Posted by Kevin on April 3, 2017 under Bankruptcy Blog | 
Same facts as previous blog.
- Without a bankruptcy, a couple would have to pay about $30,000 to the IRS for back taxes, plus about another $45,000 in medical bills and credit cards, a total of about $75,000.
- Under Chapter 13, this same couple would pay only about $18,000—36 months of $500 payments.
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.
- “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.
- 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.
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 (but may require additional work in a Chapter 7). 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.
Posted by on March 30, 2017 under Bankruptcy Blog |
If you owe recent income taxes, or multiple years of taxes, Chapter 13 can provide huge advantages over Chapter 7, and over other options.
The Example
Consider a husband and wife with the following scenario:
- Husband lost his job in 2008, so he started a business, which, after a few promising years in which it generated some income, failed in late 2012.
- The wife was consistently employed throughout this time, with pay raises only enough to keep up with inflation.
- They did not have the money to pay the quarterly estimated taxes while husband’s business was in operation, and also could not pay the amount due when they filed their joint tax returns for 2008, 2009, 2010, 2011 and 2012. To simplify the facts, for each of those five years they owe the IRS $4,000 in taxes, $750 in penalties, and $250 in interest. So their total IRS debt for those years is $25,000—including $20,000 in the tax itself, $3,750 in penalties, and $1,250 in interest.
- Husband found a reliable job six months ago, although earning 20% less than he did at the one he lost before he started his business.
- They filed every one of their joint tax returns in mid-April when they were due, and have been making modest payments on their tax balance when they have been able to.
- They have no debts with collateral—no mortgage, no vehicle loans.
- They owe $35,000 in medical bills and credit cards.
- They can currently afford to pay about $500 a month to all of their creditors, which is not nearly enough to pay their regular creditors, and that’s before paying a dime to the IRS.
- They are in big financial trouble.
Without Any Kind of Bankruptcy
- If they tried to enter into an installment payment plan with the IRS, they would be required to pay the entire tax obligation, with interest and penalties continuing to accrue until all was paid in full.
- The IRS monthly payment amount would be imposed likely without regard to the other debts they owe.
- If the couple failed to make their payments, the IRS would try to collect through garnishments and tax liens.
- Depending how long paying all these taxes would take, the couple could easily end up paying $30,000 to $35,000 with the additional interest and penalties.
- This would be in addition to their $35,000 medical and credit card debts, which could easily increase to $45,000 or more when debts went to collections or lawsuits.
- So the couple would eventually end up being forced to pay at least $75,000 to their creditors.
Under Chapter 13
- The 2008 and 2009 taxes, interest and penalties would very likely be paid nothing and discharged at the end of the case. Same with the penalties for 2010, 2011, and 2012. That covers $11,500 of the $25,000 present tax debt.
- The remaining $13,500 of taxes and interest for 2010, 2011, and 2012 would have to be paid as a “priority” debt, although without any additional interest or penalties once the Chapter 13 case is filed.
- Assuming that their income qualified them for a three-year Chapter 13 plan, this couple would likely be allowed to pay about $500 per month for 36 months, or about $18,000, even though they owe many times that to all their creditors.
- This would be enough to pay the $13,500 “priority” portion of the taxes and interest, plus the “administrative expenses” (the Chapter 13 trustee fees and your attorney fees).
- Then after three years of payments, they’d be completely done. The “priority” portion of the IRS debt would have been paid in full, but the older IRS debt and all the penalties would be discharged (written off), likely without being paid anything. So would the credit card and medical debts.
After the three years, under Chapter 13 the couple would have paid a total of around $18,000, instead of eventually paying at least $75,000 without the Chapter 13 case. They’d be done—debt-free—instead of just barely starting to pay their mountain of debt. And they would have not spent the last three years worrying about IRS garnishments and tax liens, lawsuits and harassing phone calls, and the constant lack of money for necessary living expenses.
The next blog post will follow up on this theme.
Posted by on June 11, 2015 under Bankruptcy Blog |
Did You Know…
- The first income tax was enacted during the Civil War, but it expired a few years after the war ended.
- The first peacetime income tax was passed in 1894, an effort of the Populists to get the wealthy to pay a greater share of the cost of the national government. It was a two percent tax on incomes over $4,000 (worth about $108,000 in today’s dollars), which at the time affected only about the top two percent of wage earners.
- The next year the U.S. Supreme Court overturned this law as unconstitutional, in a 5-4 decision. Pollock v. Farmers’ Loan & Trust Co., 158 U.S. 161 (1895).
