How Does Chapter 13 Work to
Save So Much on Taxes and Other Debts?
- Tax debts that are old enough are grouped with the
“general unsecured” debts—such as medical bills and credit cards. These
are paid usually based on how much money there is left over after paying
other more important debts. This means that often these older taxes are
paid either nothing or only a few pennies on the dollar.
- The more recent “priority” taxes DO have to be paid in
full in a Chapter 13 case, along with interest accrued until the filing of
the case. However: 1) penalties—which can be a significant portion of the
debt—are treated like “general unsecured” debts and thus paid little or
nothing, and 2) usually interest or penalties stop when the Chapter 13 is
filed. These can significantly reduce the total amount that has to be
paid.
- “Priority” taxes—those more recent ones that do have to
be paid in full—are all paid before anything is paid to the “general
unsecured” debts—the medical bills, credit cards, older income taxes and
such. In many cases this means that having these “priority” taxes to pay simply
reduces the amount of money which would otherwise have been paid to those
“general unsecured” creditors. As a result, in these situations having tax
debt does not increase the amount that would have to be paid in a Chapter
13 case, which is after all based on what the debtors can afford. In our
example, the couple pays $500 per month because that is what their budget
allows. That’s the same amount they would have to pay even if they owed
nothing to the IRS! The couple meets their obligations under Chapter 13 by
having most of their plan payments go to the IRS recent tax debts, and
likely nothing to their other creditors or older IRS debts.
- The bankruptcy law that stops creditors from trying to
collect their debts while a bankruptcy case is active—the “automatic
stay”—is as effective stopping the IRS as any other creditor. The IRS can
continue to do some very limited and sensible things like demand the
filing of a tax return or conduct an audit, but it can’t use the
aggressive collection tools that the law otherwise grants to it. Gaining
relief from collection pressure from the IRS AND all the rest of the
creditors is one of the biggest benefits of Chapter 13.
Deciding Between Chapter 7 and 13
for Income Taxes
If, unlike the example, all of the
taxes were old enough to meet the conditions for discharging them under Chapter
7, there would be no need for a Chapter 13 case. On the other hand if more
“priority” tax debts had to be paid than in the example, the debtors would have
to pay more into their Chapter 13 plan, either through larger monthly payments
or for a longer period of time.
There are definitely situations
where it is a close call choosing between Chapter 7 or Chapter 13. And
sometimes preparing an offer in compromise with the IRS—either instead of or
together with a bankruptcy filing—is the best route. To decide which of these
is best for you, you need the advice of an experienced bankruptcy attorney to
help you make an informed decision and then to execute on it.
