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Archive for the ‘writing off income taxes’ tag

Avoiding Income Tax Interest and Penalties

August 10th, 2020 at 7:00 am

Bankruptcy timing can affect not only whether you must pay a tax debt but also whether you must pay certain tax interest and penalties.


This blog post is in a series about the importance of smart timing of your bankruptcy filing. Today we cover how good bankruptcy timing can prevent you having to pay certain income tax interest and penalties.

Avoiding Income Tax Interest and Penalties by Discharging the Tax Itself

Two weeks ago we discussed how to time a Chapter 7 “straight bankruptcy” appropriately to discharge an income tax debt. “Discharge” means to legally, permanently write off the tax. Then last week we discussed how to discharge an income tax in a Chapter 13 “adjustment of debts” case. When you discharge a tax in these ways what happens to the interest and penalties tied to that tax?

Generally, if you discharge an income tax debt, that also discharges any interest and penalties associated with that tax. That’s the most straightforward way to avoid such tax interest and penalties.

What If the Tax Does Not Qualify for Discharge?

If your tax debt doesn’t meet the timing and other conditions for discharge, what happens to the interest and penalties? That depends on whether you (with the help of your bankruptcy lawyer) file a Chapter 7 or Chapter 13 case.

Interest and Penalties on Nondischargeable Tax under Chapter 7

If you file a Chapter 7 bankruptcy you continue owing the tax, and the interest and taxes keep accumulating.

You do receive one brief benefit. During the 3-4 months of the bankruptcy procedure the IRS and/or state legally may not collect the tax. The “automatic stay” that stops just about all debt collection activity applies to all your income tax debts. But as soon as the Chapter 7 case is done, the tax collection activity can resume. The interest and penalties continues to accumulate even during your case. And after the case they will continue accumulating as normal until you pay the tax, interest, and penalties in full. So with taxes that don’t qualify for discharge, Chapter 7 does not help with tax interest and penalties.

Interest and Penalties on Nondischargeable Tax under Chapter 13

However, if you file a Chapter 13 case there is some help with tax interest and penalties. This can be true even with a nondischargeable income tax.

In most Chapter 13 cases you do not have to pay any ongoing interest and penalties after filing your case. Through your payment plan you pay the tax over the 3-to-5-year life of your case. But the IRS/state writes off any after-filing accumulating interest and penalties as long as you successfully complete your case. (If you don’t complete your case, the IRS/state tacks on any accumulating interest and penalties to whatever tax you didn’t pay.)

What about the before-Chapter-13-filing interest and penalties? You must pay the interest portion along with the nondischargeable tax that you have to pay.

However you usually don’t have to pay the before-bankruptcy-filing penalty portion in full. Sometimes you don’t have to pay any of it. The tax penalties are a “general unsecured” debt. You generally pay general unsecured debts only as much as you can afford to pay during the life of your Chapter 13 case. This means that you may pay as little as none of the pre-bankruptcy penalties.

Furthermore, in most cases these penalties don’t add a dime to the amount you must pay into your Chapter 13 case. That’s because in most cases you pay what you can afford into the pool of general unsecured debts over the life of your payment plan. A set amount filters down to these debts. So the dollar amount of tax penalties merely reduces how much other general unsecured debts receive. You don’t pay any more. The amount you pay just gets shifted around among these debts.

Exceptions

There are exceptions to the above. Sometimes the amount you pay into your payment plan is driven less by your budget than by non-exempt (unprotected) assets. Then you may need to pay more to your general unsecured debts (which includes the pre-bankruptcy penalties). You may even need to pay them in full—a so-called 100% plan. But that’s rare. Your bankruptcy lawyer will discuss this with you if you have this unusual situation.

What about the Effect of a Recorded Income Tax Lien?

That’s a great question. The recording of an income tax lien before filing a bankruptcy case can definitely create additional headaches for you. This can be true about both the underlying tax itself and the related interest and penalties.

So the simple timing preference is, when possible, file your bankruptcy case before the IRS/state records a tax lien.

The effect of a tax lien depends on whether the tax at issue qualifies for discharge, and whether you file a Chapter 7 or 13 case. We’ll cover these in our blog post next week.

