If you owe federal taxes and other debts you cannot pay, you may be a candidate for Chapter 13 bankruptcy. If you qualify, the tax court will develop a plan to repay your debt over three to five years based on the amount of money you have available after approved cost-of-living expenses.
Tax debts are treated differently by the bankruptcy court depending on whether they are categorized as priority or nonpriority debts. The latter category, which also includes unsecured debts such as credit cards and medical bills, will be discharged after you complete your repayment plan. Priority debts, on the other hand, must be repaid under the plan.
In most cases, an unpaid tax is considered a priority debt and must be completely repaid during your Chapter 13 repayment plan. This categorization may be advantageous since your tax debts will be fully paid within a few years with an affordable monthly payment. Because your available debt repayment funds are devoted to priority debts first, the amount dedicated to nonpriority debts will be limited.
Tax debts that are categorized as priority debts include:
Tax debt that has resulted in a lien is a secured obligation, which is always considered a priority debt.
Income tax is not considered a priority debt when it meets all these conditions:
Although filing for bankruptcy will discharge non-priority tax debt, it does not remove any liens placed on your personal property for that debt. Only repaying the debt can resolve the lien, so you may want to explore options such as an offer in compromise with the IRS. This compromise is an agreement in which you can repay the debt for less than the total amount that you owe.
If you are in the process of filing for Chapter 13 bankruptcy and receive a tax refund, the court may use it to repay your creditors. That is because your repayment plan requires that all disposable income be applied toward your debt. Because your tax refund was not included in your repayment plan, it is considered a surplus that is disposable.
In some cases, however, you may be able to account for an upcoming tax refund in your repayment plan so that you can keep it and apply it to your approved living expenses. You will then need to modify your repayment plan for subsequent years with the amount of the tax return you want to use for expenses, how it will be used, and the date you expect to receive it.
Examples of necessary items you may be able to use the refund for include:
If you accrue tax debt while you are completing a Chapter 13 plan, the amount will be added to your repayment plan for subsequent years.
If you are overwhelmed by debt, talk with a bankruptcy attorney. He or she will review your financial situation and determine whether bankruptcy could give you a fresh start as well as how the court will likely treat your tax debt.
Gather all your IRS paperwork for any years in which you owe taxes. This paperwork should include the tax account transcript from the IRS, which lists the amount of the tax, the date on which it was assessed, whether any property liens have been recorded, and whether the statute of limitations was tolled at any point during collection actions.
Your bankruptcy attorney will list all your outstanding tax debt and the agency to which it is owed as part of your court filing. The IRS or your state and local tax agency have 180 days to respond to the filing. If they fail to do so, the tax debt may be treated as nonpriority debt and eventually discharged.
This type of bankruptcy may be an effective method of debt relief for you if:
After the court approves your Chapter 13 repayment plan, you will make one monthly payment to a trustee, who is responsible for distributing the funds to your creditors as agreed. Although late payments may cause your dismissal from the plan, you can seek a modification of the terms if your income changes. You can also repay the plan sooner and receive an early discharge.
If you are not sure how to handle your debt, get started with Solvable today. We can match you with experienced companies that provide solutions for your student loans, credit cards, and tax obligations so that you can get back on your feet financially.