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Archive for the ‘Tax Debts’ Category

The Effects of an Income Tax Lien

August 31st, 2020 at 7:00 am

Try to file bankruptcy before a tax lien gets recorded. But if you can’t, here are the effects of a tax lien under Chapter 7 and 13.

 

This blog post continues a series about the smart timing of your bankruptcy filing. (It was interrupted by two blog posts updating federal unemployment benefits.) The last in this series was about how good bankruptcy timing prevents you paying certain income tax interest and penalties. We ended with this: “The effect of a tax lien depends on whether the tax at issue qualifies for discharge, and whether you file a Chapter 7 or 13 case.” That’s today’s important topic.

Bankruptcy Timing and Tax Liens

The recording of a tax lien by the IRS or state often causes extra headaches. So it’s usually better to file your bankruptcy case before you’re hit with a tax lien.

But you may go to see a bankruptcy lawyer until after that’s already happened. Or your lawyer may advise to you wait to file for some tactical reason. That reason may be related to your income tax debt(s). It’s not unusual to delay filing until the tax meets the conditions for discharge (full write-off). While you’re holding off on filing, you run the risk of the IRS/state recording a tax lien.

If you’re waiting to file on the advice of your bankruptcy lawyer, he or she will likely tell you about the risks and potential effects of a tax lien. The following outlines what you may hear.

General Effect of a Tax Lien

The recording of a tax lien gives the IRS/state a security interest on everything you own. Your assets then become collateral on the tax debt.

Actually, where or how the IRS/state records the lien determines the assets that it covers. Usually one tax lien covers your real estate, while another covers your personal property—everything else you own. Look carefully at the wording of the tax lien to see what tax years it covers and what assets it encumbers. These details matter as you and your lawyer determine the effect of the lien(s).

A Tax Lien on a Non-Dischargeable Tax under Chapter 7

Assume you file a Chapter 7 “straight bankruptcy” case and you owe a tax that does not qualify for discharge.

The recording of a tax lien on such a tax does not greatly affect what happens in that bankruptcy case. As discussed in our last tax-related blog post, you’ll have to arrange to pay that tax after completing your bankruptcy. You’ll also have to pay the ongoing interest and penalties.

The tax lien may put more pressure on you to make those payment arrangements. You’ll also want to get reassurances that the IRS/state will not take any other collection actions while you pay as agreed. The lien will also motivate you to pay the tax as fast as possible to get a release of the lien.

You’ll usually go this Chapter 7 direction if it will discharge your other debts so that you can reasonably pay off the tax debt(s).

A Tax Lien on a Non-Dischargeable Tax under Chapter 13

The situation is somewhat similar under an “adjustment of debts” Chapter 13 case. You still have to pay the tax that doesn’t meet the timing and other conditions of discharge. But you do that through your 3-to-5-year Chapter 13 payment plan. This gives you the benefit of not having to make payment arrangements with the IRS/state. The Chapter 13 procedure does that for you.

You just pay your monthly play payment, and your tax debt is incorporated into that. The IRS/state must comply with the “automatic stay,” which prevent all your creditors from taking any collection action against you. At the end of your case you will have paid off the tax. So the IRS/state will release any tax lien related to it.

A pre-existing tax lien in the Chapter 13 context can be meaningful in one way. The tax lien effects the payment of interest and penalties.

In a Chapter 7 case with a nondischargeable income tax you have to pay all interest and penalties. That’s true regardless whether there’s a pre-filing tax lien. The tax lien mostly serves to put more pressure on you to make payment arrangements and pay it off fast.

A Chapter 13 case is different. If there’s no tax lien, you would not have to pay ongoing interest and penalties. You’d likely pay only a portion of the penalties accrued as of the date of filing the Chapter 13 case. Sometimes you’d pay none.

 But with a tax lien, you must generally pay ongoing interest in your Chapter 13 payment plan. That can add how much you must pay into your plan and thus how long your plan takes.  

A Tax Lien on a Dischargeable Tax under Chapter 7

The effect of a tax lien on a tax debt that otherwise qualifies for Chapter 7 discharge can be huge. The Chapter 7 case would usually simply discharge that debt, so you would owe nothing.

But if there’s a prior recorded tax lien, that lien survives the bankruptcy case. The discharge of the tax debt does not legally affect the lien. Then the key issue becomes the value of the assets to which the lien attaches.