 

Timing Chapter 13 to Discharge Income Taxes

August 3rd, 2020 at 7:00 am

Usually you can discharge income taxes (write them off forever) by waiting long enough to file bankruptcy. Here’s how it works with Chapter 13.


Our blog post of three weeks ago introduced the importance of timing your bankruptcy filing right. We gave a list of 15 examples where timing can make a huge difference. Two weeks we covered the first one, timing bankruptcy to cover as many debts as possible. Last week was about discharging/writing off income taxes, specifically under a Chapter 7 “straight bankruptcy.” This week is about doing so under Chapter 13 “adjustment of debts.”

How to Time a Chapter 13 Filing to Discharge a Tax?

See our last blog post about the timing rules under Chapter 7. That’s because whether you can discharge an income tax is the same under Chapter 7 and 13. Very briefly, you can discharge an income tax as long as you file your Chapter 13 case both:

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

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

You and your bankruptcy lawyer will carefully review and apply these rules to see if you can meet them. Your situation may be too urgent to wait long enough. There may be creditor pressures, by the IRS/state tax agency or other unrelated creditors, so you can’t wait. Or there may be other good reasons to file before enough time has passed.

But let’s assume that you find out that you can meet the two timing rules. Also assume that you meet other conditions for discharging the tax. (See last week’s blog post for some other conditions beyond the two timing ones.) You file the Chapter 13 case and the income tax debt qualifies for discharge.

Then what happens? How is the tax dealt with under Chapter 13?

Using Chapter 13 Instead of Chapter 7 to Discharge a Tax

Chapter 7 usually discharges a dischargeable income tax very fast. The moment you file your bankruptcy case the “automatic stay” would protect you from all collection of that tax. Then you would very likely no longer legally owe the tax about 4 months after filing a Chapter 7 case.

Chapter 13 is just as fast at protecting you from tax collection: the “automatic stay” goes immediately into effect. But the discharge of the tax happens only at the end of the case, usually 3 to 5 years later.

Furthermore, often you need to pay some portion of that tax before you can discharge the rest. Not always, but if you have money to spare in your payment plan some will go towards the tax.

Why in the world would you file a Chapter 13 case when it’s so much slower? Why would you when under Chapter 13 you risk paying something on the tax instead of nothing?

Why Discharge Tax through Chapter 13?

The straightforward reason is that Chapter 13 could be much better for you for other reasons. Those other reasons may outweigh the benefit of discharging your dischargeable tax debt quickly and completely.

Chapter 7 and 13 each has tons of potential advantages and disadvantages. Your bankruptcy lawyer’s job is to help you determine whether the other advantages of Chapter 13 outweigh these disadvantages.

What might be some of those advantages?

One example: you may owe some other income tax debt(s) which do not meet the timing conditions for discharge. So these other taxes would not be discharged under either Chapter 7 or 13. In a Chapter 7 case, you’d owe that tax in full immediately upon finishing the case, about 4 months after filing. Interest and penalties would continue accruing. Those tax/interest/penalties may be too large to pay off reasonably through a monthly payment plan with the IRS/state.  It may not qualify for an Offer in Compromise or other settlement. Chapter 13 would enable you to pay it more flexibly, usually without accruing interest and penalties. So, you could well save money and avoid significant risks by handling all of your taxes in a Chapter 13 case.

There are many, many other reasons unrelated to income taxes that Chapter 13 could be worthwhile for you. It could potentially prevent a home foreclosure or vehicle repossession, and then give you a workable way to save the home or vehicle. Chapter 13 can often solve child or spousal support problems much better than Chapter 7. There are many other situations where Chapter 13 gives you extraordinary powers over your debts. So those advantages can make this longer procedure very worthwhile overall.

How Does Chapter 13 Discharge an Income Tax?

Assume again that your tax debt qualifies for discharge, timing-wise and by meeting all the legal conditions. So it can get discharged in your Chapter 13 case.

However, Chapter 13 treats a dischargeable tax differently than under Chapter 7. As mentioned above, the discharge happens at the end of the case usually years later. And you may have to pay something on it before then.

What determines how much, if any, you pay on this tax?

Under Chapter 13 a dischargeable income tax debt is treated like the rest of your “general unsecured” debts. Under your payment plan all such debts receive the same percentage of their total amounts. That percentage may be any amount from 0% to 100% of the debt amount, depending on your budget and other factors.

