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Archive for the ‘tax liens’ tag

The Surprising Benefits: Chapter 13 Handles an Income Tax Lien on a Tax that Can’t Be Discharged

August 28th, 2018 at 7:00 am

Chapter 13 can be the best way to deal with a nondischargeable tax debt with a recorded lien: it buys more time, protection, and flexibility.

Last week we discussed how Chapter 7 handles a recorded tax lien on a tax that bankruptcy CAN’T discharge. The tax debt already can’t be discharged (legally written off in bankruptcy). So you can’t get out of paying it. The prior recording of a tax lien just adds another reason you have to pay the tax. If you fail to pay the IRS/state can take your assets that are subject to the recorded tax lien.

Filing a Chapter 13 “adjustment of debts” case can be a better way to handle such a tax debt than a Chapter 7 “straight bankruptcy” one.

Buys Time  

Whether you file under Chapter 13 or Chapter 7 does not affect whether you must pay this tax. But filing a Chapter 13 case can often buy you more time.

After completing a Chapter 7 case you must pay the not-dischargeable tax as fast as the IRS/state demands. Otherwise all the powerful tax collection tools can be used against you. With a recorded tax lien already on your real and/or personal property, the IRS/state has even more leverage against you.

What if you can’t pay the tax as fast as demanded? Among other things the IRS/state could garnish your wages and/or bank accounts, and seize your property.

Chapter 13 could prevent all of that because you’d be given as much as 5 years to pay the tax. You and your bankruptcy lawyer would incorporate that tax debt into your Chapter 13 payment plan. You’d pay the IRS/state along with any other special debts that you must pay. Often, you’d pay only a small portion of your remaining debts. Sometimes you’d pay nothing on such debts. As a result you can focus your financial energies for 5 years on your tax debt.

Buys Protection

During that 5 years (which can be as short as 3 years), your paycheck, your checking/savings and other financial accounts, and your property are protected. Bankruptcy’s valuable “automatic stay” protection from collection lasts only 3-4 months in a Chapter 7 case. But this protection lasts the full 3-to-5 years of your Chapter 13 case. The peace of mind that comes from this extended protection is often invaluable.

Buys Flexibility

Sometimes what you need more than time is flexibility in how you pay a tax debt.

You may have some other even higher-priority debt that your financial future depends on. If you’re behind on a vehicle loan you may need to catch up so you’ll have transportation to your job. Or, if you’re late on child support catching up may be crucial to avoiding wage garnishment. Chapter 13 can let you pay some debts ahead of taxes, even nondischargeable taxes with a recorded tax lien.

Or if you can’t pay the taxes until some event in the future, Chapter 13 can buy you that flexibility. The event can even be a few years into the future. For example, if you plan on selling your house and moving away in two years, say, after a child graduates from high school, you may well be able to delay paying all or most of the tax debt until that house sale.

Conclusion

Chapter 13 can be a much better way to deal with a nondischargeable tax debt with a recorded lien. It often gives you more time to pay it, protects you many times longer than Chapter 7, and gives you flexibility that could be crucial in your unique circumstances.

 

The Surprising Benefits: An Income Tax Lien on a Tax that Can’t Be Discharged

August 20th, 2018 at 7:00 am

A recorded tax lien on a tax that already doesn’t qualify to be discharged makes you all the more want to pay that tax. Chapter 7 might help. 

 

We’ve been talking about the effect of a tax lien on an income tax that bankruptcy CAN discharge. A tax lien can turn that tax from one you don’t have to pay into one you have to pay in full. That’s because a tax lien recording turns an unsecured debt that bankruptcy can write off into a secured one. The tax becomes secured by your real estate, or your personal property, or both. So, if you want to keep what you own, you must pay the tax.

But what about a tax lien on a tax that bankruptcy CAN’T discharge? The tax already doesn’t qualify for being written off. What difference does the recording of a tax lien make on such a tax? And how can bankruptcy help in these situations?

