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The Surprising Benefits: Break a Tax Payment Plan through Chapter 13

June 11th, 2018 at 7:00 am

Use Chapter 7 to stop paying an unaffordable income tax payment plan when the tax owed is dischargeable. Use Chapter 13 when it’s not. 

Tax Agreement Payments Too High

We laid out the problem last week. You’d entered into a monthly payment plan with the IRS or your state because you couldn’t pay what you owed. But now you don’t have the money to make the payments. Or you’re in a payment plan but will owe more income taxes soon, putting you then in violation of your payment agreement.  

If you violate your tax agreement the IRS/state could then take aggressive collection action against you. Or you might be able to add an upcoming new income tax owed into your current tax payment agreement. But the increased monthly payment may well push you over the financial edge. But even if you think you could afford it, you’d be going backwards instead of making progress.

Chapter 7 Makes Sense When Your Tax Owed Can Be Discharged

If all, or most, of the income tax debt in your present monthly payment plan is dischargeable, Chapter 7 likely makes sense. You’d discharge (forever write off) all or most of the taxes you owe. You’d either owe no taxes or owe a small enough amount to be able to handle it with a new smaller payment plan.

But if you can’t discharge all your income taxes, or enough, through Chapter 7, Chapter 13 “adjustment of debts” is likely the better tool.

Chapter 13 Plan

A Chapter 13 payment plan wraps all or most of your debts into a single monthly payment. This payment includes any tax debts. This single Chapter 13 monthly plan payment is based on your actual budget. Some debts—such as taxes, and secured debts such as a home mortgage and vehicle loan—get prioritized. Usually you pay less on your other debts, often not much, sometimes nothing.

Advantages

Dealing with income tax debts with Chapter 13 gives you the following advantages over Chapter 7:

  • Income taxes that don’t qualify for discharge do need to be paid in full, but on a very flexible schedule. You and your bankruptcy lawyer create a new plan incorporating all of your debts. This plan focuses your resources on your most important debts, including nondischargeable income taxes.
  • Usually you don’t pay ongoing interest and penalties. This saves you potentially lots of money. That’s particularly true if tax interest rates will rise in the near future along with other interest rates.
  • Other even more important debts—such as child/spousal support, or unpaid mortgage or home mortgage payments—can often be paid ahead of income tax debts.  
  • The budget you enter into earmarks enough money to withhold from your paycheck or pay quarterly for the current year’s taxes. This enables you to break out of the endless cycle of being behind on your income taxes.
  • Chapter 13 handles income tax liens much better than Chapter 7. If there’s no equity supporting the lien, you can often get rid of the lien without paying anything for it. If the lien is partially secured, you will likely pay less to get rid of it than otherwise. Chapter 13 takes away much of the leverage of tax liens from the tax authorities.
  • You are protected throughout your entire 3-5-year Chapter 13 payment plan from tax collection. Bankruptcy stops all tax collection, including the recording of tax liens. In Chapter 7 this protection lasts only 3-4 months. Then you’re on your own dealing with any remaining tax debts. With Chapter 13 the protection lasts until the end of your Chapter 13 case. At that point you should owe absolutely no tax debt.

Conclusion

Filing bankruptcy allows you to unilaterally break your monthly payment agreement with the IRS and/or state. With Chapter 7 you may be able to discharge all or most of your tax debts. Or, discharging all or most of your other debts may make it possible to stay in your tax payment plan, if that’s your only significant debt. However, if Chapter 7 doesn’t help you enough, Chapter 13 gives you many other significant advantages (some listed above). Talk with an experienced local bankruptcy lawyer to figure out which is better for you.

 

Buy Lots More Time to Deal with Multiple Years of Income Tax Debts

October 27th, 2017 at 7:00 am

If you have an income tax debt that qualifies for discharge and also some tax debt that doesn’t, Chapter 13 is often your best option. 

Stopping Tax Liens through Chapter 13 

In our last blog post we showed how Chapter 7 might prevent an income tax lien from hitting your home. It stops the recording of the tax lien through the power of the “automatic stay,” which stop virtually all creditor collection activities. And then you get a discharge (write-off) of the tax debt.  But then we added a twist: owing one or more additional tax years’ of debt which does not qualify for discharge. What if you have a tax that meets the conditions for discharge and one or more years’ that don’t? We showed how sometimes Chapter 7 can deal with this effectively, if the still-remaining tax debt is manageable.

But what if the taxes you still owe are not manageable? In a Chapter 7 case the protection of the “automatic stay” ends as soon as the case ends, usually just 3-4 months after it’s filed. So after that you could easily get a tax lien recorded against your home for the still-owed taxes.

Last time we ended by saying a Chapter 13 “adjustment of debts” could be a better option in these situations.

An Example

Let’s show how Chapter 13 could be a better option with an example.

Assume that you owe income taxes of $24,000—$8,000 for the each of the 2012, 2013, and 2014 tax years. The 2012 and 2013 taxes meet all the conditions for discharge. The 2014 one doesn’t, mostly because it hasn’t yet been 3 years (as of when this is being written) since the date its tax return was due on April 15, 2015.

On advice of your bankruptcy lawyer you file a Chapter 13 case. You do so because you:

  • couldn’t reliably pay into a monthly installment plan with the IRS/state for the remaining $8,000 tax owed for 2014. That’s because you have some other important debts that would also survive the Chapter 7 case. In particular you’re behind on your home mortgage and child support payments. Support enforcement is getting very aggressive, and you don’t want to lose your house. Chapter 7 would not help with these.
  • don’t qualify for Chapter 7 under the “means test.”  Your income under that test is too high, and your allowed expenses leave you with too much disposable income. You don’t have Chapter 7 as an option.
  • need to file a Chapter 13 case for its other benefits. You want to get lots of protected time to catch up on your first mortgage and your child support. Chapter 13 gives you strong tools for dealing with these special debts (and many others).

