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Archive for the ‘tax interest and penalties’ tag

Include 2018 Income Taxes in a Chapter 13 Case Filed in 2019

January 21st, 2019 at 8:00 am

Do you expect to owe income taxes for the 2018 tax year? Starting January 1, 2019 you can wrap that tax into a new Chapter 13 payment plan. 

 

Have you been considering filing bankruptcy and now also expect to owe income taxes for 2018? If so, the start of 2019 gives you more reason to file a Chapter 13 “adjustment of debts” case.

Why? Because filing in 2019 allows you to include 2018 income taxes into your payment plan. That gives you major advantages:

  1. Saves you money on your payment of the 2018 tax
  2. Gives you some very valuable flexibility
  3. Stops tax collections and a tax lien on the 2018 tax

1. Save Money

Wrapping your 2018 income tax debt into a Chapter 13 payment plan usually allows you to pay no more interest and penalties on that tax. The savings can be much more than you think.

You’ll have to pay the 2018 base income tax itself in full, but usually not the interest or penalties. The base tax itself is a “priority” debt that you have to pay. But almost always no interest or penalties accrue on that tax (as long as you finish the case successfully).  

This especially helpful because practically speaking you’d probably not pay that 2018 tax for quite  a while:

  • If you don’t file bankruptcy your other financial pressures would likely prevent you from paying that tax quickly. You might even be tempted to put off filing the tax return, thereby aggravating the problem. The interest and penalties would accrue fast.
  • If you do file a Chapter 13 case in your payment plan you’d most likely pay other even higher priority debts ahead of the 2018 tax. There’s a good chance that tax wouldn’t get paid until near the end of your 3-to-5-year plan. A huge amount of interest and penalties would accrue in the meantime.

2. Valuable Flexibility

Wrapping your 2015 taxes into a Chapter 13 payment plan gives you tremendous flexibility in paying the tax. This can be a real game changer, especially when you have other financial obligations that can’t wait. Chapter 13 allows you to delay paying your 2018 tax debt until you can afford doing so AFTER paying, for example:

  • home mortgage arrearage to save your home
  • unpaid real property taxes, which usually accrue interest at a high rate
  • vehicle loan arrearage or “cramdown” payments to keep your vehicle
  • child or spousal support arrearage
  • other years’ income taxes, including protecting a home or other possession from previously recorded liens

3. Stop Future Tax Collection Including Liens

An important benefit of waiting until 2019 to include the 2018 income tax debt is to stop its aggressive collection. Filing a Chapter 13 case prevents the IRS and/or state from taking just about any collection actions on that tax. This protection against collection stays in effect throughout the years of the case (as long as you fulfill your obligations). Not having to worry about collection of this debt is a huge emotional and practical benefit.

It’s especially nice not have to worry about getting hit with a tax lien. Tax liens are dangerous for a number of reasons. They put your precious assets at risk, thereby giving the IRS/state tremendous leverage. Chapter 13 prevents tax liens while giving you the means to pay off the tax on a relatively flexible budget.

 

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: 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.

 

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

June 11th, 2018 at 7:00 am

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

Tax Agreement Payments Too High

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

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

Chapter 7 Makes Sense When Your Tax Owed Can Be Discharged

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

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

Chapter 13 Plan

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

Advantages

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

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

Conclusion

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

 

The Surprising Benefits: Break a Tax Payment Plan through Chapter 7

June 4th, 2018 at 7:00 am

Can’t afford your current IRS/state monthly payment plan? Have an upcoming additional new year of taxes to pay? Chapter 7 can often help.

Tax Installment Agreement You Can’t Afford

It’s a common problem. You owed income taxes a year or two ago when you sent in your tax returns. Money was very tight so you couldn’t just pay it off. You found out that the IRS let you pay that unpaid tax through a monthly installment plan. If you also owed state income taxes, you likely found out that your state taxing authority lets you do this, too.

So you set up the payment plan with the IRS and/or state. But your financial situation only got tighter because now you had a new monthly obligation you absolutely had to pay.  So now you are struggling to pay the monthly tax payment along with your living expenses and other debts. You wish there was a way to get out of your IRS/state monthly tax payment and other debts.

