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Your Comprehensive Guide on How Taxes Are Handled Under Chapter 13 Bankruptcy


March 11, 2022 ( Newswire) US National Debt has not hit $30 trillion dollars. Are you unable to meet your debt obligations, and your creditors are threatening to sue you? Have you recently gotten a letter with a return address of PO Box 1280 Oaks PA? Inside that envelope could lie a letter letting you know that your creditor is pursuing you for the debts you owe. While filing for bankruptcy comes with a lot of stigma and side effects, it has its benefits - like stopping any debt-related lawsuits for the time being. The main advantage is the ability to spread your tax debt according to the terms of your bankruptcy plan. Therefore, the IRS will not seize money from your bank accounts, and you can follow a payment plan with reasonable interest rates. These rates are significantly lesser than IRS penalty repayments plans would have cost. Here is an in-depth guide on how tax obligations are handled under Chapter 13 bankruptcy.

Understanding The Two Types of Income Tax Debt Under Chapter 13

Priority tax debts are obligations that can't be wiped out. Therefore, they must be repaid in full according to your Chapter 13 plan within three to five years. On the other hand, non-priority tax debt is repaid in small portions from your disposable income. However, the remaining balance gets written off once you get your bankruptcy discharge.

Although priority tax debts must be repaid, filing for bankruptcy is advantageous as your interest on tax debt will stop accruing. Additionally, chapter 13 stops any additional penalties on your tax debt.

Non-priority tax debt is considered an unsecured creditor. Therefore, any non-priority tax will get a percentage of the total amount owed according to the chapter 13 plan. Any outstanding amount for these tax debts is discharged after filing for bankruptcy. Thus, you will not be legally obliged to repay the outstanding amount, and the creditor cannot take any collection efforts to recover the debt.

Nonetheless, there is a certain percentage of outstanding non-priority tax debt you must pay. The percentage will depend on your disposable income, recent financial transactions, and assets. So, your financial situation and net worth will determine how much non-priority tax debt can be discharged. In some cases, you can be lucky to get rid of 1 cent on the dollar.

Which Criteria Is Used to Classify a Tax Debt as Nonpriority?

Your ability to get rid of tax debts after filing for bankruptcy depends on the type of debt. Is it a priority or non-priority tax debt?

It is a relief to know you can discharge some taxes and the interest or penalties attached to these taxes. However, determining which taxes can be discharged and which cannot is overwhelming. Here is a criterion used to determine which debt is a non-priority;

The 3-2-240 Rule:

This is the Bankruptcy Code used by the IRS to determine if your outstanding taxes are dischargeable. It is the 3-year, 2-year, and 240-days rule. Here is a breakdown of each;

  • Three Years - the tax debt must have been due for at least three years before filing for Chapter 13. Since most tax obligations are due on April 15 each year, add three years to your due tax dates and determine when you can file for bankruptcy to discharge your taxes. For example, your 2018 taxes were due in April 2019. So, if you want to file for bankruptcy to discharge these tax debts, you can file for bankruptcy in April 2022. An exception is if you get an extension on the time to file. For example, if your 2018 taxes were due in April 2019, you get an extension to file the taxes on October 15, 2019. Therefore, you will need to wait until October 15, 2022, to file bankruptcy.
  • Two Years - it states that you need to file income tax returns no less than two years before filing for Chapter 13. This rule requires you to discharge your taxes, irrespective of whether you file the forms late, provided they are filled two years before your bankruptcy petition. For example, if you should have filed your 2009 income taxes on April 15, 2010, but didn't file them until April 2011, you cannot file for bankruptcy until April 2013
  • 240 Days - This rule states that the IRS must assess your taxes 240 days before filing for chapter 13. Assuming the taxing agency agrees on the amount of taxes you filed, the original date of the IRS assessment should be around the date you filed your taxes.

Once you meet these three requirements, your tax obligation can be discharged. However, you can only discharge non-priority tax debt if you did not file fraudulent returns or didn't evade paying the taxes.

What Is a Tax Lien? - Secured Tax Debts

When your tax debt is overdue, the tax-collecting agency will send notices demanding payment. When these notices go unanswered, the government could place a lien on your assets. A tax lien refers to a legal claim by the government against your assets or those of a business that has lagged back on paying taxes.

If you agree to a repayment plan, the government may remove the lien. However, if you fail to satisfy the obligation, the government may seize your assets. Liens are placed on secured tax debts, debts which you must offset under the Chapter 13 plan for the lien to be removed.

Fortunately, secured tax debt is limited to the total value of the asset. Therefore, amounts above the lien become unsecured debts. For example, if the IRS filed a $60,000 lien against you, and your net assets total $15,000, you are obliged to pay $15,000. So, the remaining $45,000 is unsecured debt. However, the unsecured debt needs to be vetted using the 3-2-240 rule to determine if it is dischargeable.

What is the Chapter 7 Cost in Relation to Chapter 13 Bankruptcy?

Many people consider Chapter 13 bankruptcy because their tax debts may be handled, but if your tax debt exposure is small, should you file Chapter 7 bankruptcy instead? If so, what's the cost of Chapter 7 bankruptcy? Chapter 7 bankruptcy is often much more affordable.

The cost of Chapter 7 bankruptcy is determinant often by your location. For example, you may be wondering, "how much does it cost to file bankruptcy in New Jersey? Or how much does it cost to file bankruptcy in Florida?"

Chapter 13 Effect on Other Types of Tax Debts

Although you can discharge income tax debt, not all types of tax debts can be discharged. Here are other types of tax debt;

  • Employee Payroll Taxes- employers are responsible for employee payroll taxes. Thus, they cannot discharge taxes they did not pay, making them ineligible for discharge
  • Tax Refunds- you cannot discharge tax refunds that you received erroneously
  • Employer Payroll Taxes- they can be discharged under Chapter 13 can be
  • Sales Taxes - since sales tax is not paid to the government, it is not dischargeable
  • Property Taxes- are not dischargeable and should be paid within a year of filing chapter 13.
  • Tax Penalties- they can only be discharged on non-priority tax debts

There are more types of taxes that can and cannot be discharged even after filing for bankruptcy. Therefore, schedule a consultation with a bankruptcy lawyer for help reviewing your current tax debts.

Should You File Chapter 13 Bankruptcy to Get Rid of Tax Debts?

Most people sinking in debt consider filing for bankruptcy a better option to handle tax debts. However, tax debts can be a little complicated. Therefore, you need to fully understand how tax debt works under Chapter 13 and if your tax debts qualify for discharge. If you're wondering whether or not bankruptcy is right for you, consider taking a "Should I File For Bankruptcy Quiz." This can help you estimate how effective bankruptcy can be for you.

When filing for bankruptcy, remember to include all your tax debts in the chapter 13 plan. If you leave out some tax debts, they will survive bankruptcy filing, and you will be legally obliged to pay them. Seek expert advice to understand if filing Chapter 13 bankruptcy is the best option for you.

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