(Note that any one of these reasons may well be enough to make Chapter 13 worthwhile or appropriate. The particular combination of facts here would very likely make Chapter 13 the right choice.)

The Example’s Chapter 13 Plan

In this example the $16,000 of 2012 and 2013 tax debts would be treated as “general unsecured” debts. This means that they’d be paid—if at all—to the same extent as your other ordinary debts with no collateral. In most Chapter 13 cases there’s only a set amount available to pay to the entire pool of “general unsecured” debts. This means that usually that $16,000 would just go into the pot with those other debts, and you’d pay no more than if there was no $16,000 tax debt. That $16,000 tax debt just reduces how much other “general unsecured” debts get paid, without increasing how much you pay. In fact, in many bankruptcy courts you’re even allowed to pay nothing to the “general unsecured” debts. That happens if all your money during the life of the plan goes elsewhere.

Speaking of money going elsewhere, you’d pay the remaining $8,000 for the nondischargeable 2013 tax during the course of your 3-to-5-year Chapter 13 payment plan. It’s a “priority” debt, one that you have to pay off during your case. Throughout that 3-to-5-year period you’d be protected from the IRS/state by the “automatic stay.” That’s because it usually protects you throughout the years of the case (not for just 3-4 months like Chapter 7). That means no tax lien being recorded against your house throughout your case.

Your payment plan would also include money to catch up on your home mortgage and on your child support. These two debts could be paid ahead of or alongside the “priority” tax debt.

The End of the Chapter 13 Case

At the end of your successful Chapter 13 case the following would happen:  

  • Having by that point paid off the $8,000 “priority” tax debt, any interest and penalties that would have accumulated on that tax would be forever waived.
  • With that tax debt gone there’d be no further risk of a lien against your home from that tax.
  • To the extent that the $16,000 in older taxes would not be paid, they’d be permanently discharged. (This would usually be most, or sometimes even all, of the $16,000.)
  • Your home mortgage and child support would be caught up as well.
  • You’d be tax-debt-free, and altogether debt-free except for the on-time first mortgage.

 

Chapter 7 Permanently Prevents Tax Liens against Your Home

October 16th, 2017 at 7:00 am

Filing a Chapter 7 case prevents tax liens from hitting your home, and so avoids a dischargeable tax from turning into one you must pay. 

 

Our last blog post was about how filing a Chapter 7 case buys you time with debts on your home. It’s worth expanding on one of those Chapter 7 benefits, one that can go way beyond buying time. It could save you a lot of money, potentially many thousands of dollars.

The Dischargeable Income Tax Scenario

Filing a Chapter 7 bankruptcy can discharge certain, usually older, income tax debts. (See our blog post of this last September 22 about the conditions for writing off income taxes in bankruptcy.) If you file a Chapter 7 case before a tax lien is recorded on a dischargeable tax debt, then that will prevent the IRS or state tax authority from recording that lien against your home. The tax will then be discharged (permanently written off) about 4 months of your bankruptcy filing. After that the IRS/state can never record a lien or take any other collection action on the tax. It’s gone forever, and the threat of a lien against your home is also gone forever.

The Very Bad Alternative

What happens instead if the IRS or state records a lien against your home before you file bankruptcy?

Assume you’d have some equity in your home but no more than the homestead exemption. (That’s the amount of equity that’s protected from most creditors in bankruptcy—the specific amount varies state to state.) If you’d owe a tax debt that would qualify for discharge and the IRS/state had recorded a lien on that debt against your home, that lien would continue on after you’d complete your bankruptcy case. Your homestead exemption would not help with a tax lien. That lien would continue to encumber the equity you have in your home. You’d have to pay the lien in full when you’d sell or refinance your home. The lien would effectively turn a debt that you could have discharged within a few months after filing bankruptcy into an anchor attached to your home.

Assume instead that you’d have no equity in your home. The IRS/state would probably still want to keep its lien against your home. The lien would at the time have no equity to encumber but the lien would still attach to your title. Later the IRS/state could likely renew the lien, leaving it on your home’s title for a very long time. Odds are you’d be forced to pay the tax at some point, maybe when your home’s value increased enough. Instead of you getting the benefit of that equity, it would go to pay a tax that you could have discharged long before, if you’d just filed a bankruptcy case before the tax lien hit your home.

An Example

Let’s say you owe $6,000 in income tax for the 2012 tax year and $3,000 for the 2013 tax year. And this is after you’d paid monthly instalment payments for years. Those amounts include a lot of interest and tax penalties. Assume that both of these tax debts qualify for bankruptcy discharge. (This would mostly be because enough time has passed since their tax returns were due and actually submitted.) Assume also that you own a home worth $250,000 with a $225,000 mortgage. That $25,000 of equity is fully covered by your state’s $30,000 homestead exemption.

The following would happen if you filed a Chapter 7 case with your bankruptcy lawyer before any tax lien was recorded:

  • The “automatic stay” from the bankruptcy filing would immediately prevent the IRS/state from recording a tax lien on your home (or on anything else you own). Your home and its equity would be immediately protected.
  • Both the $6,000 2012 tax debt and the $3,000 2013 one would be discharged about 4 months later.
  • The IRS/state could never file a tax lien on these taxes ever again. They could take no further collection action of any sort. The $9,000 debt would be gone. The IRS’s/state’s ability to attach that debt to your home would be gone as well.

