Chapter 7 can only help in certain tax debt situations. Chapter 13 “adjustment of debts” is both more powerful and more flexible.
What Chapter 7 Can and Can’t Do
As the last post explained, a Chapter 7 “straight bankruptcy” may be able to help by, first, stopping any pending IRS levy on a paycheck or other assets—at least for a few months, and then either:
- discharging (legally writing off forever) certain—particularly older—income tax debts;
- discharging enough of your other debts so that you can afford to enter—after the Chapter 7 case is completed—into a reasonable monthly payment plan with the IRS for taxes that can’t be discharged; or
- a combination of the above two—discharging some tax debt, as well as some other debts, so that you can afford to enter into a monthly payment plan with the IRS for the tax debts that could not be discharged.
But what if none of your income taxes meet the conditions for them to be discharged? Or what if some of your income taxes could get discharged but you would still owe so much in the rest of your tax debts that you couldn’t enter into a reasonable monthly payment plan with the IRS?
We illustrate how Chapter 13 can help in such situations with an example:
Jackie has owned and operated a small retail women’s clothing store since 2006. It is a sole proprietorship with an assumed business name, J’s Favorites. The store was moderately profitable within a year of opening, and then provided enough income to meet Jackie’s basic living expenses. She was able to hire two part-time employees, who working hours went up or down depending on the seasons.
After riding out the beginning of the Great Recession reasonably well, Jackie became ill and could not work consistently for much of 2009 and 2010, with her absence both cutting into sales and greatly increasing her employee costs.
Jackie is now back in good health, but her finances, especially with the IRS, are a mess. During 2009 and 2010 every dollar she took out of the business went to pay her most basic living expenses, plus to pay the loan on her vehicle, which she absolutely needed for her medical appointments and to run her business.
During previous years she had diligently paid the appropriate quarterly estimated income tax payments to the IRS, but failed to do so in 2009 and 2010. She filed the tax returns on time, on April 15, 2010 and April 15, 2011, respectively. She owes $5,000 for 2009 (after making monthly payments on it during the last year) and $14,000 for 2010. She paid some but not enough quarterly payments in 2011 and owes another $2,500 for that year. She has been paying appropriate amounts each quarter in 2012 and 2013 so is not expected to owe for these two years.
What the IRS is most excited about is that during the second half of 2009 and the first half of 2010, during the worst of her illness and the height of her employee costs, she failed to pay the IRS most of the taxes that she withheld from her employees’ paychecks. She has paid some of that in the meantime but still owes a total of $8,500 in these unpaid withholding taxes.
Jackie’s business is now generally back on an even keel, generating enough income for her business and living expenses, and to pay current income and withholding taxes. Jackie paid off her vehicle loan a few months ago. She owes a total of $10,000 in personal and business credit card debt, racked up during her illness that she’s making minimum payments on, plus $5,000 in yet unpaid medical bills from her illness that she has arranged to make small payments on.
The most urgent problem is that the IRS has just sent a Final Notice of Intent to Levy on her business checking account, inventory and equipment, because of the unpaid withholding taxes. A levy on these business assets would devastate her business.
The Benefits of Chapter 13
After reviewing her situation with a bankruptcy attorney, Jackie is advised that a Chapter 7 would not be very helpful to her. Most of her tax debts would not be discharged—only the $5,000 in 2009 income tax is old enough to qualify, and withholding taxes can never be discharged. That would leave $16,500 for the 2010 and 2011 income taxes, plus $8,500 for the withholding taxes, a total of $25,000. And while her credit card and medical debts would very likely get discharged in a Chapter 7 case, that monthly cash flow benefit would not be nearly enough to enable her to pay the IRS enough each month to satisfy it, especially for the withholding taxes. And even if the IRS would accept what she could afford, the continuously added interest and penalties would mean that paying off the taxes would take forever—throughout which time the IRS could threaten her business whenever she would not be able to make a payment during a lull in her business.
Instead Jackie files a Chapter 13 case. This stops the levy threat immediately. Her budget shows that, after stopping payments on her credit cards and medical bills, she could reasonable afford to pay $550 per month on all her debts. This would be enough to pay off all the “priority” tax debts—the nondischargeable income taxes plus the withholding taxes, totaling $25,000—plus the Chapter 13 trustee fees and Jackie’s attorney’s fees, in about four and a half years, with nothing going to the “general unsecured” debts–the older income tax of $5,000 combined with her $15,000 of credit card and medical debts.
If Jackie’s business improved and her income increased she would perhaps want to and may be required to pay more each month. But unless she was able to increase how much she paid into her Chapter 13 plan so much that the “priority” portion of taxes were paid off in less than a total of three years, those increased payments would just finish her case faster without paying anything to her “general unsecured” debts.
Throughout this time no interest or penalties would be added to the taxes, and the IRS could not take any collection action on any of the taxes owed.
At the end of the Chapter 13 payment period, Jackie’s taxes that could not be discharged would be paid in full, all her remaining debts would be discharged, she’d be current on her taxes, and otherwise debt-free.