That’s right: it’s theoretically possible that you’d have to pay 100% of your tax and other debts. But that’s highly unlikely. That only happens if you have enough money in your budget that you can reasonably afford to do so. That’s very rare.

More likely your budget is barely enough for living expenses and to pay special higher-priority debts during your case. That could result in your dischargeable tax debt (and all your “general unsecured” debts) receiving 0%—absolutely nothing.

To make better practical sense of this, let’s look at two situations: First, this “0% plan,” and second, where your tax debt does not increase what you pay to your creditors.

The 0% Payment Plan

As just mentioned, in this kind of Chapter 13 case all your available money goes to living expenses plus special debts. Those special debts are either secured or “priority” ones. These could include home mortgages, vehicle loans, nondischargeable taxes, child and spousal support, and such. The law usually requires you to pay them in full before paying anything to the “general unsecured” debts.  As a result it’s possible that during your 3-to-5-year payment plan there’s no money at all for your “general unsecured” debts. That means that one of those debts, the dischargeable income tax, also receives nothing. That’s called a 0% Chapter 13 plan. (The percentage means the extent to which you’re paying the general unsecured debts.) These 0%cases are not unusual (although there are regional variations).

If you successfully complete a Chapter 13 case, when you do your bankruptcy judge discharges the entire tax. Under a 0% plan, you didn’t pay any of the tax debt during the case. And then after the discharge you don’t have to pay any of it either, foreever.  

Fixed Total Amount Chapter 13 Plans

There are other Chapter 13 payment plans in which your tax debt does not increase the amount you pay. You pay a fixed total amount to your creditors based on the amount you can afford to pay beyond your living expenses.

Often the practical effect of this is that there is some money for your “general unsecured” debts. So it’s not a 0% plan.

But because the amount you pay over the life of the case is a fixed amount, the amount left over for the pool of general unsecured debts, after paying certain secured and priority debts, is a fixed amount as well. That in turn means that all the general unsecured debts have to split up that left over amount. (This is true as long as the total amount of those debts is greater than the amount you can afford to pay. That’s almost always the situation. Otherwise you likely don’t need Chapter 13 help.)

With all the general unsecured debts being paid out of that fixed amount, this means that the total amount of this debt doesn’t matter. If the total debt amount is higher, this just means that you pay each debt a lower percentage.

This means that having a dischargeable tax debt often does not increase the amount you pay.

An Example

Here’s a simple example. Assume that during the life of a 3-year payment plan you expect to have money to pay a total of $3,000 into the pool of general unsecured debts. That’s based on what you can reasonably pay to all your debts, minus what goes to secured and priority debts. Assume also that you have $60,000 in unsecured credit cards and medical debts. This means that the $3,000 you pay would amount to paying 5% of these general unsecured debts. ($3,000 divided by $60,000 equals 5%.) 

Now assume that you also have a $10,000 of dischargeable income tax debt. You add this to the $60,000, making a total of $70,000 of general unsecured debts. Now the $3,000 gets divided among the $70,000 in debts, meaning that now you are only paying 4.3% of those debts ($3,000 divided by $70,000 equals 4.3%.) 

This situation—where you’re paying a fixed amount to the general unsecured debts—is very common. So it’s common that having a dischargeable tax debt actually does not add anything to the amount you pay. That tax debt just reduces the percentage that all the general unsecured debts receive.

 

Timing Bankruptcy to Discharge Income Taxes

July 27th, 2020 at 7:00 am

  

Usually you can discharge income taxes (write them off forever) by waiting to file bankruptcy long enough. Here’s how it works under Chapter 7.

 

Our blog post of two weeks ago introduced the importance of timing your bankruptcy filing right. We gave a list of 15 examples of timing considerations. Last week we started with the first one, timing the filing to cover as many debts as possible. Today it’s about discharging/writing off income taxes, specifically under a Chapter 7 “straight bankruptcy.”