Instead the following would happen if the IRS/state HAD recorded tax liens on both years before you filed a Chapter 7 case:

  • The tax lien recorded against your home would continue on after you filed bankruptcy.
  • The IRS/state would get paid on those liens whenever you sold or refinanced your home, potentially many years later.
  • You would very likely pay $9,000—plus likely lots more interest and penalties—to the IRS/state that otherwise you would not have needed to pay.

 

Dealing with a Recorded Income Tax Lien and Preventing Future Ones

July 15th, 2016 at 7:00 am

Chapter 7 sometimes doesn’t give much help with tax liens. But Chapter 13 hugely helps with tax liens already recorded, and stops new liens.

 

Today we cover the 5th of the 10 ways that Chapter 13 helps you keep your home, which we listed in a recent blog post. Here’s how we had introduced this one:

5. Protection from Both Previously Recorded and Future Income Tax Liens

Chapter 7 usually does nothing to address income tax liens that have already been recorded on your home. It also doesn’t prevent future tax liens on income taxes you continue to owe after the bankruptcy case is completed. In contrast, Chapter 13 provides an efficient and effective procedure for valuing, paying off, and securing release of tax liens. Plus, the IRS/state cannot record a tax lien on income taxes during the years while the Chapter 13 case is active.

Let’s show how this works in practice.

The Example

Assume that you own a home worth $215,000 with a mortgage loan balance of $210,000. The home value has been increasing modestly each year.

You tried to start a business at the beginning of 2012 which you couldn’t really get off the ground so you closed it down at the end of 2013. You worked part-time during those two years to have some income, and the business made some money. But the combined income was not nearly enough. As a result you didn’t have the money to pay estimated self-employment or withholding income taxes during those two years. And before, during and after that two-year period you racked up a bunch of credit card and other debt.

As a result you owe $8,000 in income taxes to the IRS for 2012 and $6,000 for 2013. You’ve filed all tax returns on time, don’t owe anything for 2014 and 2015, nor expect to for 2016. Your credit card and other non-mortgage debts now total $68,000.

You just received a notice that the IRS recorded a tax lien against your home on the $8,000 2012 tax debt. You are strapped, have used up all sources of credit and have fallen behind on some credit card payments. You can’t afford to pay anything to the IRS, and don’t know what to do.

Chapter 7 “Straight Bankruptcy” Not Sufficiently Helpful

At first it looks like a Chapter 7 case would solve many of your financial problems. The question is whether it would solve them adequately.

A Chapter 7 case would likely forever “discharge”—legally write off—all or most of the $68,000 in credit card and other miscellaneous debts. That would no doubt free up a fair amount of cash flow.

The 2012 income tax debt would have met the conditions for discharge (essentially, more than 2 years since the tax return was filed and more than 3 years since that tax return was due). But the new tax lien now recorded against and attached to your home would survive a Chapter 7 bankruptcy.

That means that the IRS can still force you to pay that $8,000 tax debt by sitting on the tax lien and maybe threatening to foreclose on your home. There’s currently only $5,000 in equity in the home ($215,000 value minus $210,000 mortgage), less than the amount of the tax lien. But that equity will likely increase as the home’s value increases and you pay down the mortgage. You will eventually have to pay the tax. In the meantime the tax lien will continue significantly hurting your credit.

On top of that, the $5,000 tax debt for 2013 would not yet meet the conditions for discharge. It’s not yet been 3 years since its April 2014 tax return due date. So you would continue owing that entire $5,000 tax debt. Plus the interest and penalties would just keep accruing. Then just as soon as your Chapter 7 case is completed the IRS would be able to use all of its usual collection powers. That includes recording a tax lien on this 2013 tax debt as well.

So a few month after your Chapter 7 case would be finished you would likely have two tax liens of $8,000 and $5,000 on your home, and have to figure out how to pay them off.

Chapter 13 Often Much Better

As we stated at the beginning, “Chapter 13 provides an efficient and effective procedure for valuing, paying off, and securing release of tax liens.” Here’s how that works.

In the example provided, you and your bankruptcy lawywer would propose a Chapter 13 payment plan that treats the 2012 tax debt as partially secured against your home and partially not secured. That $8,000 tax debt is secured to the extent of $5,000 (again, the $215,000 value minus $210,000 mortgage). The remaining $3,000 of that $8,000 would be declared by the court to be unsecured. That portion would be paid if, and only to the extent, that there was any leftover money to pay it during the course of the Chapter 13 case.

As for the $5,000 in 2013 income taxes, your Chapter 13 payment plan would have to earmark enough to pay that in full as an unsecured “priority” debt. But the interest and penalties would stop accruing, effectively reducing the amount that you’d have to pay. And you’d have a great deal of flexibility when and how it was paid. The payments would be based on your budget and worked around other important debts. And, in contrast to Chapter 7, and very importantly, the IRS would not be able to record a tax lien against your home during the course of your case.

At the successful completion of your case you would have paid off the secured port of the 2012 tax. And so that tax lien would be released. Whatever portion of the unsecured part of that tax would not have been paid would be discharged, along with any unpaid portion of the other $68,000 in debts. The 2013 priority debt would be paid in full. You’d owe no taxes. And other than the mortgage, you’d be altogether debt-free.

 

Preventing an Income Tax Lien on Your Home

May 23rd, 2016 at 7:00 am

The recording of an income tax lien turns your home into collateral on the tax you owe. Stop the IRS/state from getting that huge advantage.

 

Assume you owe an income tax debt of $20,000. Assume also that if you filed a bankruptcy case today that $20,000 would be “discharged”—legally written off—in bankruptcy since that tax meets the conditions for discharge. You would not have to pay a dime of this $20,000. Ever.

But now instead assume that you didn’t file bankruptcy today. Then tomorrow the IRS or state tax authority records a tax lien against your home on this $20,000 tax debt. This could mean that after that you could not discharge that debt at all but instead would have to pay it in full. Plus penalties and interest.

