Priority Income Tax Debts under Chapter 13

Posted by Kevin on July 29, 2020 under Bankruptcy Blog | Comments are off for this article

In the last blog, we discussed the advantages of paying priority debts through a Chapter 13 “adjustment of debts” case. We referred to recent income taxes as one of the most important kinds of priority debt. Today we show how Chapter 13 can greatly help you take care of recent income tax debts.

Recent Income Taxes Can’t Be Discharged

The law treats some, usually more recent, income tax debts very differently than other, usually older, income tax debts. Generally, new income taxes are “priority” debts and can’t be discharged (written off) in bankruptcy.

There are two major conditions determining whether a tax debt can be discharged. (There are other conditions but they are not very common so we don’t address them here.) Bankruptcy does NOT discharge an income tax debt:

1. if the tax return for that tax debt was legally due less than 3 years before you file your bankruptcy case (after adding the time for any tax return-filing extensions) U.S. Bankruptcy Code Section 507(a)(8)(A)(i).

OR

2. if you actually submitted the tax return to the IRS/state less than 2 years before you file the bankruptcy case. Bankruptcy Code Section 523(a)(1)(B)(ii).

Two Examples

Assume you filed a bankruptcy case on December 10, 2019. You owe income taxes for the 2017 tax year. The tax return for that tax was due on April 17, 2018 (because of a weekend and holiday). (This assumes no tax return filing extension.) That’s much less than 3 years before the December 1, 2019 bankruptcy filing date. So, no discharge of the 2017 tax debt, because of the first 3-year condition above.

As for the second condition above, assume again that you filed your bankruptcy case on December 10, 2019.  This time change the facts so that you submitted the tax return late for the 2015 taxes, on October 1, 2018. That’s less than two years before the December 10, 2019 bankruptcy filing date. So because of the second condition above, taxes due for 2015 would not get discharged in bankruptcy

Meeting either of the two conditions makes the tax debt not dischargeable. In the second example immediately above, more than 3 years had passed since the deadline to submit the tax return. (The 2015 tax return was due on or about April 15, 2016.) But less than two years had passed since the actual submission of the tax return. So, no discharge of the tax debt.

With no discharge, you would have to pay that income tax debt after finishing a Chapter 7 case. But there are advantages of paying this priority debt in a Chapter 13 case.

Advantages of Paying Priority Income Tax Debts in Chapter 13

Under Chapter 13:

1. You are protected from aggressive collection by the IRS/state not for 3-4 months as in Chapter 7 but rather 3-5 years.
2. This includes preventing any new recorded tax liens, and getting out of any installment payment plans.
3. The amount you pay monthly to all your creditors, including the priority tax, is based on your actual budget. It’s not based on often arbitrary requirements of the IRS/state.
4. The amount your priority tax gets paid each month (if any) among your other debts is flexible. You do have to pay all of the priority tax debt(s) by the time you finish your Chapter 13 case. That’s up to a maximum 5 years. But other more urgent debts (such as catching up on a home mortgage) can often get paid ahead of the taxes.
5. Usually you don’t pay any ongoing interest or penalties on the tax during the Chapter 13 case. That takes away the need to pay it quickly. Plus the lack of additional interest and penalties significantly reduces the amount needed to pay off the tax debt.
6. If the IRS/state recorded a tax lien against your home or other assets before you filed bankruptcy, Chapter 13 provides a very efficient and favorable forum to value and pay off that secured portion of the priority debt.