Here are a few eye-catching facts:

  • It is possible to discharge many income tax debts, so that you do not owe a dime of that tax.
  • You just have to meet a list of conditions.
  • Most, but not all, of those conditions involve the passing of time. You need to wait long enough before filing bankruptcy to permanently discharge a tax debt.
  • If you don’t meet the conditions, bankruptcy does not discharge the tax at all. You owe it in full. If you filed a Chapter 7 case, you have to pay the tax after completing the case.
  • In that situation you’d also have to pay the continuously incurring tax interest and penalties.
  • But if you do meet the conditions, your Chapter 7 case will discharge the entire tax. You will owe nothing after your case is finished (usually only about 4 months after filing it).
  • You will also not owe any of the related tax interest or penalties.
  • There are various additional factors—such as recorded tax liens—that can complicate the situation and the tactics involved.

Timing is Often Crucial

Although there is a list of conditions, often the ones that matter are the ones involving timing. Specifically they pertain to when you file your Chapter 7 case.

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

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

See Section 507(a)(8)(A)(i) of the U.S. Bankruptcy Code for this first timing condition; section 523(a)(1)(B) for the second.

Note: Regarding the first 3-year condition above, add any time given through an extension to file the pertinent tax return. Section 507(a)(8)(A)(i) of the Bankruptcy Code. For example, assume you got the usual 6-month tax return extension from April 15 to October 15 for the pertinent year. Then you don’t start the 3-year time period until that October 15 instead of April 15.

Applying these Timing Rules

These two timing rules will make more sense when applied to an example.

Assume the following. You:

  • owe $10,000 in income taxes for the 2016 tax year, plus a bunch of accruing interest and penalties
  • had asked for a 6-month extension to October 15, 2017 (actually to October 16 since the 15th that year was a Sunday)
  • actually did not submit the tax return until December 1, 2017

If you file a Chapter 7 case before October 16, 2020, you would not discharge the $10,000 tax. You’d continue owing the $10,000 tax, plus the accruing interest and penalties.

However, under many circumstances if you file on or after October 16, 2020 you would discharge all of the $10,000. You would no longer owe any of it, including the interest and penalties.

Why the total difference? Because as of October 16, 2020:

  1. At least 3 years would have passed since the extended tax return due date of October 16, 2017, and also
  2. At least 2 years would have passed since actually submitting the tax return on December 1, 2017.

Other Conditions

Earlier we said that are other conditions to meet besides the two timing ones referred to here. So what are those other conditions that would result in an income tax not being discharged, even after meeting the above 2-year and 3-year conditions?

There are three other conditions or situations to look out for:

  1. Tax Fraud or Evasion:  The Bankruptcy Code says you can’t get a discharge of a tax for which you “made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.” Section 523(a)(1)(C).  The problem is that language is quite vague. So bankruptcy judges interpret this language differently. For example, is it a willful attempt to evade a tax if you don’t submit the tax return when due, even if you submitted it voluntarily a year later? Talk with your bankruptcy lawyer about how your local bankruptcy court interprets this language. 
  2. Income Tax Liens: Once the IRS or state tax agency records a tax lien, that puts a legal cloud over either all your personal or real property, or both. Depending on what you own, that can turn a tax debt that bankruptcy will discharge in full into one that you still have to pay in full or in part. A tax lien creates complications that you need to thoroughly discuss with your bankruptcy lawyer.
  3. Offer in Compromise/Prior Bankruptcy: Have you made an “offer in compromise” to the IRS or state to settle the debt? Have you filed a prior bankruptcy case involving this same tax debt? Under these rather unusual circumstances there are some additional timing rules. Tell your lawyer if either of these circumstances applies to you, in order to meet the special rules.  

Conclusion

Assuming these three special conditions do not apply, and you’ve met the 2-year and 3-year conditions, a Chapter 7 case should discharge your tax debt.

 

Unfiled Tax Returns and Bankruptcy

June 29th, 2020 at 7:00 am

  

If you’re considering filing bankruptcy, should you first prepare and submit any unfiled income tax returns? Should you prioritize paying them? 


Our last two blog posts have been about what you should and should not do before filing bankruptcy. These are important to consider even if you hope to avoid bankruptcy but are sensibly admitting it’s possible.

So two weeks ago we focused on keeping, and not selling or giving up your:

  1. assets
  2. especially any retirement funds
  3. collateral on debts, such as your home, vehicles, or furniture

Last week we discussed whether to take on more debt to buy time and maybe avoid needing to file bankruptcy.