Tax Installment Agreement You Are About to Break

If you were desperate to have the money to pay the monthly tax payment (along with your other obligations), you may have arranged to withhold less from your paycheck during the current year. Or if you’re self-employed you may not have paid enough estimated quarterly taxes.

If so, you’ll likely owe income taxes again when your next tax returns are due. Assuming you couldn’t then immediately pay this new tax owed, this would likely be considered a breach of your current payment plan with the IRS/state.

At that point the IRS/state could terminate the monthly payment agreement. It could then take aggressive collection action against you, something you really want to avoid.

Or instead the IRS/state might let you roll the new tax owed into your current installment agreement. But that would likely result in an increased monthly payment. This only aggravates your problem of having more debt than you can handle.

Even if you could afford to pay an increased monthly tax installment payment, you’d be going backwards instead of making progress. The tax interest and penalties would add significantly to the amount you have to pay. You’re in vicious cycle and don’t see a way out of it.

Two Ways Out

But there ARE potentially two ways out: Chapter 7 “straight bankruptcy” and Chapter 13 “adjustment of debts.” We’ll cover Chapter 7 today; Chapter 13 next week.

Chapter 7 Discharge of Tax Debts

Which Chapter is better depends on many factors, but especially on whether your older income tax debts are “dischargeable.” This means whether the taxes can be legally, permanently written off in bankruptcy.

Some income taxes CAN be discharged. Basically, certain amounts of time must pass since the time the tax return for the tax was legally required to be submitted, and since the tax return was actually submitted. If you meet those conditions (and some other possibly relevant ones), the tax debt is dischargeable just like any ordinary debt.

When Chapter 7 Makes Sense

If ALL the income tax debt in your present monthly payment plan is dischargeable, Chapter 7 likely makes sense. You’d not have to pay anything anymore on that monthly payment plan. If you anticipate owing new taxes with your next tax return(s), you could likely enter into a fresh monthly payment plan for these taxes. You wouldn’t end up breaching your present payment plan because you would no longer owe anything on it.

If SOME of the income tax debt in your present monthly payment plan is dischargeable, Chapter 7 may also make sense. You would no longer have to pay that part of your taxes, which would presumably reduce your monthly tax payments. If that reduced amount is one that you could afford—especially after discharging all or most of your other debts—Chapter 7 would help enough to justify using this tool.

If Chapter 7 Isn’t Good Enough

If you can’t discharge all your income taxes, or enough, through Chapter 7, consider Chapter 13 “adjustment of debts.” We’ll explain in our blog post next week.

 

Buy Time to Deal with Multiple Years of Income Tax Debts

October 25th, 2017 at 7:00 am

What if you have some income tax debt that qualifies for discharge but one (or more) tax year that doesn’t? Does Chapter 7 ever help enough? 

 

Tax Liens under Chapter 7 

Last week we showed how Chapter 7 can sometimes permanently prevent an income tax lien from hitting your home. It does that by stopping the recording of the tax lien, and then discharging (writing off) the tax debt. 

This works under Chapter 7 “straight bankruptcy” when both:

  • that income tax debt meets the conditions for discharge (mostly it’s old enough)
  • the IRS/state has not already recorded a tax lien

But what if your tax debt meets these circumstances but you have other reasons to file a Chapter 13 case? (For example, you need to do a “cramdown” on your vehicle loan, catch up on a mortgage or on child/spousal support, or financially don’t qualify for a Chapter 7 case.) In particular what happens if you owe other income taxes that do not qualify for discharge? And what happens if a tax lien has already been recorded before you could stop it with a bankruptcy filing?

We’ll look into these circumstances in the upcoming blog posts. Today we get into what to do if you owe two kinds of income tax—those that qualify for discharge and those that don’t. (For the rules about what taxes can be discharged, see our blog post last month about this.)

When Chapter 7 is Appropriate

Assume that you have an income tax debt for one tax year that meets the conditions for discharge and another one from a later year that does not. To keep things simpler for now, assume that neither has had a tax lien recorded on it. So filing a Chapter 7 case would completely write off the first tax but leave you owing the second one.