A Tax Lien on a Non-Dischargeable Tax

It’s likely somewhat less common for a tax lien to be recorded on a nondischargeable tax. Broadly speaking, an income tax does not qualify for discharge because it’s not old enough. Often, by the time the IRS/state records a tax lien, the tax at issues has meet the conditions for discharge.

But that certainly isn’t always true. There are many circumstances when a tax has not qualified for bankruptcy discharge and the IRS/state records a tax lien. The taxing authority may be relatively quick on recording a tax lien because of the amount at issue. Or a prior history of unpaid taxes could encourage the same reaction. Also, if you owe more than one year of taxes, a tax lien would often apply to all taxes owed. Some of those taxes may be old enough to qualify for discharge while others may not.

So what’s the practical effect of a tax lien recording on a tax that already doesn’t qualify for discharge? The effect is much less than it would be on a dischargeable tax—making you pay a tax you could have avoided paying. In both situations the tax lien turns an unsecured tax into a secured one. With a nondischargeable tax this simply means that you have one more reason to pay a tax which you already had to pay after a Chapter 7 bankruptcy. Besides their usual collection tools, the IRS/state can now take your assets if you don’t pay.

Chapter 7’s Effect

Filing Chapter 7 only makes sense when you have a recorded tax lien secured by assets you own and want to keep (worth at least  the amount of the tax) if you are prepared to pay the tax. That’s true if the tax at issue is dischargeable or not dischargeable. With a nondischargeable tax that’s all the more true—the lien just gives you more reason to pay the tax. It gives you more reason to pay it more quickly.

There are concrete ways that a recorded tax lien gives the IRS/state that much more leverage to make you pay. The lien increases the ways the IRS/state can directly hurt you, through the seizure of your assets. In the case of a tax lien on a home, it can prevent you from refinancing your mortgage. It could even jeopardize the sale of a home. The lien is also a black mark on your credit record.

You don’t have to be prepared to pay it in full. But you need to have the cash flow—after discharging your other debts—to make appropriate monthly payments. Or, in special circumstances, you need to have strong confidence that you can successfully reduce or eliminate the tax through an offer in compromise.

What If You Can’t Pay, or Not Fast Enough?

Chapter 13 is a better option if you can’t pay the tax at issue fast enough to satisfy the IRS/state. We’ll tell you about this next week.

 

The Surprising Benefits: Chapter 7 AFTER the Recording of an Income Tax Lien

August 6th, 2018 at 7:00 am

Under certain circumstances a recorded tax lien does NOT require you to pay a dischargeable tax after Chapter 7, or at least not in full.

 

The last two blog posts have been about the benefits of preventing an income tax lien recording by filing bankruptcy. That’s especially helpful if the tax at issue is an older one that can be discharged—legally written off. The recording of a tax lien can turn such a tax debt from one you don’t have to pay at all into one that you have to pay in full. (See the IRS Notice of Federal Tax Lien form.)

But what if the IRS or state has already recorded a tax lien against you, before you could file bankruptcy? You’re likely in even more financial distress after that tax lien recording than you were before. Could filing bankruptcy still help with that tax debt even after the lien recording?

Yes, both Chapter 7 “straight bankruptcy” and Chapter 13 “adjustment of debts” could help. They could each do so in different ways. And they could each help whether the tax at issue met the conditions for discharge or instead was a newer tax that did not.

Today’s blog post covers how Chapter 7 can help with a recorded tax lien on a dischargeable tax debt. We’ll cover how Chapter 13 helps in this same tax situation next week.

The Effect of a Tax Lien Recording

In most situations the recording of a tax lien on an otherwise dischargeable tax requires to pay that tax. Again, it turns a tax that you wouldn’t have had to pay into one you have to pay in full.

How does it do that? Basically, IRS’/state’s recording of a tax lien turns an unsecured debt into a secured one. The tax meets the conditions for discharge (mostly by being old enough), but the IRS/state now has rights over your assets. You have to pay the otherwise dischargeable tax if you don’t want to lose those assets.

What assets? Which of your assets would you lose after the recording of a tax lien if you didn’t pay the tax? That’s a crucial question. That’s because under certain circumstances you might not need to pay all the tax, even after a tax lien recording.  You might not have to pay any of the tax. It depends on which of your assets, if any, the tax lien attached to.