So, bankruptcy doesn’t just write off income taxes under the right circumstances. It prevents a debt that could be written off turning into one that can’t. And protects your home in the process.

A Bad Combination of Circumstances

So the recording of an income tax lien can turn a debt that can be discharged into one that has to be paid in full. This doesn’t always happen. It happens when you have a combination of 2 circumstances. But this combination of circumstances is a common one if you owe taxes:

  • First, the income tax you owe meets the conditions for it to be discharged in bankruptcy. A tax can generally be discharged if 1) more than 3 years have passed since the tax return for that tax was due, and 2) more than 2 years have passed since the tax return was actually submitted to the IRS/state.
  • Second, your home has equity to which a tax lien could attach.

Tax Liens Often Are Recorded Against Dischargeable Debts

The IRS and the state tax authorities don’t tend to record tax liens early in the collection process. Whether or not they do depends on the amount of the tax due and other factors. But they are often not quick on recording tax liens. They tend to go through other collection procedures first, especially if you cooperate with them (although again it depends on their individual procedures and how they exercise their discretion in each case).

Often the result is that by the time they would be recording a tax lien, enough time would have passed to meet the above 2-year and 3-year conditions for discharging that tax. So when a tax lien is recorded against you, that recording often turns a tax that could have been easily discharged into one that no longer can be.

A Tax Lien Attaches to ALL Present and to FUTURE Home Equity

Whether or not you own a home is a matter of public record. The IRS and state know if you own a home. They can determine, at least roughly, how much you owe on it. And so they know whether you have any equity in it and about how much. These facts can affect whether and when they would record a tax lien against your home.

You may think that you have little or no equity in your home. But consider the following:

  • First, you may have learned that you are entitled to a “homestead exemption” that protects the equity in your home from your creditors. You may have even learned that all of the equity that you have in your home is more than covered by that homestead exemption. Doesn’t matter. The homestead exemption does not have the power to stop a tax lien from attaching to your home equity.
  • Second, a tax lien attaches not just to your present equity but also to future equity. Your home equity increases as you pay down your mortgage and as the value of the home increases. If you are behind on property taxes, homeowners’ association dues, or other debts against your home, catching up on these builds equity all the more quickly. Tax liens can last a long time and so can attach to your home’s future equity. An IRS tax lien, for example, lasts the 10 years that it can collect on a tax (and can be extended in certain situations).
  • Third, even if you have little or no equity in your home and the equity won’t significantly increase in the future, a tax lien gives the IRS/state leverage to force you to pay them in order to get rid of the tax lien. Tax liens are quite damaging on your credit record. They can prevent you from selling or refinancing your home. The IRS/state will use all this to make you pay to get a release of its lien, even if the amount you are forced to pay is more than the amount of equity that the tax lien actually attaches to.

Preventing All This

Stop the IRS and state tax authorities from gaining all these damaging advantages. Do so simply by filing bankruptcy before they record a tax lien.

If you file either a Chapter 7 “straight bankruptcy” or a Chapter 13 “adjustment of debts” before a tax lien is recorded against you and your home, the IRS and/or state are stopped from recording one. Then, the IRS/state cannot record a tax lien during your bankruptcy case. And if the income tax(es) you owe meet(s) the conditions for discharge, towards the end of your Chapter 7 or 13 case the tax will be discharged. After that the IRS/state cannot take any action to collect the debt, including to record a tax lien.   

So, especially if you owe income taxes that meet the conditions for discharge, filing bankruptcy before a tax lien is recorded can make a tremendous difference.  The difference can be between paying NOTHING on a discharged tax debt and paying ALL of that tax because the lien attached to present and future equity in your home. 

 

A Fresh Start for Your Home Partly Encumbered by a Tax Lien

February 12th, 2016 at 8:00 am

Chapter 13 handles a tax lien on a home especially well when the home has enough equity to cover some but not all of the tax lien amount.

 

In our last two blog posts we dug into tax liens, and we do so one more time today. Two blog posts ago it was about tax liens that have no equity at all to attach to. Then the last blog post was about tax liens that have enough equity in the home to cover the entire amount of the tax lien.

Today we get into the in-between situation—where there’s enough equity in the home to cover part of the tax lien but not all of it. How can you get a fresh start on you home in this situation?

A Quick Summary about Tax Liens

A recorded tax lien on your home turns an income tax debt that you could have completely discharged (legally written off) in a Chapter 7 “straight bankruptcy”case into one that you may have to pay in full. If that income tax debt meets the conditions for discharge (mostly by being old enough), whether and how much you have to pay that tax depends mostly on whether there is equity in the home to cover this tax debt.

If there’s no equity at all for the tax lien because the mortgage and other liens legally ahead of the income tax lien eat up more than the full value of the home, you may not have to pay anything, or relatively little, of the tax at issue.

If there is enough equity in the home to cover the entire value of the secured by the recorded tax lien, you will have to pay the tax if you want to keep the home.

So what happens if the tax lien is neither completely unsecured for lack of equity nor completely secured by more than enough equity? What happens with a partially secured tax lien?

The Problem with a Partially Secured Tax Debt under Chapter 7

A Chapter 7 case is great if you owe an income tax which meets the conditions for discharge, IF there’s no tax lien. But if there IS a recorded tax lien, and there’s some equity that the lien attaches to, you finish the Chapter 7 case with that dangerous tax lien still encumbering your home equity. Then the IRS/state will use that tax lien as leverage to make you pay as much of the tax as possible. If the value of the home is increasing, the IRS/state will likely be able to make you pay all or most of the tax amount before agreeing to release its tax lien.

