Chapter 13 Bankruptcy
When taxes are dischargeable in bankruptcy
The rules regarding taxes and other debts are complex and confusing when it comes to bankruptcy. Whether a tax debt can be discharged (waived, forgiven, gone) as a result of filing bankruptcy depends on many things. Such things include the kind of tax, age of tax, whether a tax return was filed on time or at all, and the type of bankruptcy.
The first step in deciding whether or not to file a tax bankruptcy is whether the taxes are dischargeable or not.
In a chapter 13 case, secured tax claims and priority taxes have to be paid in full over three to five years (usually five). Non-priority taxes usually will not be paid in full but will only receive “cents on the dollar.”
Secured Tax Claims
The IRS is entitled to file a secured tax claim in a bankruptcy when a notice of tax lien has been filed against the debtor, and there is equity in the debtor’s property for the lien to encumber. For example, if the debtor has a car with $5,000 of equity (unencumbered value) and the IRS had filed a notice of federal tax lien against the debtor, prior to the filing of the bankruptcy, then the IRS would potentially have a $5,000 secured tax claim in the bankruptcy. Such a claim usually must be paid in full, with interest, within three to five years. It does not matter what kind of tax it is or how old the tax is.
Priority Income Taxes
Generally, income taxes are priority taxes if they meet either of two tests found in the bankruptcy law. Those tests are commonly referred to as the three year rule and the 240 day rule.
The three year rule means that if the tax return due date for the particular income tax year was less than three years before the bankruptcy is filed, then it is a priority tax. Note: If an extension was filed, the three year rule is calculated from the date of that extension. Also, under this rule, it does not matter whether the tax return was actually filed or not. For example, the return for the tax year 2009 would normally be April 15, 2010. Any tax due would be classified as a priority tax until at least April 15, 2013.
The 240 day rule means that if the income tax was assessed within 240 days before the bankruptcy is filed, then it is a priority tax. The date any particular tax was assessed can be difficult to determine. Make sure you know when all taxes were assessed before you file bankruptcy.
Other Types of Priority Taxes
Certain taxes are always priority taxes regardless of any lapse of time. Taxes that are required to be collected or withheld for which the debtor is liable are always priority taxes. Such taxes include federal withholding and withheld FICA taxes and sales tax.
Non-priority taxes excepted from discharge
Even though income taxes may not be priority taxes, they still might be excepted from discharge for other reasons.
- Late filed tax returns: The taxes related to a tax return that was filed late are not dischargeable if the return was filed within two years before the bankruptcy case was filed.
- No tax return filed: The taxes related to any unfiled tax return, that should have been filed, are not dischargeable.
- A fraudulent tax return: The taxes related to a fraudulent tax return are not dischargeable.
A chapter 13 bankruptcy allows debtors to retain their assets, while making a monthly payment to their creditors. The payments are made over the course of three to five years. After all the payments are made, the debtors receive their discharge order from the court. Any unpaid debts, which were not excepted from discharge, are discharged (waived, forgiven, gone).
How Much Must Be Paid to the Creditors?
The minimum that the debtors have to pay depends on whichever one of the following three tests produces the highest dollar amount.
- First, calculate how much the creditors would have been paid if the case had been a chapter 7 liquation case, instead of a chapter 13 case (chapter 7 test or best interest of the creditor’s test).
- Second, calculate how much the creditors would be paid, if all of the debtors’ disposable income is paid to them over three to five years (disposable income test).
- Finally, the debtors must pay at least 5% to general unsecured creditors (good faith test in Buffalo, New York).
For example, if the chapter 7 test indicates that the creditors would be paid $10,000, the disposable income test indicates the creditors would be paid $9,000, and the %5 test indicates that the creditors would be paid $4,000; then the debtors must pay no less than $10,000 over the three to five years their creditors.
A chapter 13 is a great way to deal with tax debt. Not only can it eliminate vast amounts of taxes, interest and penalties for low cost, it can wipe away other types of debts as well.
Make sure you have a good attorney that understands how to deal with taxes in bankruptcy. Call the Winspear Law Group today, for a tax bankruptcy consultation.