Assets Attached by the Tax Lien

Let’s be clear. Most of the time the recording of a tax lien results in you having to pay the tax. That’s because that tax lien attaches to your assets or property that you don’t want to lose. A recorded IRS Notice of Federal Tax Lien, for example, applies to “all property and rights to property belonging to this taxpayer for the amount of these taxes… .”  So if it applies to everything that belongs to you, you pay the tax to avoid losing those assets.

But sometimes the tax lien might attach to little, or even nothing, of value. Or what it attaches to is worth much less than the tax debt. Then you may not end up paying the whole tax debt amount, or even any of it. (See the IRS’ Guidelines for Processing Notice of Federal Tax Lien Documents, including about lien releases and withdrawals.)

Examples

For example, assume you owe $10,000 in old, dischargeable income taxes but own very little—say a total of $2,500 fair market value in household goods and personal effects. There’s a recorded tax lien on that $10,000 debt covering all your property. With a Chapter 7 case you discharge the $10,000 debt, but recorded tax lien on the $2,500 in property survives. The IRS/state has limited leverage in making you pay any more than $2,500. So there’s a good chance you could settle the matter by agreeing to pay around that amount.

Another example: the IRS/state has recorded a tax lien in your county real estate recorder’s office, placing a lien on your home. (Under many state’s laws that recorded lien would only apply to real estate, not to any other personal assets.) But what if you do not own a home or any other real estate in that county? What if you recently lost your home to foreclosure? Or what if your home has no equity at that time and likely won’t for many years? In these scenarios the IRS/state would have to concede that its lien is essentially worthless. Your bankruptcy lawyer may well be able to convince the IRS/state to release or withdraw its lien as being of no collection value.  

 

The Surprising Benefits: Chapter 13 Stops the Recording of an Income Tax Lien

July 30th, 2018 at 7:00 am

Chapter 7 and 13 can both prevent the recording of a tax lien. But if the tax qualifies for discharge Chapter 7 is quicker and less risky. 

 

Last week we showed how detrimental the recording of an income tax lien can be for you. It can turn a tax that you could fully discharge (legally write off in bankruptcy) into one you’d have to fully pay. We showed how Chapter 7 “straight bankruptcy” could prevent recording of the tax lien and could discharge the tax.

How about a Chapter 13 “adjustment of debts” case? Would filing one also stop an income tax lien recording?  If so, what would happen to that tax debt?

Chapter 13’s Automatic Stay

The filing of a Chapter 13 case stops the recording of a tax lien by the IRS or state just like a Chapter 7 would. Any voluntarily filed bankruptcy case by a person entitled to file that case imposes the “automatic stay” against almost all creditor collection activities against that person and his or her property. (See Sections 301 and 362(a)  of the U.S. Bankruptcy Code.) Those “stayed” or stopped activities specifically include “any act to create, perfect, or enforce” a lien. (See Section 362(a)(4) and (5).)

So filing under Chapter 13 stops a tax lien recording just as fast and just as well a Chapter 7 would.

But Would Chapter 13 Be Better than Chapter 7?

That depends. It depends at the outset on whether the tax is one that qualifies for discharge. If it does qualify (mostly by being old enough) then a Chapter 7 is actually often better.

Under Chapter 7 the automatic stay protection lasts only the 3-4 months that the case is active.  But that’s long enough since the discharge of the tax debt would happen just before the case was closed. Once the tax debt is discharged the IRS/state could no longer do anything to collect that tax. It would certainly have no further ability to record a tax lien on that tax.

What would happen in this situation under Chapter 13, with a tax debt that qualifies for discharge? It would get discharged like under Chapter 7, but with two big differences.

First, the discharge would happened not 3-4 months after case filing but usually 3 to 5 years later.  The automatic stay protection usually lasts throughout that time, preventing tax collection, including the recording of a tax lien. But that long period of time under Chapter 13 does create more opportunities for things to go wrong. That’s all the more true because throughout that time you have various obligations, such as to make monthly Chapter 13 plan payments. If for any reason you don’t successfully complete your Chapter 13 case, the otherwise dischargeable tax debt still won’t get discharged.