That would be okay as long as, after discharging your other debts, you could afford to pay that remaining tax. The IRS and most state tax agencies have monthly payment plans that, under the right circumstances, give you a decent way of paying off a tax debt.

Common sense says that Chapter 7 tends to make more sense in two circumstances:

  • The tax(es) being discharged are relatively large
  • The tax(es) left owing are relatively small

An Example

Here’s an example of the combination of these two.

Assume that, after making payments of a while you still owe the IRS $10,000 for the 2012 tax year. And now you’ve just submitted your 2016 tax return (after getting an extension) and owe another $2,000. Assume also that your 2012 tax debt qualifies for discharge while the 2016 one does not. You’ve avoided filing bankruptcy so far, but because of new financial problems are now looking into it.

If you now filed a Chapter 7 case the $10,000 older tax debt would be permanently discharged. The newer $2,000 one would not. But especially if the bankruptcy case leaves you otherwise debt-free, paying off that $2,000 may be quite manageable.

Interest and penalties would continue to accrue during the payment period, so you need to consider that. Of course less interest and penalties would accrue if you paid the tax off faster.

The IRS would not likely record a tax lien for such a relatively small amount. But you should ask your bankruptcy lawyer about this, and about the practices of your state tax agencies if applicable.

Other Considerations

 But what if you:

  • can’t reliably pay anything monthly to the IRS/state because of other debts surviving the Chapter 7 case? (For example, if you’re behind on your home mortgage or vehicle loan or support payments.)
  • don’t qualify for Chapter 7 because of your income and expenses?
  • need to file a Chapter 13 case for its other benefits? (For example, you can “strip” a second mortgage from your home’s title, “cramdown” your vehicle loan, or delay collection of your student loans.)

 In these situations Chapter 13 “adjustment of debts” would likely be the better option. More on that in our next few blog posts.

 

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.

 

“Priority” Debts in Bankruptcy

September 5th, 2016 at 7:00 am

What makes “priority” debts so special?

 

Your debts fall into three categories:

  • Secured
  • General unsecured
  • Priority

We’ve spent many blog posts covering secured and general unsecured debts. Today it’s time for priority debts.

Priority Debts

Just like it sounds, priority debts are treated in bankruptcy law as more important than other debts. They’re more important, essentially, than “general unsecured” debts.

Debts that are not secured by liens on anything you own are all unsecured debts. Just about all unsecured debts are “general unsecured” ones.

Priority unsecured debts are simply certain kinds that the law has selected to be treated with higher priority than other debts.

Why Are They Treated with Higher Priority?

For each type of priority debt there are reasons why it is treated special.

There are really only two types of priority debts in most consumer bankruptcy cases:

  • child and spousal support—the amount of support owed as of the time of the filing of your bankruptcy case
  • certain income taxes, and some other kinds of taxes—they are priority debts only if they meet certain conditions

Support payments are treated special simply because Congress has decided that this kind of debt should be favored over other debts in bankruptcy. In fact, it is treated with the very highest priority of all priority debts. When money is distributed through bankruptcy procedures, support debts are usually paid first, ahead of all other debts.

Certain income tax debts are treated special because taxes benefit the public, so Congress has decided taxes should be favored. Unlike unpaid support payments, for income taxes to be priority they have to meet certain conditions. Those conditions mostly have to do with how old the taxes are. The newer the tax is the more likely it is to be priority. Otherwise, (older) income taxes are just general unsecured debts.

How Do Priority Debts Have Higher Priority in Bankruptcy?

In bankruptcy, a lot turns on which debts get paid ahead of other debts. That’s because the amount of money available is usually much less than the amount of debt to be paid. So, often all of the money, or most of it, goes to priority debts.

This plays out differently under Chapter 7 “straight bankruptcy” and under Chapter 13 “adjustment of debts.”

In most Chapter 7 cases the bankruptcy trustee does not take possession of any of your assets to distribute to your creditors. Because there are no funds for the trustee to pay any debts, priority debts do not come into play. But there are (relatively few) cases where there are unprotected assets for the trustee to liquidate. In those cases the trustee must pay the priority debts in full before paying the general unsecured ones anything. And the trustee must pay higher priority debts in full before paying the lower priority ones anything at all.

