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Paying Income Taxes through Chapter 13

December 23rd, 2019 at 8:00 am

Chapter 13’s advantages in paying off your priority income taxes become clearer when you see what you don’t have to pay.


Last week we got into the advantages of paying priority income taxes through a Chapter 13 “adjustment of debts” case. Those are the usually-recent income taxes which cannot be written off (“discharged”) in bankruptcy. Today we show more clearly how Chapter 13 can be tremendously helpful with income taxes.

The Example: The Tax Breakdown

This example expands on one we introduced last week. Assume that you owe $10,000 to the IRS for income taxes from the 2016 tax year.

In addition there’s a failure-to-file penalty of $2,000 for filing 4 months late without getting an extension. The IRS assesses that penalty  at 5% per month of being late. So here, 4 months at $500 per month = $2,000.

Plus there’s a failure-to-pay penalty of $1,650. That’s calculated at 0.05% each calendar month or partial month that the tax remains unpaid. So here, 33 months or partial months from the April 2017 payment due date to December 2019, at $50 per month = $1,650. (Note that this penalty is reduced to 0.025% per month if you’re in an IRS payment plan.)

You also owe interest on the unpaid tax. It’s more complicated to calculate because the rate changes. It’s been at 5% per year since April 1, 2018 and 4% for two years before that. Plus it compounds daily. To keep it simple, assume for this example that $1,200 of interest has accrued on the $10,000 tax owed.

So combining these, assume you owe $10,000 in 2016 income tax, plus $3,650 in penalties ($2,000 + $1,650), plus $1,200 in interest, a total of $14,850 owed to the IRS for this tax year.

The Tax and Interest vs. the Penalties

1. Accrued interest. If an income tax does not qualify for discharge (under the rules discussed last week), neither does the interest. So during a Chapter 13 case you’d have to pay the tax and the interest (accrued up to the date of bankruptcy) in full. In our example that’s the $10,000 in straight tax plus the $1,650 of interest, or $11,650.

2. Accrued penalties. But the accrued penalties are quite different. These are usually not treated as priority debt but rather as general unsecured debt. (This assumes there’s no recorded tax lien on the tax, which could make the debt partly or fully secured.) In a Chapter 13 case you pay general unsecured debt only to the extent you can afford to do so. This is AFTER paying all priority and appropriate secured debts. Often you don’t have to pay general unsecured debts, including tax penalties, much. It’s not uncommon that you pay nothing.

In our example the $3,650 in penalties is general unsecured debt. So during the course of your 3-to-5-year case you pay this portion only as much as you can afford. You may pay nothing.

3. Ongoing interest and penalties. Usually you don’t pay any ongoing interest or penalties on the tax during the Chapter 13 case. The IRS continues to track it. But as long as you finish the case successfully you will not have to pay any of it. This lack of ongoing interest for 3 to 5 years saves you a lot of money. It also often enables you to end your case more quickly.

Filing the Chapter 13 Case

Now assume you filed a bankruptcy case on December 10, 2019. You were in a hurry to file because the IRS was threatening to garnish your paycheck. The 2016 income tax is not discharged in bankruptcy because it’s  less than 3 years from the tax return filing deadline of April 15, 2017 and the December 10, 2019 filing date.

If you filed a Chapter 7 “straight bankruptcy” that would have provided only limited help. It would have stopped the IRS’s garnishment threat for 3 or 4 months while the Chapter 7 case was active. Then if discharging your other debts would free up enough cash flow so that you could reliably get on an installment payment plan with the IRS to pay off the $14,850 reasonably quickly, then Chapter 7 might make sense.

But that’s a big “if” which doesn’t happen often in the real world.  And even if this scenario were possible, you’d likely pay much more than under Chapter 13. After a Chapter 7 case, you’d have to pay the $3,650 in accrued penalties in full (instead of only in part or not at all under Chapter 13). Interest, and the failure-to-pay penalty, would continue accruing non-stop, until paid off. This adds to the amount you eventually have to pay. Each time you’d make a payment, part would go to that month’s new interest and penalties. So you have to keep paying longer.

Chapter 13 Instead

We’ve explained why his situation should play out much better under Chapter 13. But we’ll show how it actually works over the course of a payment plan in our blog post next week.