Today we look at whether you should file any unfiled income tax returns, and possibly prioritize paying unpaid income taxes.

The Quick Answer

In general you should:

  1. prepare but not submit your tax returns to the IRS/state before seeing your bankruptcy lawyer;
  2. not hold off on getting advice from a lawyer if you can’t get your tax return(s) prepared beforehand;
  3. avoid paying any income taxes before getting advice about doing so from a lawyer;
  4. if you’ve recently paid income taxes or are being forced to, all the more reason to get legal advice about how to proceed now.

Prepare Tax Returns

There’s a simple reason why it’s good to have any unfiled tax returns prepared before seeing a lawyer. The more information you can provide to your lawyer the more concrete his or her advice to you can be.

Bankruptcy can be a surprising good way to solve your tax problems, in numerous ways. It can virtually always stop tax collection, both forced (garnishments) and voluntary (installment payments). Bankruptcy can sometimes reduce payment of tax interest and penalties. Bankruptcy can buy you time, and protect you while you prioritize who you pay. And under the right conditions bankruptcy can even completely wipe out (“discharge”) an income tax debt.

But as you might expect the interplay between tax law and bankruptcy law can get complicated. For example, whether bankruptcy discharges an income tax debt depends on whether that tax meets some detailed conditions. So the more details about your taxes you bring to your lawyer the more specific the legal advice you’ll receive.

Therefore, if you haven’t prepared any outstanding tax returns, it helps to do so before visiting your lawyer.

But Do Not Submit the Tax Returns

There’s just as simple of a reason not to submit your tax returns to the IRS/state tax authority before seeing your lawyer. Once you submit them you can’t un-submit them.

Of course you are legally compelled to send in your income tax returns. And there’s a legal deadline to do so. And you can submit an amended return if you need to correct the original return.

But submitting a tax return is in effect a legal act which has consequences. For example, it may affect the timing of your bankruptcy filing, and impose otherwise avoidable timing pressure.  

So, when possible, it generally makes sense to see your lawyer before submitting the outstanding tax return(s).

Don’t Delay Getting Legal Advice

Life can get complicated, financial and otherwise. You may have big roadblocks to getting your tax returns prepared. You may not have the necessary information or documents available to do so. Your tax returns may need the help of a tax preparer and you don’t have the money.

However, your financial circumstances may be crying out for bankruptcy and/or other legal advice. You may simply not be able to prepare the tax return(s) beforehand. While doing so would likely be helpful, this should not stop you from getting advice when you need it.

Prioritizing Paying Income Taxes

Every situation is different but, generally, see your bankruptcy lawyer before paying taxes.

Again, obviously you have a legal obligation to pay your income taxes.

However, if you have more debts than you can pay, it’s legitimate to ask which you should pay first. What order should you pay an income tax debt vs. an unpaid home mortgage vs. a late vehicle loan payment?

If you owe more than one income tax, which should you pay first? The IRS or the state? The older or newer one? Can you earmark the payment and should you do so between the tax itself vs. the unpaid interest vs. accrued penalties?  

How does the timing of tax payments affect the timing of the possible bankruptcy filing?

So you can see that there are various fair questions about paying your income taxes when you’re considering bankruptcy. All of these questions, and likely more, would greatly benefit from legal advice.

If Paying Taxes Now

So what if you are making income tax payments now. Consider three scenarios.

First, you’re making agreed monthly installment payments on an older unpaid income tax. You know the IRS/state will come after you hard and fast if you stop paying.

However, the tax you’re paying may qualify for discharge—a complete legal write off. It may make sense to stop paying the monthly payments so you can put that money for better use. You need to determine your game plan and coordinate the timing with your bankruptcy lawyer.

Second, the IRS/state is garnishing your paycheck for an income tax debt. Whether or not that tax debt qualifies for discharge, a bankruptcy filing would stop the garnishments. Clearly you would benefit from learning about how this works, and especially the pertinent timing. Plus of course you need to learn about the different bankruptcy options for your entire financial situation.