In Chapter 13 cases, you and your bankruptcy lawyer propose a payment plan that you present to the bankruptcy court.  That payment plan must show how you will pay all priority debts in full during the 3-to-5-year case. Creditors can object, and after any objections are resolved, the court approvals a plan. Then during the course of the case you must in fact pay all the priority debts in full before you can complete the case and get a discharge (legal write-off) of your remaining unpaid debts.

The next blog post or two will show how priority debts work in practice.

 

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.

 

Beating a Recorded Income Tax Lien on Your Home

May 25th, 2016 at 7:00 am

Once an income tax lien is recorded, Chapter 13 gives you a tool that may enable you to pay no more and yet get a release of that tax lien.

 

Our last blog post was about using bankruptcy to prevent the IRS or state income tax authority from recording a tax lien on your home. But what if a tax lien has already been recorded?

The Challenge of a Tax Lien

In our last blog we also focused on how bad it is for you if the IRS/state records a tax lien 1) on an income tax debt that could otherwise be discharged (legally written off) 2) against a home that has equity against which that tax lien can attach. Then the problem is that the tax can no longer be discharged since it’s now secured by your home.

But what if the home has no present equity for the tax lien to attach to?

Dealing with a Tax Lien with No Home Equity to Attach

Maybe the IRS/state didn’t know that there was no equity when it recorded the tax lien, or maybe it just didn’t care. A recorded tax lien is a matter of public record. It hurts your credit record and your ability to sell and refinance the home. It puts you under pressure to pay the underlying tax debt. The IRS and state know this and that lien hurts you regardless that your home may have no present equity.

Filing a Chapter 7 “straight bankruptcy” usually doesn’t help because an income tax lien is not affected by it. The tax lien continues to attach to your home. And within just 3-4 months after the case is filed it’s finished and the IRS/state can resume enforcing the lien.

Determining that a Tax is Unsecured in Spite of the Tax Lien

But filing a Chapter 13 “adjustment of debts” bankruptcy instead DOES help. That’s because it comes with a truly unique tool, the ability to get a legal determination that the home has no equity attachable by the tax lien. You simply establish that as of the time the case was filed the liens that come ahead of the tax lien eat up all of your home’s equity, leaving none for the tax lien. (See Section 506(a) of the U.S. Bankruptcy Code.)

As a result the tax debt is treated as a “general unsecured” debt.  It is put into the pool of all your other “general unsecured” debts—which include medical bills, most credit cards, and all other debts that are not treated special by the bankruptcy laws.   You would pay into that pool, including on that tax debt, only as much as you could afford to pay during the life of your 3-to-5-year Chapter 13 plan, if at all.

Indeed in many situations you would pay little or nothing because you would first be required to pay other higher-priority debts. Again, you would only pay “general unsecured” debts, including the tax debt in issue, to the extent you could afford to do so with any money left over within the length of time that your Chapter 13 plan is required to last.

And in most cases when you do pay some percentage of those “general unsecured” debts, the addition of your tax debt to that pool of your “general unsecured” debts usually doesn’t increase the amount you must pay. That’s because most of the time you pay a fixed amount of money into that pool of debts. So adding the tax debt simply reduces what the other “general unsecured” creditors receive without you paying any more.

Forcing the Release of a Tax Lien When It Does Not Attach to Any Equity

Then at the end of the Chapter 13 case, any portion of the tax debt that hasn’t been paid is discharged, legally written off forever. Then, the IRS/state—regardless how much it’s been paid or not paid—must release its tax lien.

Lack of Equity Fixed As of Date of Filing

The lack of any value in the tax lien is fixed as of the beginning of the Chapter 13 case. So the home’s ongoing appreciation in value (and increase in equity as you pay down mortgage and other debt) is put beyond the reach of the tax lien. The IRS/state does not benefit from the tax lien during the course of the case while you are protected from all collection activity. Then at the end of the case the tax debt is discharged and the tax lien is release.

Under these facts, this is an excellent way to beat a tax lien.

 

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