Priority Income Tax Debts under Chapter 13

December 16th, 2019 at 8:00 am

Chapter 13 gives you huge advantages for paying off your priority income tax debts. You’re protected while you pay what you can afford.

Last week we discussed the advantages of paying priority debts through a Chapter 13 “adjustment of debts” case. We referred to recent income taxes as one of the most important kinds of priority debt. Today we show how Chapter 13 can greatly help you take care of recent income tax debts.

Recent Income Taxes Can’t Be Discharged

The law treats some, usually more recent, income tax debts very differently than other, usually older, income tax debts. Generally, new income taxes are “priority” debts and can’t be discharged (written off) in bankruptcy.

There are two conditions determining whether a tax debt can be discharged. (There are a few other conditions but they are not very common so we don’t address them here.) Bankruptcy does NOT discharge an income tax debt:

1. if the tax return for that tax debt was legally due less than 3 years before you file your bankruptcy case (after adding the time for any tax return-filing extensions) U.S. Bankruptcy Code Section 507(a)(8)(A)(i).


2. if you actually submitted the tax return to the IRS/state less than 2 years before you file the bankruptcy case. Bankruptcy Code Section 523(a)(1)(B)(ii).

Two Examples

Assume you filed a bankruptcy case on December 10, 2019. You owe income taxes for the 2017 tax year. The tax return for that tax was due on April 17, 2018 (because of a weekend and holiday). (This assumes no tax return filing extension.) That’s much less than 3 years before the December 1, 2019 bankruptcy filing date. So, no discharge of the 2017 tax debt, because of the first 3-year condition above.

As for the second condition above, assume again that you filed your bankruptcy case on December 10, 2019.  This time change the facts so that you submitted the tax return late for the 2015 taxes, on October 1, 2018. That’s less than two years before the December 10, 2019 bankruptcy filing date. So because of the second condition above, taxes due for 2015 would not get discharged in bankruptcy

Meeting either of the two conditions makes the tax debt not dischargeable. In the second example immediately above, more than 3 years had passed since the deadline to submit the tax return. (The 2015 tax return was due on or about April 15, 2016.) But less than two years had passed since the actual submission of the tax return. So, no discharge of the tax debt.

With no discharge, you would have to pay that income tax debt after finishing a Chapter 7 case. But there are advantages of paying this priority debt in a Chapter 13 case.

Advantages of Paying Priority Income Tax Debts in Chapter 13

Under Chapter 13:

  1. You are protected from aggressive collection by the IRS/state not for 3-4 months as in Chapter 7 but rather 3-5 years.
  2. This includes preventing any new recorded tax liens, and getting out of any installment payment plans.
  3. The amount you pay monthly to all your creditors, including the priority tax, is based on your actual budget. It’s not based on the often unreasonable requirements of the IRS/state.
  4. The amount your priority tax gets paid each month (if any) among your other debts is flexible. You do have to pay all of the priority tax debt(s) by the time you finish your Chapter 13 case. That’s up to a maximum 5 years. But other more urgent debts (such as catching up on a home mortgage) can often get paid ahead of the taxes.
  5. Usually you don’t pay any ongoing interest or penalties on the tax during the Chapter 13 case. That takes away the need to pay it quickly. Plus the lack of additional interest and penalties significantly reduces the amount needed to pay off the tax debt.
  6. If the IRS/state recorded a tax lien against your home or other assets before you filed bankruptcy, Chapter 13 provides a very efficient and favorable forum to value and pay off that secured portion of the priority debt.


Filing Bankruptcy in 2019 to Write Off More Income Taxes

January 7th, 2019 at 8:00 am

With smart timing you can discharge—legally and permanently write off—more income tax debts, even with a standard Chapter 7 case. 


The right timing of the filing of a bankruptcy case can make a tremendous difference. Our last 8 blog posts have all been about smart timing. If you need to use the bankruptcy laws to get relief from your creditors, it’s only sensible to get as much relief as the laws can give you by timing it right.

The discharge of income tax debts is particularly timing sensitive.