Third, you’re paying an older income tax monthly, either voluntarily or by garnishment. As a result you’re not paying any or enough current tax withholding or quarterly estimated payments. As a consequence, you may be paying an older tax debt that bankruptcy would discharge and not paying one that you could not discharge. You may be using your precious money to pay a not-required-to-pay debt instead of one you must pay after bankruptcy. It would certainly make sense to get legal advice to prevent such a less-than-best use of your money.

 

Bankruptcy Writes Off (Some) Income Taxes

March 4th, 2019 at 8:00 am

Bankruptcy permanently writes off income taxes, as long as the tax meets certain conditions. For some taxes the conditions are easy to meet. 

 

Bankruptcy DOES Write Off Income Taxes

There are certain very special debts that bankruptcy never writes off. Child and spousal support is a good example. See Sections 523(a)(5) and 101(14A) of the U.S. Bankruptcy Code.

Income taxes are different. Income taxes CAN be written off, as long as you meet a few conditions. These conditions mostly tie in to timing—when the tax was due and when (and whether) you filed its tax return.

The Two Timing Conditions

In most people meeting these conditions is straightforward. You essentially have to file your tax returns and wait long enough to comply with for the following two conditions:

  1. You submitted the pertinent tax return to the IRS/state and did so more than 2 years before filing your bankruptcy case. Section 523(a)(1)(B)(ii) of the Bankruptcy Code.
  2. The legal due date for that tax return was more than 3 years before filing your bankruptcy case. Section 507(a)(8) of the Bankruptcy Code.

For example, assume you owe the IRS $5,000 for the 2014 tax year, and you submitted its tax return a full year late—in April 2016. It’s been more than 2 years since that so you meet the first condition. The legal due date for that tax return was in April 2015, which is more than 3 years ago. So you also meet the second condition. So in most situations bankruptcy would write off that 2014 income tax debt of $5,000.

A Few Important Twists about the Timing

Keep three practical considerations in mind about these two time periods:

  1. The 3-year period only starts to run when the tax return was “last due, including extensions.” Section 523(a)(1)(B)(ii). The 3 years only begins at the extended due date. It’s absolutely crucial that your bankruptcy lawyer gets the correct information from you about whether you got an extension that year.
  2. If you’re cutting it close (because you’re in a big hurry to file), the precise tax return due date can be crucial. Remember that taxes are not always due on April 15 and October 15 (for extensions). Weekends and holidays can push the due date out even several days. That means you may have to wait some extra days to file your bankruptcy case to be able to write off that tax debt.
  3. Careful about making a mistake about whether and when you actually submitted your tax return. It may be worth finding out directly from the IRS/state to avoid getting a rude surprise after filing your bankruptcy case.

Other Uncommon Conditions

There are two other conditions that might possibly apply, in more complicated situations.

  1. More than 240 days must pass from when the IRS/state assessed the income tax to when filing your bankruptcy case. Assessment usually happens within a few weeks after you get your tax returns in to the IRS/state. So usually this condition is easily met. It only tends to apply if assessment gets delayed with a tax audit, litigation in Tax Court, a tax appeal, offer in compromise, and other complications.
  2. Regardless of all these timing rules, you can never write off an income tax based on a fraudulent tax return or if you intentionally evade a tax. This is uncommon. It tends to only come up if you were significantly dishonest with the tax authorities.

Conclusion

In most situations you can write off the tax if you filed your pertinent tax return and both the 2-year and 3-year periods have passed. But the intersection between bankruptcy and income taxes is definitely complicated. Be sure to see a competent bankruptcy lawyer if you owe taxes so that you get the full benefit of the law.

 

Filing Chapter 13 in 2019 to Write Off More Income Taxes

January 14th, 2019 at 8:00 am

Chapter 13 is a riskier, longer, and maybe more expensive way to escape a dischargeable income tax debt—but may still be your best option. 


Last week we showed how to permanently write off (“discharge”) more of your tax debts through Chapter 7 “straight bankruptcy.” Today we show how to do this with Chapter 13 “adjustment of debts.”

Why Use Chapter 13 If Chapter 7 is Faster and Cleaner?

Chapter 7 is a very fast way to discharge an income tax debt that qualifies for discharge. You would very likely no longer owe the tax only about 4 months after filing a Chapter 7 case.

