Chapter 13 “adjustment of debts” gives you many tools that Chapter 7 “straight bankruptcy” does not.
In our last blog post we gave you some scenarios in which filing a Chapter 7 case would not write off some of your income taxes but would still make more sense than a Chapter 13 case. But those scenarios are all ones in which the Chapter 7 case would leave you able to manage your remaining tax debts directly with the IRS and/or state tax agencies. That’s often just not the case
If you have any significant tax debt, Chapter 13 IS worth a close look because it comes with many, many advantages. Granted, going through a 3-to-5-year Chapter 13 case appears on the face of it to be more complicated, more expensive, and take much longer. But not necessarily.
As to how long it takes, the issue is not so much when your bankruptcy case will be over but rather when you will be free of your tax debts. That may come faster and less expensively under Chapter 13.
So while you certainly can’t assume that Chapter 13 is the best option if you owe back taxes, you definitely need to understand what it can do for you.
Here are the key advantages provided by Chapter 13 for income tax debts that do not qualify for being discharged under Chapter 7.
1. More Control and Flexibility
If you file a Chapter 7 case which leaves you owing some income taxes, you have to deal directly with the IRS and/or state taxing authority to arrange to pay off or settle that tax debt. To a large degree you are at their mercy about how much you have to pay each month. Sometimes that’s OK—if the taxes owed are relatively small and you can afford to make the monthly payments that the IRS/state will demand.
But what if your income is too low to be able to make the required payments? What if you have other urgent debts to pay—like back child support—or to catch up on—like missed payments on a vehicle loan or your home mortgage?
Chapter 13 allows you to put together a payment plan a very flexible plan for paying off those taxes that can’t be discharged. That plan just has to show how those taxes will be paid off within the 3-to-5-year plan. That enables you to keep other important creditors satisfied. And it gives you the flexibility you need if you anticipate upcoming changes in your income or expenses.
2. Pay Less
Unlike Chapter 7, in which interest and penalties continue accruing on any taxes that aren’t discharged, under Chapter 13, usually no more interest and penalties accrue. With the payments being stretched out over the course of years, this can save you lots of money and enable you to pay off the taxes more quickly.
Also unlike Chapter 7, in which you have to pay all previously accrued interest and penalties, under Chapter 13 you often pay little or nothing on the previously accrued penalties. Because those penalties can be a large portion of what you owe, this can also save you money.
In addition, a Chapter 7 case does not help much, or at all, if a tax lien has been recorded against you, because tax liens usually remain in effect after a Chapter 7 bankruptcy case is completed. But Chapter 13 helps a lot with tax liens. It provides a very efficient and transparent procedure for determine the value of the property or possessions that the lien attaches to. That’s important because that takes away the huge leverage the IRS/state otherwise have against you as a result of the tax lien. Instead, the effect of the tax lien is determined through your Chapter 13 plan at the beginning of your case, and you simply pay interest, at a relatively low rate, on the portion of the tax covered by the lien. The tax lien is released when you finish the Chapter 13 case.
3. Protection Throughout
Under both Chapter 7 and 13 you are protected from the collection activity of the tax agencies—as with all other creditors—during the course of the case. But that protection in a Chapter 7 case usually last only three or four months, while in a Chapter 13 case it lasts three to five years.
So under Chapter 13 the tax debts that can’t be discharged are paid while you’re under this bankruptcy protection. Under Chapter 7 the tax payments are made after the protection has expired.
The continuous Chapter 13 protection can become tremendously important if your finances change during your repayment period. Instead of having to work within the self-serving procedures and policies of the IRS/state, your Chapter 13 plan payments can usually be adjusted to fit your new budget.