Second, under Chapter 13 you may have to pay part of the tax debt before it is discharged. This is in contrast to usually paying nothing on it under Chapter 7. (This assumes that you’d have a “no-asset” Chapter 7 case—in which all of your assets would be “exempt”, protected.) Whether  you’d pay anything on a dischargeable tax debt in a Chapter 13 case, and if so how much, depends on many factors, mostly the nature and amount of your other debts and your income and expenses. But why risk paying something on a tax debt under Chapter 13 if you wouldn’t have to pay anything under Chapter 7?

So Chapter 7 Is Usually Better at Dealing with a Dischargeable Tax Debt?

The answer is likely “yes” if you focus only on this one part of your financial life.

But you may have other reasons to file a Chapter 13 case. For example, you may owe a more recent income tax debt that does not qualify for discharge, in addition to the one that does qualify. Chapter 13 provides a number of significant advantages in dealing with the nondischargeable tax. These could make Chapter 13 much better for you overall.

Or you may have considerations nothing to do with taxes, such as being behind on a home mortgage, a vehicle loan, or child support. Chapter 13 gives you huge advantages with each of these kinds of debts. Your bankruptcy lawyer and you will sort out all the advantages and disadvantages of each legal option to choose the best one.

 

The Surprising Benefits: Chapter 7 Stops the Recording of an Income Tax Lien

July 23rd, 2018 at 7:00 am

The recording of a tax lien often immediately turns an unsecured debt into a secured one, forcing you to pay what you could have written off.

 

If you owe income taxes, stopping the IRS or state record a tax lien can be a huge benefit of filing bankruptcy. How much of a benefit turns on details about the taxes you owe and the type of bankruptcy you file. Today and in our next blog post we’ll look at income taxes that would be discharged (forever written off in full). Today we focus  on the benefits of filing Chapter 7; next week we’ll do the same for Chapter 13.

Secured and Unsecured Debts in Bankruptcy

The leverage that any creditor has over you depends a lot on whether its debt is secured by your property. For example, if a debt is secured by your home, the home is collateral on that debt. In most situations even after filing bankruptcy you have to either pay the debt or you could lose the home.

The Effect of a Tax Lien

If you can’t pay an income tax, that tax debt is an unsecured one. It’s not secured by anything you own. The IRS and state taxing authorities have some powerful collection techniques they can use to collect the tax. But they can’t simply take anything of yours to pay off the tax debt. That’s because that tax debt is not secured by anything you own.

This completely changes when the IRS/state records a tax lien against your tax debt. The recording legally converts the unsecured tax debt into a debt secured by your property. Which property becomes security against that particular tax debt depends on the details of 1) the tax lien itself and 2) your state’s property laws.

But regardless of these details, IRS/state tax liens can potentially turn pretty much everything you own into security on that tax debt. That means that if you don’t pay the tax, the IRS/state can often take whatever you own in payment of that tax debt. Usually the practical result is not that they take everything, or even anything. Rather, you end up paying the tax debt, sooner or later.

Unsecured Older Income Tax Debts in Bankruptcy

Contrast that from what would happen to that tax if there was no recorded tax lien.

Most ordinary unsecured debts can be legally forever written off in bankruptcy. This is true of some income tax debts as well, if they meet certain conditions. Basically, bankruptcy discharges (writes off) income taxes for which the tax return:

  • was due more than 3 years before your bankruptcy case is filed, AND
  • was in fact filed more than 2 years before bankruptcy.

An Older Income Tax Debt WITHOUT a Tax Lien Under Chapter 7

If you meet the above 2 conditions (and a couple other seldom applicable ones), filing Chapter 7 will simply forever discharge that tax debt. Within about 3-4 months after you file the case, it will be legally gone. You will not have to pay it.

You filed bankruptcy in time to stop the IRS/state from recording a tax lien. And after discharge they’ll never be able to record a lien, or collect in any other wayr.