If you don’t have any real estate and your other assets are minimal, the IRS/state has less leverage over you. Especially if the tax debt was not large, some tax entities will then voluntarily release the tax lien. Both the tax and the tax lien would then be gone.

But some tax entities are more aggressive. This is more likely if the amount of the dischargeable tax is relatively large. They will leverage their tax lien to require you to pay all or part of the tax debt. They won’t release their lien otherwise.  Sounds unfair considering that the debt is otherwise dischargeable. But that’s the potential effect of the tax lien.

This leveraging is understandably much more likely if the assets to which their tax lien(s) attach are substantial. And in particular, this is true if that asset is equity in your home. You could be made to pay an entire tax debt that otherwise qualifies for discharge because of a tax lien.

So there’s a lot of uncomfortable ambiguity when you have tax lien on a dischargeable tax in Chapter 7.

A Tax Lien on a Dischargeable Tax under Chapter 13

A lot of this ambiguity is resolved in a Chapter 13 case. That’s because there’s an efficient procedure for determining the effect of a tax lien.

You and your bankruptcy lawyer will propose the value of assets that are encumbered by the tax lien. That’s done in the Chapter 13 plan you file with the bankruptcy court. You’re effectively stating what you believe to be the practical value of that tax lien, and thus the amount you’ll pay.

The IRS/state can object to this proposed treatment or not. If it objects, the value and amount you pay is usually negotiated, or if necessary decided by the bankruptcy judge.

Or, as is often the case, the IRS/state does not object. That often happens if what you and your bankruptcy lawyer propose is reasonable. Next, whatever you proposed becomes the court-approved plan. Assuming you pay off the plan as approved, that will take care of the IRS/state. Then at the end of the case the judge will discharge the remaining debt. With the debt gone, the IRS/state will then release the tax lien(s).

 

Timing: Writing Off Income Taxes

September 22nd, 2017 at 7:00 am

Usually you can discharge—write off—an income tax debt by just waiting long enough. Here’s how to discharge a tax debt under Chapter 7.  

 

Timing is Just About Everything

If you owe an income tax debt and file a Chapter 7 “straight bankruptcy” case, one of two things will happen to that debt:

  1. It will be discharged—permanently written off—just like any medical bill or other ordinary debt, or else
  2. Nothing will happen to that tax debt; you’ll continue to owe it as if you hadn’t filed bankruptcy.

The difference, most of the time, is timing—when you file your Chapter 7 case.

The Timing Rules

In most situations a Chapter 7 case will discharge an income tax debt if you meet two timing conditions. The date you and your bankruptcy lawyer file that case must be both:

  1. at least 3 years after the tax return for that tax was due, and
  2. at least 2 years after that tax return was actually submitted to the IRS or state tax authority.  

See Sections 507(a)(8)(A)(i) and 523(a)(1)(B) of the U.S. Bankruptcy Code.

One important twist: IF you got an extension to file the applicable tax return, then the above 3-year waiting period doesn’t begin until the end of the extension. Section 507(a)(8)(A)(i). For example, let’s say you got a 6-month extension from April 15 to October 15 of the pertinent year. So then the 3-year period starts on that October 15 instead of on the usual April 15 return filing due date.

These Rules Applied

Assume you owe $7,500 in income taxes for the 2013 tax year. You’d asked for a 6-month extension to October 15, 2014. But then you didn’t actually submit the tax return until December 31, 2014.  

If you’d file a Chapter 7 case at any point before October 15, 2017, you’d continue owing the $7,500 tax. If you’d file on or after October 15 you would likely not owe a dime.

That’s because on October 15, 2017:

  1. At least 3 years would have passed since the extended due date of October 15, 2014, and ALSO
  2. At least 2 years would have passed since actually submitting the tax return on December 31, 2014.

Or, take with same $7,500 tax debt for the 2013 tax year with similar facts but a couple differences. You didn’t ask for an extension, but also didn’t submit the tax return until December 31, 2015.

Under these facts you’d have to wait until after December 31, 2017 to file the Chapter 7 case.

That’s because:

  1. 3 years since the tax return was due—on April 15, 2014—would have passed on April  15, 2017, but
  2. 2 years from the day the return was actually submitted would not pass until December 31, 2017.

Other Conditions

Earlier we said that “in most situations” Chapter 7 discharges income taxes debt when you meet the two timing conditions. So what are the other situations when taxes would not be discharged, even after meeting the 2-year and 3-year conditions?

