how Chapter 13 usually allows you to catch up on other important debts—some child support arrearages there—often ahead of the income taxes.
That can be very important because people who are behind on income taxes are often also behind on other important debts. Today we show how that works if you owe income taxes and are also behind on your home mortgage as well as property taxes, a common situation.
Our Hypothetical Taxpayers
David and Nicole fell behind on income taxes during periods of unemployment and underemployment during the Great Recession. They currently jointly owe $4,000 to the IRS for each of the tax years 2011 through 2013, totaling $12,000. They filed their taxes diligently on April 15 of the following year each of those tax years, and have been making monthly payments to the IRS through a monthly instalment plan, but not before the IRS recorded a tax lien against their home on the $4,000 currently owed for 2011. Nicole and David do not expect to owe more income taxes when they file their tax returns for 2014 because they have been both fully employed since the beginning of that year and have had appropriate amounts being withheld for income taxes from their paychecks since then.
During their period of less than full employment the couple also racked up some medical bills and credit cards, totaling $60,000. They are struggling to pay them as much as they can. Some are in collections, and threatening lawsuits.
Because of these debts and having to make the monthly payments for their past due income taxes, they have fallen 5 months behind on $1,200 monthly mortgage (totaling $6,000), and did not pay the recent $2,750 annual property tax bill.
Nicole and David would really like to hang onto their home because they’ve had it for 10 years and they are finally just about to start building equity in it again (after the big home value slide of the Great Recession and slow climb back up since then). The home is worth about what is owed on the mortgage and property taxes combined, meaning that if they paid off those arrearages that would build equity all the more quickly. This also means that the income tax lien on the home is not currently backed up by any equity right now. Apartment and home rentals have risen quickly in their area so that it would cost them more to rent than to own, especially when accounting for the home mortgage interest deduction for their income taxes.
Their Income and Property Taxes Under Chapter 7
If David and Nicole filed a Chapter 7 case (as of when this blog post is being written, April of 2015), practically speaking they would not avoid paying any of their income tax debts.
That’s because, first, although the 2011 tax debt would normally qualify for discharge (because its tax return was due more than 3 years earlier and was in fact submitted to the IRS more than 2 years earlier), the tax lien recorded against their home means that tax debt would likely need to be paid to get the lien off their home’s title. Although there may not be equity securing the lien now, the IRS will not likely release the lien given the likelihood of there being equity soon.
Second, the 2012 and 2013 tax debts would not be discharged because of the above 3-year rule: it hasn’t been three years since those tax returns were due.
And as for their mortgage and property tax arrears, Chapter 7 provides no structured and protected way to catch up on those. If it weren’t for their large income tax debts, Nicole and David could potentially have worked something out with their mortgage company and county to pay off those arrears, but not with the pressure being put on them by the IRS.
The Structured and Protected Chapter 13 Solution
On the advice of their attorney, David and Nicole instead filed a Chapter 13 case, through which to take care of all their debts in one tidy and effective package.
Their attorney helped them put together a thorough budget providing them reasonable amounts for all their living expenses, including their ongoing monthly mortgage and (prorated) property tax payments but excluding all other creditors. This left $500 of “disposable income” for them to pay into their Chapter 13 Plan for ALL of their creditors. Paying that $500 per month for three years, or a total of $18,000, is enough to bring Nicole and David current on their income and property taxes, catch up on their mortgage, get rid of the income tax lien, and leave them completely debt-free (except for their up-to-date mortgage) at the end of those three years.
How can paying $18,000 be enough when this couple owes $12,000 in income taxes, is $6,000 behind on their mortgage and $2,750 on their property taxes, plus another $60,000 in other debts, a total of $80,750?
Their Chapter 13 Plan
First, under Chapter 13 the tax lien would be considered not secured by the couple’s home because there is currently no equity in the home (beyond the debt in property taxes and the mortgage). The IRS would have to release the tax lien. Because the underlying $4,000 of 2011 tax debt is otherwise dischargeable, it would be lumped together with the $60,000 of other “general unsecured” debts—the medical and credit card bills—and only paid to the extent that there would be any available money for this during the 3-year Plan.
Second, the property taxes would be earmarked for relatively quick payoff, say about $400 out of the $500 per month Plan payment until the back property tax is paid off. This should be paid off first because it is the only obligation that must be paid with interest, and usually a relatively high rate of interest.
Third, the $6,000 in mortgage arrearage and $8,000 in income taxes (for 2012 and 2013) would take most of the rest of the Plan payments.
Fourth, depending on the amount of interest that would accrue and be paid on the property taxes, there would likely be very little of the $18,000 left and available for all of the other “general unsecured” creditors. They would receive whatever would be left, on a prorated basis, likely only a few pennies on the dollar.
(Note: for the sake of easier calculation we’ve skipped the “administrative expenses”—the Chapter 13 trustee fees and David and Nicole’s attorney fees. The trustee fee is usually close to 5% of whatever is paid through the Plan, and the amount of attorney fees paid through the Plan depends on how much Nicole and David paid to their attorney at the beginning of the case and how much attorney time the case requires.)
So to reiterate what we said a few paragraphs above, after three years of $500 payments Nicole and David would be free of all debt except their up-to-date mortgage. They would have paid little or nothing on their 2011 income tax regardless of the recorded tax lien on it, and that $4,000 tax debt would be discharged and the lien permanently released. The 2012 and 2013 income taxes totaling $8,000 would be paid in full, but any ongoing interest and penalties would be discharged, leaving the couple tax debt free. The property tax and mortgage would be caught up and current, with a meaningful amount of equity in the home likely built up. Lastly, the $60,000 in other debts would have been paid very little, and the rest permanently discharged.
David and Nicole would have used Chapter 13 to save their home while successfully solving both their income and property tax problems.