Here’s an illustration how a Chapter 13 case would pay your taxes that you could not discharge (write off) in a Chapter 7 bankruptcy.
In our last blog post (a couple days ago) we explained how a Chapter 13 “adjustment of debts” can protect you from your income tax debts, and in that process can greatly help you pay off income taxes that you’d still owe if instead you’d file a Chapter 7 “straight bankruptcy” case. We ended that blog post with a list of the big advantages of paying these kinds of taxes through Chapter 13. And said we’d show how this all works through the example of a hypothetical taxpayer who owes a lot of taxes that can’t be discharged. That illustration follows.
Our Hypothetical Taxpayer
Jennifer started a small business in 2009 during the Great Recession, which she built up quickly into what for a while seemed like a promising one-person enterprise. But she never could get it to make enough money. Because of the immediate financial needs of her family, from 2009 through late 2014 she put money she made from the business into paying their essential living expenses, and home mortgage and vehicle loan payments. So throughout that period she didn’t pay nearly enough money towards her quarterly estimated income taxes.
She negligently avoided the issue by not filing tax returns for 2009, 2010, and 2011 until October 15 of 2013, and owed $4,000 to the IRS for each of those three years. Then on October 15, 2014 Jennifer filed tax returns for 2012 and 2013, and owed $5,000 to the IRS for each of those two years. She expects to owe another $2,500 for 2014.
Jennifer threw in the towel on her business when in late 2014 she found a full-time, decently-paying job in her field. Ever since late 2013 the IRS had put a great deal of pressure on her to make payments on her 2009, 2010, and 2011 taxes. So she made monthly payment arrangements directly with the IRS and as a result managed to pay off the 2009 taxes. But she defaulted on that arrangement when she again did not pay enough into her ongoing quarterly estimated taxes and owed substantial additional taxes for 2012 and 2013.
So Jennifer now still owes $8,000 (2 times $4,000) for 2010 and 2011, plus $10,000 (2 times $5,000 for 2012 and 2013, plus she expects to owe $2,500 more for 2014, a total of $20,500. Although her present job is stable and pays relatively well, because Jennifer is in breach of her IRS agreement she is at immediate risk of the IRS recording a tax lien on her home and vehicle, and placing a levy on her paycheck.
The Limitations of a Chapter 7 Case
If Jennifer were to file a Chapter 7 case now (as of the April 6, 2015 writing of this blog post), she would not be able to discharge ANY of the $20,500 she owes the IRS. That’s because none of her tax debts meet both of the two main qualifications for discharge: 1) more than 3 years since the tax return at issue was due, and 2) more than 2 years since the tax return at issue was actually submitted to the IRS.
The only way that Chapter 7 would be able to help Jennifer is if she has so much other debts that she’s been paying on that discharging those other debts would free up enough money for her to be able to keep the IRS satisfied. But as soon as the Chapter 7 case were finished—usually only about three months after it would be filed—the IRS would be free to levy on her wages and record a lien on her home and vehicle.
The Benefits of a Chapter 13 Case
Jennifer was justifiably afraid that an IRS levy on her paycheck would jeopardize her job, because in that job she handled financially sensitive matters and she knew her new employers would not react well to a levy. After her attorney informed her of the benefits of Chapter 13, that is what she decided to file.
As a result:
- Jennifer got protection from the IRS throughout the length of her Chapter 13 Plan, which in her case was 60 months, the maximum. The IRS was forbidden from recording a tax lien throughout those 60 months.
- Jennifer‘s budget showed that she could reasonably afford to pay $500 per month to all her non-mortgage creditors, so this is what her Chapter 13 Plan payment became. The IRS was forced to accept being paid out of that $500, regardless what it could have required otherwise.
- Because much of Jennifer’s $500 Plan payment at first was earmarked to catch up on a child support arrearage she’d fallen behind on, the IRS didn’t receive any money for the first 4 months of her Chapter 13 case. But the IRS had no grounds to complain about that.
- Jennifer didn’t pay any interest or penalties on the tax during the entire 5-year Chapter 13 case. That took away some pressure to pay the IRS off quickly, and also reduced how much she needed to pay before the tax was paid off.
- By the end of Jennifer’s case, she’d paid off the entire $20,500 in taxes she owed through her $500 per month Plan payments. To the extent any ongoing interest and penalties would have incurred against those taxes, these were discharged, along with any other debts that she owed. After the end of her case, Jennifer owed no taxes and, other than her mortgage, was completely debt-free.