An Older Income Tax Debt WITH a Tax Lien Under Chapter 7

But it’s completely different if you did not file bankruptcy until after the tax lien recording.

If the tax debt meets the timing conditions, your Chapter 7 filing would technically discharge the tax debt itself. However, the IRS/state would still have a lien on your property after the bankruptcy case was completed.

Because of this surviving tax lien, the IRS/state would at that point be able to exert its rights under the lien. That means it could take and sell whatever property the lien attached to. That would usually be all your personal property or your real estate, or possibly both.

To prevent this from happening, you’d want to contact the IRS/state to make payment arrangements. As mentioned above, the result is usually that you have to pay the tax in full, along with its continually accruing tax penalties and interest.

The Lesson

The lesson is very clear. If you owe income taxes, file bankruptcy before the tax authorities record a tax lien. If the tax you owe meets the timing conditions, you’ll be able discharge the entire tax and pay nothing on it.

 

The Surprising Benefits: Stop Income Tax Collection

June 25th, 2018 at 7:00 am

Income tax debts can be handled in bankruptcy more than you think. This is true even with those taxes that are too new to be discharged. 

 

The Automatic Staying, and the Discharge, of Income Tax Debts

Sometimes people are surprised to learn that filing bankruptcy gives you power over income taxes. It does so in two big ways. First, filing bankruptcy stops the IRS and state from collecting your tax debts—either temporarily or permanently. This is the “automatic stay” applicable to pretty much all of your creditors. Second, bankruptcy permanently writes off (“discharges”) some income tax debts—generally older taxes.

If all the income taxes you owe qualify for discharge, then your situation is quite straightforward. You file a Chapter 7 “straight bankruptcy” case, which stops any ongoing tax collection during the case. Then 3-4 months later, near the end of the Chapter 7 case, your tax debt is discharged. The “automatic stay” protection against tax collection ends. But you no longer need to worry about tax collection because you no long owe any taxes.

Or if instead you file a Chapter 13 “adjustment of debts” case (for reasons other than the tax debt), there’s a similar result. The dischargeable income taxes are treated just like your other “general unsecured” debts. They only get paid to the extent you can afford to do so, if at all, during your case. Often, during the 3-5-year Chapter 13 payment plan most or all of your available money goes elsewhere. It goes towards priority debts like child/spousal support or more recent taxes. Or it goes to catch up on a home mortgage or vehicle loan payments. Regardless how much, if any, you pay on the dischargeable taxes, at the end of your case the rest is discharged. So, as with Chapter 7, you then owe no more on those taxes so you don’t need to worry about any more tax collection.

The Expiring Automatic Stay and Nondischargeable Income Taxes

But what happens if some or all of your income tax debts do not qualify for discharge?  The “automatic stay” does still go into effect as to those nondischargeable taxes. Your filing of a Chapter 7 case gives you a break from most collection actions of the IRS and/or state. If you are being garnished, that would stop. If the IRS/state was about to record a tax lien against your home, that would be prevented. If you are being pressured to enter into a monthly tax payment plan, that pressure would stop.

But this break from collection would not last long.  The “automatic stay” expires in a Chapter 7 case at “the time a discharge is granted.” (See Section 362(c)(2)(C) of the U.S. Bankruptcy Code about the expiration of the “automatic stay.”) In just about all consumer Chapter 7 cases the bankruptcy court grants the discharge only 3-4 months after case filing. So you get a break but not much of one.

So what do you do if you have income taxes that would not be discharged in a Chapter 7 case?

The Chapter 7 Solution

If you filed a Chapter 7 case, it may discharge enough of your other debts that you could afford to enter into a monthly installment payment plan with the IRS/state for the remaining tax debts. The discharged debts may include some older, dischargeable income taxes, leaving you with less tax liability to still pay.

If discharging other debts leaves you in a position to pay your remaining tax debts over time, you (or your lawyer) should contact the tax authority immediately after the discharge to make payment arrangements. It may make sense to make contact even earlier so that the IRS/state knows your intentions. Ask your bankruptcy lawyer about the best timing.

