Tax Season: More Protection While Dealing with Your Income Tax Debts through Chapter 13
It’s much safer than under Chapter 7 because the protection lasts for years instead of just a few months, and is more flexible.
Chapter 7 Discharging All Tax Debts
As we explained here a couple of weeks ago, income taxes CAN be discharged (permanently written off) with a regular Chapter 7 case when they meet a list of conditions. If you are fortunate enough to have any tax you owe meet those conditions (mostly related to how old the tax is), than you don’t need any more protection than what Chapter 7 provides.
The minute your bankruptcy case is filed, you are protected from virtually all collection efforts of the IRS and/or your state taxing authority—in a Chapter 7 case just the same as in a Chapter 13 one. That protection, called the “automatic stay,” is in place under Chapter 7 until you receive a discharge of your debts, including your tax debts, usually only three or four months later.
Once the bankruptcy judge signs the discharge order, all of your creditors—including the tax creditors—are forever forbidden to do anything to collect the debt. That includes grabbing future tax refunds, garnishing wages, anything. The debt is legally gone.
Risks with Debts Not Discharged through Chapter 7
But if you owe a tax which would NOT be discharged in a Chapter 7 case, the protection against the IRS and/or state as to that tax ends as soon as you receive the discharge of your other debts, again usually only three or four months after your case was filed. The “automatic stay” ends. The taxing authority can then use whatever collection authority it has to garnish your paycheck and bank accounts, levy on your vehicle and other assets, and record income tax liens against your home and all other assets, among other aggressive collection methods. In truth, you can often avoid these by quickly entering into a monthly installment payment program, but that assumes you can pay what they want, and do so without fail.
Protection Against Tax Collection Lasts for Years through Chapter 13
Unlike Chapter 7, a Chapter 13 is designed to last generally three to five years long, and the “automatic stay” usually is in place protecting you throughout that time.
The tax debts that would not be discharged in a Chapter 7 case and that you’d have to deal with directly with the IRS and/or the state without the protection of the “automatic stay,” under Chapter 13 are paid during the course of the case while the “automatic stay” continues in effect. Besides being able to pay the IRS/state much more under your own terms (see the very last blog post about that), you can rest easy throughout the repayment period because for them to take any collection action against you throughout that time would be illegal.
At the end of a successful Chapter 13 case the taxes (those that would not have been discharged under Chapter 7) would be paid in full. So no further protection from tax collection would be needed. The “automatic stay” expires in Chapter 13 at the time of the entry of the discharge just as in Chapter 7. But under Chapter 13, it’s years later and after the tax at issue has by that time been paid in full under the plan.
Protection Under Chapter 13 If Your Circumstances Change
The continuous protection of the “automatic stay” is particularly important when your financial circumstances change during your repayment period. Instead of being at the mercy of the IRS/state, your attorney can usually make adjustments to your Chapter 13 plan payments. The taxing authorities usually do not have grounds to object if your new plan complies with the law. You usually have much more control over the situation than if you were dealing one on one with a taxing authority outside of Chapter 13.
Limitations to the “Automatic Stay” Protection under Chapter 13
Under some circumstances you CAN lose this protection during the course of the case, such as if you do not follow the rules of the game, by failing to make your monthly Chapter 13 plan payments or to file your subsequent tax returns, for example. But generally as long as you and your attorney deal with your situation proactively—by amending your plan, or taking some other appropriate action—you can usually preserve that protection throughout the life of your case.