The problem is that there is no legal mechanism under Chapter 7 to divide the partially secured tax lien into two parts, the secured part and the unsecured part. You can’t discharge the unsecured part and just pay on the secured part. Instead the IRS/state takes advantage of its tax lien by making you pay all or most of the tax.

A Partially Secured Tax Debt under Chapter 13

However, Chapter 13 “adjustment of debts” does have exactly this kind of legal mechanism. The bankruptcy court helps you fix in time the amount of equity in your home to which an income tax lien attaches. Then that amount—that part of the tax lien—and no more, is paid over time through the Chapter 13 payment plan. That’s the secured part of the tax debt.

The rest of the tax beyond the secured part is treated as a “general unsecured” debt. So it’s lumped in with the rest of your bottom-of-the-barrel “general unsecured” debts. So that unsecured part of the tax is paid only to the extent that you have money left over after paying the secured part, and after paying all your other legally more important debts in full.

In practice you usually don’t increase the amount you pay into your 3-to-5-year Chapter 13 payment plan payments when you add the unsecured part of your income tax. There can be two reasons for this.

First, sometimes you can only afford to pay the secured part of the tax and other legally more important debts—like catching up on your home mortgage, paying off your vehicle loan, and paying more recent income taxes that can’t be discharged—leaving nothing for ANY of the “general unsecured” debts. Paying nothing on your “general unsecured” debts means paying nothing on the unsecured part of the income tax with the tax lien.

Second, in most Chapter 13 cases, after paying the secured part of the tax with the tax lien and the other legally more important debts you have only a certain amount of money available during the life of your payment plan to pay to all of your “general unsecured” debts. So adding the unsecured part of the lien tax debt to that pool of “general unsecured” debts does not increase the amount of money you have to pay of the debts in that pool of debts, You pay the same amount and that amount is just spread out among more debts. Having the unsecured part of the tax with the tax lien just results in the other “general unsecured” debts getting less of that fixed amount that you pay.

Chapter 13 Example

This makes more sense with an example. Assume that a home is worth $225,000 with a first mortgage of $190,000 and second mortgage of $30,000, leaving equity of $5,000. The equity is increasing as property values increase and the mortgages are paid down. The IRS is owed $20,000 for the 2010 and 2011 tax years. That $20,000 could have been discharged without paying anything because the tax returns for those two years of taxes were due more than 3 years ago and were indeed filed more than 2 year ago. But then the IRS recorded a tax lien on the home for that $20,000.

That tax lien covers the $5,000 in present equity. But after a Chapter 7 was filed the IRS would not likely release its tax lien for $5,000 because it could just wait for the property values to increase and the mortgages to be paid down for the equity covered by its lien to increase.

However under Chapter 13 the bankruptcy court could order the $20,000 tax debt to be divided into a $5,000 secured part and a $15,000 unsecured part. The $5,000 would then be paid over the 3-to-5-year court-approved payment plan, throughout which time the IRS would be prevented from taking any collection action. The remaining $15,000 unsecured part would be lumped in with the other “general unsecured” debts, usually not increasing the amount paid into the plan.

 

A Fresh Start for Your Home Equity Encumbered by a Tax Lien

February 10th, 2016 at 8:00 am

A tax lien encumbering the equity in your home is dangerous. Chapter 13 takes away the danger. 

 

If the IRS or your state tax collector records an income tax lien against your home, and you want to keep the home, sometimes through bankruptcy you don’t have to pay the tax. If there’s no equity at all in the home to cover the tax lien, and if the tax meets the conditions for being “discharged” –written off, mostly by being old enough—you may not have to pay most of that tax. You might even not have to pay any of it. And that’s in spite of the recorded tax lien, which would be removed from your home’s title. See our last blog post about how this can happen.

But it’s a different story if there’s equity in your home to cover the tax lien.

You Have to Pay the Tax

If your home is worth enough so that it has equity to cover the entire amount of the tax lien, you’re going to have to pay the tax. Even in bankruptcy. That’s as long as you want to keep the home.

That’s true even if that tax would otherwise qualify for being legally discharged—completely written off.

That’s right. If the tax return for the tax you owe was due to be filed with the IRS/state more than 3 years ago, and was actually filed more than 2 years ago, you would likely not have to pay that tax debt at all in a Chapter 7 “straight bankruptcy.” And under Chapter 13 “adjustment of debts” you would likely not have to pay most of it, and maybe none at all.

But the moment a tax lien is recorded on a home with equity to cover that lien, it’s a completely different story. The tax has to be paid in full.

This clearly means that whenever possible you should look into filing bankruptcy BEFORE a tax lien is recorded.

The Homestead Exemption Doesn’t Count with Tax Liens

When we say that you have to pay a tax debt that you could otherwise discharge if your home has equity to cover the tax lien, let’s be clear what that means.

When determining whether the home has equity of the tax lien, the homestead exemption is irrelevant. With certain kinds of liens—particularly judgment liens—the homestead exemption is effectively stronger than the lien. But not with income tax liens. You don’t get to factor in the homestead exemption.

Let’s make this clearer with a simple example. If you owned a home worth $200,000 with a mortgage of $170,000 and a recorded tax lien of $20,000, the home would have equity of $30,000 ($200,000 minus $170,000) for the tax lien to attach to. Assume that in your state you would be entitled to a homestead exemption of $40,000. If you didn’t have the tax lien, all that $30,000 in home equity would be protected in bankruptcy by the homestead exemption. And if the income tax debt met the time-based conditions for being written off, you would likely not have to pay any of it.

But once the tax lien is recorded, it attaches to the equity in your home. As long as you want to keep the home you have to pay the tax in order to get rid of the tax lien.