You might also qualify for a reduction in the surviving tax debt amount. The IRS has a procedure for “offers in compromise” to settle a tax debt by paying less than the full balance. Most states have similar procedures. These are somewhat complicated to go through. You should not enter into such an attempt without getting solid legal advice about your chances of being successful.  

The Chapter 13 Solution

Your financial situation after a Chapter 7 discharge may not allow you to pay off the remaining income tax debts through a tax payment plan. You may not have enough cash flow to pay it off fast enough to qualify. Furthermore, interest and tax penalties will continue to accrue, requiring you to pay substantially more over time.

You may also not be a good candidate for getting a reduction in the tax amount through a “compromise.”

So if instead you file a Chapter 13 case, the protection of the “automatic stay” remains in effect throughout the 3-to-5-year length of the case. This gives you up to 5 years to pay off the nondischargeable income taxes without any tax collections against you. This allows you to pay off those taxes under very flexible terms. You can often pay other even more urgent debts—like child support or home mortgage arrearages—ahead of the taxes.

Usually you don’t have to pay any additional interest and penalties. That alone could save you a significant amount, enabling you to pay off the tax faster and easier.

Also, the IRS/state can’t record a tax lien against you during the Chapter 13 case. That takes significant leverage away from the taxing authority. And if a tax lien had already been recorded against you, Chapter 13 usually can deal with it very favorably.

Overall, if a Chapter 7 would leave you too much at the mercy of the IRS/state, Chapter 13 is often a good alternative.

 

What the IRS/State Can and Can’t Do After You File Bankruptcy

February 16th, 2018 at 8:00 am

Filing bankruptcy stops tax collection just like it stops other debt collection by more conventional creditors. But there are exceptions.  

 

The last several weeks of blog posts have been about bankruptcy’s “automatic stay” protection from creditor collections.  We’ve also gotten into many of the exceptions to that protection—when certain creditors CAN take certain actions.

Today we focus on some very limited exceptions to the automatic stay protection, those which apply specifically to income taxes. In bankruptcy you don’t want surprises, especially from a tax collector. These limited exceptions are reasonable. But it’ll still help you to understand them in order to not be surprised by them.

Tax Determination is Allowed, Tax Collection is Not

Simply put, the exceptions to the automatic stay protections are about determining the amount of tax owed. The IRS and the state tax authorities can take steps during bankruptcy to figure out how much you owe. They can make you do what the law requires along these lines. For example, they can require you to file your tax returns, regardless that you’ve filed bankruptcy. But then they can’t take any action beyond that to collect any taxes owed.

The IRS/State CAN’T. . .

The automatic stay immediately stops virtually all debt collection activity against you when you file bankruptcy. This protects you, your income, and your assets. Everything is put on hold so that the bankruptcy laws can be applied to your entire financial situation.

Debts that the law discharges—legally writes off—disappear. Other possible debts that the law does not discharge you continue to owe. With income taxes, if they’re old enough and meet other conditions, they’re discharged. Otherwise you’ll either owe them after completing the Chapter 7 case or you’ll pay them through the Chapter 13 case. But in the meantime the IRS and state are forbidden from collecting the debt. They are also forbidden to take any action directly related to collection, like recording a tax lien against your home or vehicle.

So to be clear, the automatic stay exceptions we’re discussing here do NOT allow the tax authorities to take any action to get your money or assets. The IRS and state tax authority can’t start or continue garnishing your paychecks or bank accounts. They can’t levy on (take away) anything else you own. They can’t call you to pay the tax, and can’t send you tax bills.

The IRS/State CAN. . .

