Advantages of Paying Your 2018 Income Tax through Chapter 13

Posted by Kevin on January 21, 2019 under Bankruptcy Blog | Comments are off for this article

Say you owe $8000 on your 2018 federal taxes and have $18000 of credit card debt.  If you file under Chapter 7, you should discharge the $18,000 credit card debt, but you will owe the IRS $8000- and they will come after you.

Chapter 13 can help.

Payment of 2018 Income Taxes in Chapter 13 Case

Chapter 13 is a very flexible procedure, especially appropriate for taking care of income tax debt. If you file in 2019, your plan will include taxes owed in 2018.   In fact, that 2018 taxes (and any other years) income tax MUST be paid in full under the terms of your Chapter 13 plan. But the requirement that you pay that tax in full can be used to your advantage in a Chapter 13.

Basic Benefits

No matter what else is going on in your Chapter 13 case, you get three major benefits for paying your 2018 taxes through it.

1. The IRS (and any applicable state income tax agency) cannot harass you during the repayment process.

2. You have much more flexibility on the terms for paying the 2018 tax, including the ability to delay paying anything while focusing on even higher priorities (such as a home/vehicle/child support arrearage).

3. No additional interest or penalties are added while you are in the Chapter 13 case, so you will pay less while paying off the 2018 tax debt.

Paying Off Your 2018 Tax For Free

Sometimes the fact that you owe some recent income taxes can cost you absolutely nothing beyond what you would have had to pay anyway through your Chapter 13 case. How could this be?

The justification for this comes from the Chapter 13 requirement that you must pay all your “disposable income” into your plan each month during the required period of time. Usually that means that all your creditors are scheduled to receive a certain percent of the debt you owe them.  However,  priority creditors (including taxes) and secured creditors are paid first, and then whatever is left over is divided among the “general unsecured” creditors (credit cards).

An Example

Say you have disposable income of $300 per month, a 3 year plan and general unsecured debts of $18,000.  You have to pay into the plan (assuming no trustee or attorney fees for the sake of simplicity), $10,800 (36 months times $300 per month) which would go to “general unsecured” debts.

But now assume that you have a 2018 income tax debt of $8,000. You would still pay $300 per month for 36 months, but now the $8,000 income tax would be paid out first, reducing the amount paid out to the “general unsecured” creditors.  Those creditors would receive only $2,800 ($10,800 minus $8,000) out of the $18,000 owed to them, and you still get a discharge.

Since those 2018 taxes are not dischargeable, you, are, in effect, paying your taxes off the backs of your unsecured creditors.  And you not only discharge your credit card debt but you paid your taxes in full. Not bad.