Tax Season: Have Your Chapter 7 Trustee Pay Your Income Tax Debt

You may have assets not protected by the property exemptions. If you owe recent income taxes, surrender the assets so the taxes get paid.

 

In this bankruptcy blog, week after week we cover a lot of scenarios. Some are applicable to many of our website visitors. Other scenarios apply to much fewer people. We readily admit that today’s blog post’s topic applies to a relatively small percentage of our readers. But where it does apply, the solution it presents can be very helpful.

Chapter 7 “Liquidation”

At its heart, Chapter 7 “straight bankruptcy” involves the surrender of all of a person’s unprotected property to his or her creditors—in the person of the bankruptcy trustee—in return for being relieved of the debts owed to those creditors. The trustee sells—liquidates—the unprotected property, and distributes the proceeds to the creditors.

However, most of the time there is no “liquidation” at all under Chapter 7. That’s because for most people all of their assets are protected through “exemptions”—categories of assets protected up to certain maximum dollar amounts.  

But occasionally there ARE assets that don’t fit within the available exemptions. In these cases, the trustee would distribute the proceeds of sale of those assets to the creditors.

The Chapter 7 Trustee Pays Your Recent Income Tax Debts Before Most Other Debts

IF a person filing a Chapter 7 case has non-exempt (unprotected) assets, AND owes some relatively recent income taxes, there is a good chance that the trustee will pay some or most of the proceeds of the asset liquidation to the income taxes. That’s because bankruptcy law lays out the order in which the trustee must pay certain kinds of debts. “Priority” debts must be paid in full before anything is paid to “general unsecured” creditors. Furthermore, the “priority” debts must be paid in a particular order, with higher order creditors to be paid in full before anything goes to the lower “priority” debts.

So if the only “priority” debt a person owed consisted of income taxes, then all of the proceeds of the trustee’s asset liquidation would first go to pay the income taxes (other than trustee fees).

For Example

Consider a person who owed $3,000 to the IRS for income taxes of two years ago, plus $60,000 in credit cards and medical debts. He or she also owns a non-exempt boat, worth $4,000. When this person files a Chapter 7 case, the bankruptcy trustee would take possession of and sell the boat, let’s say for $4,000. After paying himself or herself the statutorily determined court-approved trustee fee, the trustee would pay the remaining money to the IRS up to the $3,000 owed, before paying anything whatsoever on the credit cards and medical debts.

“Priority” Debts with a Higher Priority Than Income Taxes

Careful because In the above example the IRS debt would receive no payment from the trustee if some even higher priority debt had to be paid first, leaving nothing available to pay the taxes.

The kinds of debts which are higher than income taxes in priority list include:

  • Child and spousal support arrearage
  • Any wages, salaries, commissions, and employee benefits earned by employees during the 180 days before filing or before the end of the business, up to $10,000
  • Any contributions to employee benefit plans, with certain limitations

Conclusion

You may be able to have your Chapter 7 trustee pay some or all of your recent income taxes IF you:

1) have assets that are not protected by the exemptions,

2) you owe “priority” income taxes, and

3) you don’t have any even higher priority debts such as child support. 

 

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