As we said above, the taxing authorities can take certain specific steps to determine how much tax you owe. Some of these steps you wouldn’t expect your bankruptcy filing to affect—they’re probably not surprising. You filing bankruptcy does not prevent the IRS/state from doing the following:

  • Start or finish a tax audit “to determine tax liability.” (See Section 362(b)(9)(A) of the Bankruptcy Code.) But there can be no attempt to collect whatever that tax liability ends up being.
  • Send you a notice about the amount of tax that you owe—a “notice of tax deficiency.” (Section 362(b)(9)(B).) That notice is NOT a demand to pay the tax.
  • Demand that you file your tax returns. (Section 362(b)(9)(C).) In fact this step is often essential for the processing of your bankruptcy case.
  • Make an “assessment” of your taxes and issue a “notice and demand for payment.” (Section 362(b)(9)(D).) “Assessment” is a formal determination of the tax amount. The “demand” here is a term of art meaning that you are put on notice that you are obligated to pay the debt. But whether and when you really owe it usually depends on bankruptcy law.

Conclusion

The interplay between bankruptcy law and tax law can be quite complex. The rule of thumb is that bankruptcy stops tax collection but not tax determination. But your situation may have nuances that could make that rule of thumb misleading. If you are in the midst of, or fear, tax collections, be sure to see an experienced bankruptcy lawyer to find out what would happen in your unique situation. And it really does make sense to do so as early as possible. Tax debts are very much an area where early and wise planning could save you a lot of money.

 

Dealing with Recorded Tax Liens through Chapter 13

October 30th, 2017 at 7:00 am

A recorded tax lien gives the IRS/state a lot of leverage against you and your home. Chapter 13 can gain you back some of that leverage.  


Stopping Tax Liens by Filing Bankruptcy

In our last blog post we showed how Chapter 13 can buy you more time and flexibility than Chapter 7. We showed an example how that’s especially true if you owe more than one year of income taxes. Our example assumed that two tax years met the conditions to discharge (legally write off) that debt, while another tax year didn’t.

That example assumed that the IRS/state had not yet recorded a tax lien on your home for either tax year. A bankruptcy filing stops a tax lien’s recording. Then if the tax debt is discharged, the debt is gone so there’s no further basis for a tax lien. Or if the tax debt is paid in full (usually through a Chapter 13 payment plan) again there’s no further debt on which to impose a tax lien.

Dealing with Tax Liens under Chapter 13

But what if the IRS/state HAS already recorded a tax lien on your home?

That can cause all kinds of problems. Two weeks ago we wrote about how a tax lien can turn a completely dischargeable tax debt into one you have to pay in full. Beyond that, any tax lien is terrible on your credit report. It can make refinancing your home much harder. It may even add a problematic hurdle in the selling of your home. Even if you have little or no equity in your home, the tax lien can sit on your title until there’s enough equity to pay it in full.

So if you get a tax lien recorded against your home you need to consider your options. Assuming you want to keep your home, filing a Chapter 13 “adjustment of debts” is one option worth understanding.

Let’s take the same example we used in our last blog post, with a few more facts.

Our Example

Assume again 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.

The IRS/state has just recorded tax liens on all three tax years against your home. Your home is worth $250,000, and has a $245,000 first mortgage owed on it. So, before the tax liens’ recordings you had $5,000 of equity in the home. Now you have NEGATIVE $19,000 of equity. And you are under the financial risks outlined above from the tax liens.

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

  • can’t afford to pay nearly as much as the IRS/state are demanding each month in monthly installment payments
  • are afraid of the actions the IRS/state can take against you and your home on the tax liens
  • are afraid of the other collection actions they can take on the $24,000 in taxes
  • need a plan for taking care of these taxes in a way that you can reasonably manage

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. That is, they would but for the tax liens. Now those two tax debt are “secured” against your home because of their tax liens.

However, under Chapter 13 you have the power to establish that they are secured only to the extent of your home’s equity. So, the 2012 debt of $8,000 is secured by the $5,000 equity in the home. The remaining $3,000 is not secured. The 2013 debt of $8,000 has no remaining equity in the home for it to be secured by. So both that and the remaining $3,000 of the 2012 tax it is treated as a “general unsecured” debt.

This means that this $11,000 ($3,000 + $8,000) would 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 $11,000 would just go into the pot with those other debts, and you’d pay no more than if there was no such $11,000 tax debt. That $11,000 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.

The “Priority” Tax Debt

And how about the third tax year—2014—which doesn’t meet the conditions for discharge? What affect does its tax lien have on it?