Chapter 7’s Limited Help

“Straight bankruptcy” can help by discharging (again, permanently writing off) all or most of your other debts so that you can focus on paying the income tax debt with the lien on your home.

If you also owe another income tax debt that has no recorded lien and also qualifies for discharge, you could reduce your tax load by discharging that other tax debt through Chapter 7.

Then after the Chapter 7 case is over and you concentrate on paying the tax with the recorded lien, you may be able to get the IRS/state to agree to take no further action on a tax lien if you enter into and comply with a monthly payment plan.

So your Chapter 7 case could leave you in a decent place, taking care of the tax debt and lien in a feasible way.

Often Chapter 7 Doesn’t Help Enough

Unfortunately the scenario we just describe often simply doesn’t work.

That’s because even after discharging your debts through Chapter 7, you may not qualify for or be able to afford to pay what the IRS/state requires in a monthly installment tax payoff plan.

First, you may have other crucial debts to pay that Chapter 7 does not discharge. These debts—such as unpaid child or spousal support, or student loans—would still need to be paid, making it hard to pay off the income tax secured by the tax lien.

Second, you may be behind on other obligations on your home–property taxes, the mortgage(s), or a homeowner’s association assessment—that need to be caught up.

Third, you may need to use the legal tools that only Chapter 13 provides. For example, you may need to save money on your vehicle loan through a “cramdown,” reducing both the monthly payments and your total vehicle debt. Or you may need to discharge non-support obligations to your ex-spouse, or to keep student loan payments on hold for a few years.

How Chapter 13 Can Be Much Better

Besides giving you some tools that Chapter 7 can’t provide, Chapter 13 deals with and protects you from the tax lien itself in the following ways:

1. It stops the IRS/state from enforcing the tax lien through foreclosure of the lien. It also stops all collection of all the income tax debts. In contrast, when you enter into a payment plan with the IRS/state after a Chapter 7 is over, you have no further bankruptcy protection. In Chapter 13 that protection continues throughout the 3-to-5-year payment plan.

2. Your payments on the underlying tax can be delayed or reduced while you pay other even more time-pressing debts, such as support arrearage or home mortgage or vehicle arrearage. The IRS/state doesn’t have grounds for objection as long as the tax secured by the tax lien gets paid off before your case is finished.

3. If your financial circumstances change during the 3-to-5-year Chapter 13 court-approved payment plan, you can usually adjust your plan payments, along with the payments being paid to the IRS/state on the income tax debt. Instead of being at the mercy of the IRS/state after the completion of a Chapter 7 case, you would likely have more flexibility and protection within Chapter 13.

Conclusion

So, if you have a recorded income tax lien on a home you very much want to keep, and your home has equity to cover that tax lien, look into whether getting rid of your other debts through Chapter 7 would free up enough of your cash flow to be able to enter into a reasonable monthly payment plan with the IRS/state.

If not, and/or if you need the other benefits that Chapter 13 provides, that is often the best way to go. 

Bankruptcy Timing and the Holidays: Filing in 2016 to Cover More Income Taxes

December 30th, 2015 at 2:00 am

During the first months of 2016 your bankruptcy can write off more of your tax debts.  

 

Filing bankruptcy at the right time in 2016 can help you deal with income tax debts in two main ways:

  • Discharging (legally writing off) more of your tax debts (likely for the 2012 tax year), under a Chapter 7 “straight bankruptcy” or a Chapter 13 “adjustment of debts”
  • Including any taxes owed for the 2015 tax year in your Chapter 13 payment plan, with the advantages that provides

Today we’ll show the first step to this—how to write off more income taxes under Chapter 7 in 2016. We’ll cover the rest during the first days of this coming year.

Discharge of More Income Tax under Chapter 7

The most direct way bankruptcy can help with taxes is through a Chapter 7 case to discharge—permanently write-off—of one or more tax year that you owe. That way you would not legally owe the tax at all usually within less than 4 months after filing the bankruptcy case.

You can in most situations discharge older income taxes through Chapter 7 by meeting the following two conditions. The date of the bankruptcy filing must be both:

1) at least 3 years after the pertinent tax return was due (plus any time for extensions), and

2) at least 2 years after the tax return was actually submitted to the IRS or state tax agency.  

(There are some other possible conditions but practically speaking these seldom come into play.)

Income Taxes Owed for 2012

Relevant to now, if you owe income taxes for the 2012 tax year you would meet the first of the above two conditions by waiting to file your Chapter 7 case until after April 15, 2016. That’s because at that point 3 years would have passed since that tax return was due.

This assumes you were not granted an extension to file that tax return. If an extension to file the return was granted to October 15, 2013, you’d have to wait to file the Chapter 7 case until after October 15, 2016 to meet this 3-year rule.

As to the second of the above two conditions, you’d meet it by waiting to file your Chapter 7 case until at least 2 years had passed since you submitted your 2012 tax return to the IRS/state. If you filed that return by the (non-extended) due date of April 15, 2013 then you would have already met this 2-year condition in April of last year. But you could have submitted the tax return a full year late—by April 15, 2014—and still meet this 2-year condition.

A Simple Example

If you owed, say, $5,000 to the IRS for 2012 income taxes, did not get an extension for that tax return, submitted the tax return to the IRS on or before April 15, 2014, and then filed a Chapter 7 case after April 15, 2016, that $5,000 tax debt would very likely be permanently gone—discharged—by about the middle of the year. You would simply not legally owe it any more, and the IRS could do nothing to try to collect it.

(Next week we’ll show how these principles apply to Chapter 13—if you need its special advantages for some reason—and also how waiting to file a Chapter 13 case until early 2016 can help with 2015 income taxes.)