How Chapter 7 and Chapter 13 Conquer Income Tax Debts

Filing bankruptcy with smart timing in 2019 conquers your income tax debts in two main ways:

  • Discharge (legally write off) more of your tax debts (likely for the 2015 tax year). This applies to both Chapter 7 “straight bankruptcy” and Chapter 13 “adjustment of debts.”
  • Include any taxes owed for the 2018 tax year in your Chapter 13 payment plan. This gives you huge advantages.

Today we’ll show the first part—how to discharge more income taxes in 2019 with a Chapter 7 case. We’ll cover the Chapter 13 aspects in the next two weeks.

Is Chapter 7 “Straight Bankruptcy” Good Enough?

You may be surprised that income tax debts can be discharged under Chapter 7 just like most other debts. They are discharged just as completely as a medical bill or credit card balance. You just need to time it right. You do also need to meet some other conditions. But much of the time those other conditions are met rather easily.

What’s the easiest way to deal with a tax debt?  You may have heard that the more complicated Chapter 13 is better if you owe income taxes. That’s often true, especially if you owe for multiple years and/or for more recent tax years.

However, under the following circumstances Chapter 7 is likely better:

  • All of the income taxes you owe qualify for discharge
  • Some but not all of your income taxes qualify for discharge, but you can handle the rest either through:

The main advantage with Chapter 7 is speed. An income tax that qualifies will be forever discharged. This will usually happen about 4 months after you file your Chapter 7 case. Your whole case will, in most situations, be fully completed at that point. You can get on with your life. In contrast, a Chapter 13 case usually takes at least 3 years and can stretch as long as 5.

Discharge More Income Tax under Chapter 7

There are two main timing conditions for discharging income taxes through Chapter 7. The day that your bankruptcy lawyer files the case must be both:

1) at least 3 years past when the applicable tax return was due, adding any time for extensions to submit the return (Section 507(a)(8)(A)(i) of the U.S. Bankruptcy Code.)

2) at least 2 years past when the tax return was actually submitted to the IRS or state tax agency (Section 523(a)(1) of the Bankruptcy Code.)

Again, there are other conditions. Some involve timing, such as additional time added if you’ve made an offer in compromise on that tax, or filed a prior bankruptcy. (Section 507(a)(8)(A)(ii).) The other main condition is if you “made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.” (Section 523(a)(1)(C).) A recorded tax lien on the tax would add some additional complications. But these additional conditions often don’t apply. If you ARE concerned that any might apply to you, tell your lawyer early in your first meeting.

Applied to Income Tax Owed for 2015

Let’s apply this to a tax debt for the 2015 tax year.

If you owe income taxes for 2015, when would you meet the first of the two main timing conditions? The 2015 tax return was due April 15, 2016. So you need to file your Chapter 7 case 3 years after that, after April 15, 2019. So then the required 3 years will have passed since that tax return was due.

This assumes you didn’t get a tax return filing extension. What happens if you did? That year the standard extension to October 15, 2016 fell on a Saturday. So the extended deadline would have actually been Monday, October 17, 2016. (As you can see, these kinds of minor-seeming details can be crucial.)  So if you got this extension you’d have to file your Chapter 7 case after October 17, 2019.

How about the second of the above two conditions? When did you submit your 2015 tax return(s) to the IRS/state? You have to make sure at least 2 years have passed since you’d submitted it/them. If submitted by either the regular due date of April 15, 2016 or the extended date of October 17, 2016, then you’ve already met this 2-year condition (as of the writing of this blog post). If you submitted the return(s) any later, you have to make sure that you meet this 2-year condition.

An Example

Assume that you:

  • owed $7,000 to the IRS for 2015 income taxes
  • submitted that tax return to the IRS on or before April 15, 2016 without an extension
  • did not pursue an Offer in Compromise or file an interim bankruptcy case, or if you did the resulting additional time has passed
  • the tax return was not fraudulent and you didn’t “willfully attempt” “to evade or defeat” the tax

If you now file a Chapter 7 case after April 15, 2019, this $7,000 tax debt would almost certainly be completely discharged within 4 months of filing. If you file before then this tax debt would not be discharged. See a competent bankruptcy lawyer as soon as possible to determine what’s best for you regardless.


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: 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.


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.


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.


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