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.
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.