 

Chapter 7 and Chapter 13–Income Tax Lien Partly Secured by Equity in Your Home

November 20th, 2015 at 8:00 am

If you don’t have much equity in your home, so that a tax lien eats up all that equity and then some, how can you get rid of that tax lien?

 

Our last 2 blog posts discussed your options if the IRS or state records a tax lien against your home. We first got into what happens if your home has no equity so that the tax lien does not attach to anything of value. And second we looked at your options if your home has plenty of equity so that there is more than enough to cover the entire amount of the tax lien.

But what if you have some equity in the home but less than the amount of the tax lien? How do you minimize what you have to pay of that tax before getting that tax lien released from your home?

A Tax Lien on a Dischargeable Tax

As in the last couple of blog posts, assume that the tax debt in question meets the conditions for legal write-off in bankruptcy. Because those conditions mostly involve how old the tax is, and because it usually takes some time before a tax lien is recorded, tax liens are mostly put on taxes that would otherwise qualify for discharge.

Som how best to deal with a tax lien only partially secured by your home, where the underlying income tax could have been discharged but for the recording of the tax lien?

The Special Problems of a Partially Secured Tax Debt

As explained in our last few blog posts a recorded tax lien gives the IRS/state huge leverage against you. The IRS/state tries to exploit that leverage to get paid as much as possible even when the home equity that the lien attaches to is smaller than the tax owed.

An example shows how this works. Assume you have a home with not much equity—say, about $5,000. Let’s say the income tax owed is $20,000, and a tax lien has been recorded on that tax debt against the home. The IRS/state wants the $20,000 tax paid, and won’t want to release its tax lien without being paid in full. Or at least it will use the tax lien to make you pay as much of the $20,000 as fast as you can even though that lien is only secured by $5,000 in home equity.

So for instance, if you tried to sell or refinance the home the IRS/state could challenge and perhaps disrupt the sale or refinance on grounds that it is not getting paid enough money on its lien. It is not required to release its lien unless it is paid in full, even if there’s not enough value in the home to pay off that lien.

A Partially Secured Tax Debt in a Chapter 7 Case

A Chapter 7 “straight bankruptcy” works very well against a tax debt that meets the conditions for discharge. Within about 4 months after the Chapter 7 case is filed, the debt is discharged along with the rest of your debts, and you’re done, that tax debt is gone forever.

But once a tax lien is recorded, Chapter 7often does not help you much in overcoming the leverage of a tax lien. That’s true even if the underlying tax debt otherwise meets the conditions for being discharged. That’s because the tax lien against your home survives a Chapter 7 bankruptcy. As a result the IRS/state will use that tax lien as its leverage to make you pay as much of the tax as possible. It will likely drive a hard bargain, trying to get more than the value of the home equity that the lien attaches to.

In the above example, the tax authority would try to make you pay more than $5,000 to get a release of the lien on your home, even if that’s the amount of equity in your home. The IRS/state knows that the property’s value may well increase over time, potentially giving it more money then. So time is mostly on its side.

The IRS/state also recognizes that you probably have intangible reasons for getting a release of the tax lien —such as the desire to improve your credit record, or to sell or refinance the home, or the most common motivation—to turn off the tax collection pressure. All these drive you to be willing to pay a premium to get rid of the tax lien.

The problem is that Chapter 7 does NOT provide a procedure of determining the amount of the home equity that a tax lien attaches to when that equity is less than the amount of the tax owed. So the IRS/state can often exploit this to get more money from you after the Chapter 7 is finished in return for releasing the tax lien.

A Partially Secured Tax Debt in a Chapter 13 Case 

In contrast, the Chapter 13 “adjustment of debts” DOES have a procedure for determining the amount of the home equity that a tax lien attaches to. Then that amount—for example the $5,000 in the above example—and no more, can be paid over time through the Chapter 13 payment plan. That is considered to be the secured portion of the tax debt. Being able to determine and pay that amount takes away much of the leverage of the IRS/state’s tax lien.

The rest of the tax beyond the secured portion is treated as a “general unsecured” debt—in our example the remaining $15,000. That amount only has to be paid to the extent that you have money left over after paying the secured $5,000 plus any other legally more important debts in full. Indeed usually you don’t have to pay any more into your Chapter 13 plan payments because of that $15,000 because most of the time you pay a set amount to all of your “general unsecured” debts. So adding the $15,000 unsecured portion tax debt to that pool of “general unsecured” debts just means that the rest of the pool will be paid less.

To finish the example, the secured portion—$5,000—would be paid over the length of the 3-to-5-year payment plan, under very flexible payment terms, and while under protection from the IRS/state. The remaining $15,000 would not have to be paid except to the extent that there would be money to spare for that. Then at the end of the Chapter 13 case the remaining unpaid portion of the tax would be discharged and the tax lien would be released.

 

Chapter 7 and Chapter 13–An Income Tax Lien Secured by Equity in Your Home

November 18th, 2015 at 8:00 am

If you have enough equity in your home to cover a recorded tax lien, to keep your home you must pay that tax. Here’s how bankruptcy helps.

 

Our last blog post laid out the options if a tax lien was recorded against your home but there WASN’T equity in the home to cover that tax lien. Today’s blog post is about dealing with an income tax lien recorded against a home which DOES have enough equity to cover the full amount of the income tax owed on that lien.

Let’s make this clearer with an example. Assume your home is worth about $20,000 more than you owe against on your mortgage(s). Imagine that you owe $6,000 in income taxes to the IRS for the 2011 tax year that you’d been struggling to pay when the IRS recorded a tax lien on your home a few months ago on that tax. The equity in your home is larger than the amount of that tax lien, so the entire $6,000 tax is now secured by your home.

What are your options for dealing with this tax?

Dischargeable Tax or Not?