But Chapter 13 case could be much better for you than Chapter 7 for other reasons. Those other reasons may outweigh the benefit of discharging your dischargeable tax debt quickly.

You may owe some other income tax debt(s) which do not meet the conditions for discharge. These other taxes that may be too large to pay off reasonably through a monthly payment plan with the IRS/state.  The other taxes may not qualify for an Offer in Compromise or other settlement. You may well save money and avoid significant risks by handling all of your taxes in a Chapter 13 case.

There are also many other reasons that Chapter 13 would be worthwhile for you, reasons not involving income taxes. It may save your home from foreclosure or your vehicle(s) from repossession. Chapter 13 can deal with a child or spousal support arrearage much better than Chapter 7. There are many other situations where Chapter 13 gives you extraordinary and unique powers. So it can be worthwhile overall in spite of its disadvantages in dealing with a dischargeable tax debt.

How Does Chapter 13 Deal with Dischargeable Income Taxes?

Determining whether a particular income tax debt can be discharged in Chapter 13 is the same as in Chapter 7. Please see our last blog post for the conditions of discharge. These conditions mostly involve how long it’s been since the tax return for the tax at issue was due and when the return was actually submitted to the IRS/state. Sometimes there are other pertinent conditions, but usually it’s just a matter of timing.

Because of how the timing works, there are certain points of time in 2019 when a tax that hadn’t earlier qualified for discharge would then qualify. Again, see our last blog post about those crucial times happening this year.

If your tax does meet the conditions for discharge, it can get discharged in your Chapter 13 case. But this works quite differently than under Chapter 7.

One key difference is that under Chapter 13 there’s a good chance that you would pay something on your dischargeable tax debt.

Under Chapter 13 dischargeable income tax debts is treated like the rest of your “general unsecured” debts. Under your payment plan all such debts get paid the same percentage of their total amounts. That percentage may be any amount from 0% to 100% of their amount, depending on your budget and other factors.

Consider two situations: First, if you have a “0% plan” then you’d pay nothing on the dischargeable tax just like in a straightforward Chapter 7 case. Second, even if you do pay some percentage, often that actually doesn’t increase the amount you pay into your payment. We’ll explain these two situations.

A 0% Payment Plan

In some Chapter 13 cases all the money that the debtor can afford to pay goes to special creditors. All the money going into the Chapter 13 payment plan goes either to secured or to “priority” debts. These would include home mortgages, vehicle loans, nondischargeable taxes, child and spousal support, and such. These usually have to be paid in full before the “general unsecured” debts receive anything.  So during the 3-to-5-year payment plan no money goes to the dischargeable income taxes. That’s a 0% Chapter 13 plan.

Assuming the bankruptcy approves the plan, and you successfully complete it, at its conclusion the dischargeable taxes get discharged, without you having to pay any of it.

Payment Plans Which Do Not Increase the Amount You Pay

In many Chapter 13 plans the amount available for the pool of the “general unsecured” debts is a fixed amount. That amount is based on what you can afford to pay over the required length of the plan. (That required length is usually 3 or 5 years.) That fixed amount does not change regardless how much in “general unsecured” debts you owe. The amount just gets distributed to all those debts pro rata. The more you owe in “general unsecured” debts the lower the percent of the debts that fixed amount can pay.

For example, assume you can afford to pay the pool of “general unsecured” debts a total of $2,000 during the course of the payment plan. All the rest of the money you pay into the plan is earmarked for secured and “priority” debts. Assume also that you have $20,000 in unsecured credit card and medical debts and $5,000 of dischargeable income tax. Without the income tax, the $2,000 would be paid towards the $20,000 in “general unsecured” debts, resulting in a 10% plan. ($2,000 is 10% of $20,000.) Now when you add in the $5,000 tax, there’s a total of $25,000 of “general unsecured” debt. $2,000 is 8% of $25,000, resulting in an 8% plan.

You would be paying no more—the fixed amount of $2,000—over the length of your plan. The fact that you owe the $5,000 in dischargeable tax would not increase the amount you would pay. Then at the successful completion of the case all remaining “general unsecured” debts, including whatever was remaining on the dischargeable tax, would be forever discharged.