- A constitutional amendment to allow an income tax was proposed by the Republican President William Howard Taft, and the resolution for that amendment was passed by Congress with the Republicans in control of both the Senate and the House of Representatives.
- The entire Sixteenth Amendment states: “The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration.”
- After the required 3/4ths of state legislatures (36 of the 48 then-existing states) ratified it, on February 25, 1913 the Sixteenth Amendment was proclaimed ratified and became part of the Constitution.
So February 25, 2013 was the 100 year anniversary of the income tax becoming constitutional. Funny, I don’t remember any anniversary celebrations!
The MOST Interesting Facts
As the blogs in this series on taxes have been describing, bankruptcy can help you with income tax debts in a variety of ways. If it’s true that in life the facts that are most interesting to you are those that are going to help your pocketbook, then check out the following facts:
- Some income taxes CAN be forever discharged (legally written off).
- Taxes can be discharged under either Chapter 7 or Chapter 13, depending on which is right for you based on your other circumstances.
- The protection from creditors you receive by filing bankruptcy—the “automatic stay”—protects you from the IRS (and other tax creditors) like any other creditor.
- In a Chapter 13 payment plan, that protection can last for 3 to 5 years, giving you that much time to pay taxes that can’t be discharged.
- Even if you owe a tax that can’t be discharged, a Chapter 7 bankruptcy can put you in a much better position afterwards either to enter into a payment plan or negotiate a settlement.
- Chapter 13 usually stops accruing interest and penalties on tax debts that can’t be discharged, reducing the overall amount you have to pay.
- If you owe a number of years of income taxes, Chapter 13 is often an excellent tool because all your taxes—as well as all your other debts—are handled in one tidy package.
Taxes and bankruptcy DO mix, often greatly in your favor.
Posted by on May 30, 2015 under Bankruptcy Blog |
If you can’t discharge your income tax debt through Chapter 7, or make workable payment arrangements on the remaining tax debt, then Chapter 13 can be a good solution.
The Previous Chapter 7 Options
A consistent theme through these past blogs has been that in many situations you do not need to incur the extra expense and time of going through a three-to-five-year Chapter 13 case when other solutions will work. But Chapter 13 IS often an excellent mechanism for resolving all your income tax debts (and usually all your other debts, too).
Chapter 13 Can Be the Easiest Way to Address Your Income Tax Debts
A Chapter 13 payment plan is often a significantly easier way to deal with income tax debts than the other alternatives because:
1. The payment amount going to the taxes are often more reasonable than the IRS/state would require. That’s because they are based on what you can actually afford, by allowing you more reasonable amounts for your expenses.
2. Your Chapter 13 case incorporates ALL your debts in one package, so that you are not forced to satisfy the IRS/state to the exclusion of other important creditors (such as your mortgage, vehicle payments, and child/spousal support). The taxes may have to wait their turn to be paid after debts that are a higher priority for you, instead of just getting paid first.
3. Putting all your debts into one Chapter 13 package also includes all categories of your income taxes—particularly those that are being discharged and those that aren’t. This avoids the situation under Chapter 7 in which you discharge some of the taxes but then have to deal directly with the IRS/state for the taxes that were not discharged.
4. The payments going to the IRS/state can be adjusted during the course of the Chapter 13 if your circumstances change, usually without much room for their objection.
Chapter 13 Can Be a Cheaper Way to Pay Non-Discharged Taxes
It can be cheaper because:
1. In contrast to the other scenarios, under Chapter 13 usually no more interest and penalties can be added after the case is filed.
2. Often you don’t have to pay even the previously accrued penalties.
3. If you have a tax lien attached to any of your tax debts, the lien can sometimes be paid off more cheaply by paying the secured value of the lien instead of the full tax.
If your tax debt is high, and you are paying into your plan for the full five years, these savings can amount to many thousands of dollars.
Chapter 13 Is a Safer Way to Pay Non-Discharged Taxes
It’s safer because:
1. Instead of being at the mercy of the IRS/state if you are not able to make a payment, under Chapter 13 your “automatic stay” protection from all your creditors—including tax creditors—persists throughout your case. So you are not a hair-trigger away from being hit with tax liens, or levies on your wage and bank accounts.
2. You CAN lose this protection, but if you and your attorney deal with your situation proactively you can usually preserve it.
3. This protection is particularly important when your circumstances change—instead of being at the mercy of the IRS/state, your attorney can make adjustments to your Chapter 13 plan. Or if necessary, even more aggressive or creative steps may be appropriate, such as changing to a new bankruptcy case. The point is that you usually have much more control over the situation.