There are two sets of them.

The first set comes into play if you made an “offer in compromise” to the IRS or state to settle the debt, or if you had filed a prior bankruptcy case involving this same tax debt. Since these are unusual situations, and the rules are detailed, talk with your bankruptcy lawyer if they apply to you.

The second set applies in situations in which the taxpayer “made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.” Section 523(a)(1)(C).  Different bankruptcy judges interpret this language differently. For example, is it a willful attempt to evade a tax to merely not submit its tax return when due, even if you submitted it voluntarily a year later? How about if you didn’t submit the tax return until the IRS personally contacted you to do so? Again, talk with your bankruptcy lawyer about how this part of the Bankruptcy Code is interpreted by your court. 

 

Dealing with Unpaid Property Taxes on Your Home

May 18th, 2016 at 7:00 am

Catching up on property taxes benefits both you and your mortgage lender. Chapter 13 helps you pull this off under much less pressure.

 

Slipping Behind on Property Taxes

If you’ve fallen behind on your mortgage payments, you’ve likely also fallen behind on your property taxes.

You may be required to pay those taxes as part of your mortgage payment. So not paying the mortgage automatically means you’re not paying the property taxes.

Or you may be supposed to pay the property taxes directly, separate from your mortgage. So you’ve not paid the property taxes because the mortgage lender is much quicker to complain and makes more noise if you don’t pay the mortgage.  So you pay that as much as you can instead of the property taxes.

Either way you fall behind on the property taxes. So how to solve this problem?

Some Help from Chapter 7 “Straight Bankruptcy”

Two blog posts ago we explained how Chapter 7 can enable people to keep their home as long as they can catch up on their unpaid mortgage payments within a few months after filing their bankruptcy case.

That’s all the harder if you are also behind on property taxes.

But in some situations, the filing of a Chapter 7 case allows a homeowner to stop paying a lot of money each month to other creditors, freeing that money to be paid towards the unpaid mortgage and property taxes.

Your Mortgage Lender’s Harsh Leverage

The problem is the impatience of your mortgage lender.

Usually a foreclosure by a property tax agency does not happen until a number of years after you don’t pay a property tax bill. So you’d think you’d have years to get current.

Maybe so if you own the property free and clear of a mortgage.

But not if you have a mortgage. In the reams of paperwork you signed when you got the mortgage you promised your mortgage lender that you would always keep current on the property taxes. So if you don’t, that’s a breach of your mortgage loan. It gives your lender a separate justification for foreclosing on your home, regardless whether or not you are current on the mortgage payments themselves.

Chapter 13 “Adjustment of Debts” Buys Much More Time

A Chapter 13 payment plan gives you time to catch up on your property taxes. And it keeps your mortgage lender off your back while you do so.

Our last blog post showed how Chapter 13 can usually give you as long as 5 years to catch up on missed mortgage payments. Same thing with back property taxes. And same thing if you are behind on both.

Stretching out the catch-up period that long reduces how much you have to pay monthly, on the property taxes or on both the property taxes and the mortgage. That makes catching up easier. If you are far behind, it may make the otherwise impossible become possible.

Chapter 13 Protects Your Home

Chapter 13 cases usually last 3 to 5 years. If you follow the payment plan that you and your lawyer propose and the bankruptcy judge approves, throughout that time you and your home are protected from foreclosure and other collection activity.

This protection applies both to the property tax creditor and to your mortgage lender. You do need to keep current on new tax years and on new mortgage payments as they come due. And you do need to make your “plan payments” so that you are making progress on the past due property taxes (and mortgage payments, if you’re behind on them, too). Or you could lose this protection and this opportunity to get current over time.

Flexibility under Chapter 13

Although Chapter 13 gives you as long as 5 years to catch up on your property taxes, often you’d be able to pay your back property taxes more quickly. That’s because in your Chapter 13 plan you can usually delay paying other creditors while you first catch up on the property taxes. That’s helpful because property taxes tend to have high interest. Besides saving you on interest, you build equity in your home, and satisfy your mortgage lender more quickly.

Chapter 13 is also a particularly good option if you have other liens against the home, such as a second mortgage, or liens for income taxes, for child or spousal support, for a judgment, or just about any other lien. More about those in our upcoming blog posts.

 

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.

 

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