Conclusion

So you see that Chapter 13 is a slower and somewhat riskier way to discharge an income tax debt. Plus you may have to pay a portion of the tax instead of quickly discharging all of it under Chapter 7. But then again you may not have to pay anything on it, as described above. In any event, the delay and risks may well be worthwhile. Your bankruptcy lawyer will help you weigh all the advantages and disadvantages so that you can make the right choice.

 

Timing: Writing Off Income Taxes

September 22nd, 2017 at 7:00 am

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

 

Timing is Just About Everything

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

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

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

The Timing Rules

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

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

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

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

These Rules Applied

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

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

That’s because on October 15, 2017:

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

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

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

That’s because:

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

Other Conditions

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

There are two sets of them.

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

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

 

Income Taxes Discharged and Not Discharged in Bankruptcy

April 15th, 2016 at 7:00 am

Bankruptcy DOES discharge–permanently write off–certain income taxes. It’s mostly just a matter of time.  

 

 

Taxes Can Be Discharged (Legally Written Off)

Some special kinds of debts can never be discharged through bankruptcy. Examples are child and spousal support, and criminal fines and restitution. A bankruptcy filing does not write off these kinds of debts.

Income taxes are not like these. Almost all income taxes can be discharged, once a few conditions have been met.

Once the tax you owe meets those conditions, it is discharged exactly like any other debt. The IRS and your state taxing authority are no different than your credit card creditor. Once a tax debt is discharged, they can never chase you for that debt again.

The Two Main Conditions to Discharge Income Taxes

For most people the conditions are not complicated. They require filing your tax returns and waiting out a certain amount of time.

To discharge an income tax in bankruptcy, BOTH:

  • More than 2 years must have passed between the date that you submitted the pertinent tax return to the IRS or state tax agency and the date you file your bankruptcy case.
  • More than 3 years must have passed between the legal due date for that tax return and the date you file your bankruptcy case.

That’s usually all it takes: filing the tax return and waiting for these two-year and three-year deadlines to pass before filing bankruptcy.

A Few Cautions

Keep three practical considerations in mind about these two time periods:

  • The 3-year period starts to run when the tax return was “last due, including extensions.” So if you asked for (and got) an extension of time to send in the tax return—from April 15 to October 15, usually—the three-year period does not begin until the extended due date for filing the tax.
  • You need to be precise about the actual date the tax return was due for the tax year in question. For example, this year April 15 falls on a Friday but that’s also a holiday in Washington D.C., so tax returns are not actually due until Monday, April 18. A couple days may seem minor but can make all the difference between a tax debt being completely discharged and being still fully owed.
  • With the 2-years-since-tax-returns-filed condition, be sure to determine accurately whether and when the IRS/state actually received your tax returns. Unless you already have documented proof of that date, get that directly from the IRS/state to make sure.

Two Other Conditions that Seldom Apply

Most of the time, your tax debt is discharged if those two conditions are met. But there are two conditions that could possibly come into play for some people.

  • More than 240 days must have passed between the date that the tax was assessed by the IRS/state and the date you file your bankruptcy case. This is seldom an issue because assessment usually happens within a few weeks after you get your tax returns in to the IRS/state. So you automatically meet this 240-day condition when you meet the 2-year and 3-year ones. It only comes into play when assessment gets delayed with a tax audit, litigation in Tax Court, a tax appeal, offer in compromise, and similar complications.
  • If you file a fraudulent tax return or intentionally evade a tax, it cannot be discharged in bankruptcy. This is relatively rare. It arises only if you were materially dishonest on your tax return, by not including some of your income, or by intentionally claiming deductions or credits which you knew you were not entitled to, or by cheating the IRS/state in some other way.

Conclusion

Assuming that these last two conditions don’t apply to you, and you filed your tax return for the tax in question, that tax can be discharged once the 2-year and 3-year periods have expired.

For example, assume you owe $7,500 for 2012 income taxes, for which you submitted your tax return for that tax on the regular due date of April 15, 2013. Assume the tax was assessed as usual way back in 2013, and there’s no tax fraud involved. You met the 2-year condition as of April 16, 2015. You meet the 3-year condition by filing your bankruptcy case on or after April 16, 2016. That bankruptcy case would discharge the $7,500 income tax debt and it would be permanently out of your life.

 

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