Resolving your tax debts through Chapter 13 “adjustment of debts” can cost you less than Chapter 7.
The last several blog posts have been about how a Chapter 7 “straight bankruptcy” can often be a good option for addressing income tax debts. But Chapter 13 can give you many advantages with this special type of debt, making it the better option, especially if you owe a relatively large amount of back taxes or owe for multiple years.
Today’s blog post begins a series on advantages under Chapter 13. The overall question to consider—in reading this and the upcoming ones, and then discussing their contents with your attorney—is whether these advantages apply to you, and whether they will outweigh the potential disadvantages of Chapter 13—especially that it takes so much longer.
Chapter 13 Can Cost You LESS in Taxes in 3 Ways…
Advantage #1—Accruing Interest and Penalties:
If you file a Chapter 7 case and then afterwards pay for whatever income taxes that are not discharged (legally written off) through a monthly installment plan, interest and penalties will continue accruing. They will accrue while the Chapter 7 case runs its course, and throughout the monthly payment plan, which can last for several years.
Under Chapter 13, from the moment the case is filed no more interest and penalties accrue (as long as no tax lien has been recorded). By the end of the case, the tax portion has been paid off and the interest and penalties that would have accrued never have to be paid. If the tax amount at the time of filing is relatively large, the savings can be large.
Advantage #2—Prior Penalties:
Under Chapter 7, if you have an older income tax debt which meets all the conditions for discharge, then the tax will be discharged, along with any previously accrued interest and penalties. But if you owe newer income taxes, any previously accrued interest and penalties will have to be paid.
Under Chapter 13, the previously accrued penalties are treated as a “general unsecured” instead of a “priority” debt, which means it is only paid as much as the rest of the “general unsecured” debts. Because often “general unsecured” debts are paid little or nothing in Chapter 13 cases, this means that the previously accrued penalties are paid little or nothing. If the penalties you owe are substantial—and especially if they attach to multiple tax years—this advantage can save you that much more money, reducing how much you have to pay before becoming tax-debt free at the end of your case.
Advantage #3—Tax Liens:
If you have a tax lien recorded on any of the income taxes you owe, Chapter 7 will generally have no effect on that lien. Furthermore, if you have not had a recorded tax lien before your case was filed, once it’s over there is nothing to stop a tax lien from being recorded against you and your assets.
Chapter 13, in contrast, deals very favorably with tax liens. If it is recorded on a tax that is otherwise dischargeable, an efficient mechanism is in place for valuing that lien and paying it off under the protection of the bankruptcy court. If the tax lien is recorded on a tax that is not dischargeable and therefore needs to be paid, the lien will usually have little effect except requiring some interest to be paid. At the end of your successful Chapter 13 case, the IRS and/or state taxing authorities must release any tax liens.
Please come back in the next few days to see how Chapter 13 can also be a more convenient and safer way to deal with taxes than Chapter 7.