In our last blog post we explained how there are two big considerations for determining your options here. First, whether there’s equity to cover the tax lien, and second, whether the underlying income tax is one that can be discharged—legally written off—in bankruptcy.

Today let’s again look at the scenario in which the income tax meets the conditions for discharge. So continuing with the above example of the $6,000 tax owed for 2011, assume that you filed the tax return for that tax by the usual April 2012 deadline. This means the $6,000 tax would very likely now be dischargeable in bankruptcy. That’s because it meets the two main necessary conditions: more than 3 years have passed since that tax return was due (April 2012) and more than 2 years since that tax return was actually filed (the same date).

Without the recorded tax lien, this $6,000 tax could be discharged in either a Chapter 7 “straight bankruptcy” or a Chapter 13 “adjustment of debts.” Under Chapter 7 you’d likely not have to pay ANYTHING on that tax before it would be discharged forever. Under Chapter 13 you’d likely not have to pay ANYTHING MORE than you’d pay otherwise to all of your creditors if you hadn’t owed the tax.

But the recorded tax lien, securing that debt with the equity in your home, changes everything.

Without Any Bankruptcy

A recorded tax lien gives tremendous leverage to the IRS or state taxing authority. It makes your tax debt a matter of public record. It directly and seriously hurts your credit record. A tax lien requires you to pay the underlying tax—plus interest, penalties, and costs—in full if you sell or refinance your home. And the lien can even jeopardize your ability to sell or refinance your home at all. Under some circumstances the IRS/state may even foreclose on its tax lien.

So a tax lien gives you a much incentive to pay off the IRS/state lien. But most likely you can’t. You’ve wanted to take care of that tax debt but just haven’t had the money to do so. You may even entered into a payment plan with the IRS/state and not been able to keep it up. Or you simply have not had the money to begin making payments to them. Either way you need help.

How Chapter 7 Can Help

“Straight bankruptcy” can help in two ways.

First, the main benefit of filing a Chapter 7 case is that it can discharge all or most of your other debts—perhaps even some other years’ income taxes—so that you can focus your financial attention on the income tax debt with the lien on your home.

The IRS and state taxing authorities will often agree to take no further action on a tax lien if you enter into and comply with a monthly payment plan with them. So your Chapter 7 case could take away most of your other financial pressures so that you could focus on taking care of the tax debt and lien in a feasible way.

Second, if you decided to sell your home or walk away from it, Chapter 7 would help by discharging the income tax with the tax lien on it, so you’d not owe anything more on that tax. If you sold your home but it didn’t sell for enough to pay off the tax, or if you surrendered the home and the IRS/state got nothing from the mortgage holder’s foreclosure of the home, outside of bankruptcy you’d owe whatever tax debt would remain. But assuming that the tax qualified for discharge (as in the $6,000 example we’ve been using), you would not owe any of that tax after the Chapter 7 case was completed and the home was gone

How Chapter 13 Can Help More

But assuming you want to keep your home, entering into a payment plan with the IRS/state to satisfy the tax lien after completing a Chapter 7 case doesn’t always work.

Even after discharging your debts through Chapter 7, you may not qualify for or be able to afford to pay what the IRS/state requires in a payment plan.

You may have other crucial debts to pay that Chapter 7 does not help with, debts that would compete with what you’d otherwise be able to pay to satisfy the tax lien. If you want to keep the home, you may need to catch up on its property taxes, mortgage(s), or a homeowner’s association assessment. To keep your vehicle, you may need to catch up on its payments. Or you may need to quickly catch up on your child or spousal support to stop paycheck garnishments or the suspension of your driver’s license.

You may need the benefits that only Chapter 13 provides. These include “stripping” a second or third mortgage so that you could avoid making those payments and get closer to having equity on your home. Or you may need to catch up on child or spousal support and protect yourself and your income and assets from your ex-spouse or the support enforcement people while you do so. You may need to save money on your vehicle loan through a “cramdown,” reducing both monthly payments and on your total vehicle debt. Or you may need to discharge non-support obligations to your ex-spouse, or to keep student loan payments on hold for a few years.

How Chapter 13 Helps with the Tax Lien

Besides giving you unique tools such as the mortgage “strip,” stopping collection of support arrearage, vehicle loan cramdown, and others that Chapter 7 can’t provide, Chapter 13 deals with and protects you from the tax lien itself.

First, it stops the IRS/state from enforcing the tax lien through foreclosure of the lien or any other heavy-handed collection tactics. When you enter into a payment plan with the IRS/state after a Chapter 7 is over, you have no further bankruptcy protection. In contrast, that protection continues throughout the 3-to-5-year Chapter 13 payment plan.

Second, your payments on the underlying tax can be delayed or reduced while you pay other even more time-pressing debts, such as support arrearage or home mortgage or vehicle arrearage. The IRS/state doesn’t have grounds for objection as long as the tax secured by the tax lien is being paid before your case is finished.

Third, if your financial circumstances change, you can usually adjust your Chapter 13 plan payments and the payments being paid to the IRS/state on the income tax debt to account for those changes. Instead of being at the mercy of the IRS/state and their largely arbitrary rules, you would likely have more flexibility and protection within the bankruptcy procedures.

Finally, if your personal circumstances change or the value of your home increases or decreases so that instead of staying in your home you decide instead to sell or surrender it, you can usually change your Chapter 13 plan to incorporate those changes in dealing with the tax and tax lien in a way most favorable to you. You also have an almost universal right at any point to either dismiss (get out of) your Chapter 13 case altogether or to convert it into a Chapter 7 one.

Assuming that you wanted to keep your home, and you completed your Chapter 13 plan either as originally approved or as amended later, at its completion the tax debt with the tax lien would be paid in full and the IRS/state would release the tax lien.

 

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