It has no effect because all of the home’s equity has already been absorbed by the 2012 tax year.  This 2014 tax already has to be paid in full through the Chapter 13 payment plan. It’s a “priority” debt.  Had there been equity in the home to cover this lien then you’d also pay interest on this tax. Without any equity this 2014 tax is effectively unsecured. So it’s treated like any other “priority” debt. You have to pay it in full during your 3-to-5-year Chapter 13 payment plan.

So you have up to 5 years to pay the $5,000 secured portion of the 2012 tax and the $8,000 2014 tax. Throughout that payment period you’d be protected from the IRS/state by the “automatic stay.” This usually protects you throughout the years of the case (not for just 3-4 months like Chapter 7). That means no further IRS/state or other creditor actions against your or your house throughout your case.

Your payment plan may or may not include some money to pay towards your “general unsecured” debts. This includes the unsecured part of the 2012 tax and all of the 2013 tax. How much, if any, you’d pay on these would mostly depends on what you could afford to do so, after paying the other taxes. The secured part of the 2012 tax and the 2014 “priority” tax debts would usually get paid in full before the “general unsecured” debts would receive anything.

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 $5,000 secured part of the 2012 tax debt, the unpaid portion of the remaining $3,000 would be forever discharged.
  • The unpaid portion of the 2013 tax debt would also be discharged.
  • 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 all your tax debts either paid or discharged, there’d be no further risk of a lien against your home from that tax.
  • You’d be tax-debt-free, and altogether debt-free (except for long-term debt like your home 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.

 

The Tax Exceptions to the Automatic Stay

October 24th, 2016 at 7:00 am

In spite of you filing bankruptcy, the taxing authorities can still take certain very specific actions as exceptions to the automatic stay. 

 

The last few blog posts have been about bankruptcy’s automatic stay protection from the collection actions of creditors. The last couple of them have been about exceptions to that protection—when certain creditors can take certain actions.

Today we focus on a set of very limited exceptions to the automatic stay which applies specifically to taxes.

What Taxing Authorities CAN’T Do

The automatic stay protections are designed to immediately stop virtually all debt collection activity against you and your assets. The point is to have all creditors stop going after you so that everybody can shift to applying the bankruptcy laws to your financial situation.

Those bankruptcy laws may result in the discharge of a particular tax debt if that tax meets certain conditions. (A “discharge” is a legal, permanent erasing of a debt in bankruptcy.) And if those conditions aren’t met, the tax is not discharged in bankruptcy.

But regardless whether or not a tax is going to be discharged, the automatic stay prevents the taxing authorities from taking the usual actions to collect that tax. The automatic stay tax exceptions do NOT allow them to take any action to get your money or assets. The IRS and state taxing authorities can’t start or continue garnishing (“levying on”) your paychecks. They can’t levy on (take away) anything else you own. They can’t call you to pay the tax. They can’t mail you notices that you must pay the tax (except as stated below).

The Tax Exceptions to the Automatic Stay

What the taxing authorities CAN DO is take certain administrative actions related to DETERMINING the amount of tax you owe, NOT to COLLECTING the tax. So, in spite of you filing bankruptcy, they can do the following:

  • Start or finish a tax audit “to determine tax liability.” (See Section 362(b)(9)(A) of the Bankruptcy Code.)
  • Send you a notice about the amount of tax that you owe—a “notice of tax deficiency.” (Section 362(b)(9)(B).)
  • Demand that you file your tax returns, a legal requirement understandably not affected by your bankruptcy filing, and which indeed is often necessary to be able to administer your bankruptcy case. (Section 362(b)(9)(C).)
  • Make an “assessment” of your taxes and issue a “notice and demand for payment.” (Section 362(b)(9)(D).)
  • Under certain limited circumstances the assessment a tax lien can attach to your personal property and real estate. (Section 362(b)(9)(D).)

Again, other than these limited actions, it’s a violation of the automatic stay and so is illegal for the taxing authorities to take any other collection action against you once you file bankruptcy.

 

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