How Does Chapter 13 Bankruptcy Affect Your Federal Taxes?

Andrea Miller
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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.

What Types of Tax Debts Are Priority Obligations?

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:

How Does Chapter 13 Bankruptcy Affect Your Federal Taxes?
  • Income tax obligations, except those that meet specific criteria described below
  • Withheld or collected taxes that were not remitted, such as payroll or sales tax
  • Fees associated with nondischargeable tax
  • Property taxes incurred less than a year before your bankruptcy filing
  • Customs duties, employment, and certain excise taxes

Tax debt that has resulted in a lien is a secured obligation, which is always considered a priority debt.

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When Is Tax Debt a Non-Priority Obligation?

Income tax is not considered a priority debt when it meets all these conditions:

  • The deadline to pay the debt was more than three years before your bankruptcy filing.
  • The tax return for the debt in question was filed more than two years before your bankruptcy filing.
  • You did not commit willful tax evasion or fraud.
  • The IRS’s liability assessment for the debt took place more than 240 days before your bankruptcy filing.

What Else Do I Need To Consider?

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.

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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.

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Examples of necessary items you may be able to use the refund for include:

  • Vehicle replacement or repair
  • Appliance replacement or repair
  • Medical, dental, or funeral expenses

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.

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What Steps Should I Take?

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.

Should I Apply for Chapter 13 Bankruptcy?

This type of bankruptcy may be an effective method of debt relief for you if:

  • You have a good income but are behind on your bills and unable to make immediate payment.
  • You have property that you want to arrange to keep and continue paying for, such as a home or vehicle.
  • You want to eliminate high-interest debts such as credit card and medical bills.
  • You want to avoid foreclosure, and foreclosure may already be in progress.
  • You have less than $394,725 in unsecured debt and less than $1,184,200 in secured debts such as mortgage and car loans.
  • You are willing to undergo credit counseling and pay a filing fee.
  • You have not had another bankruptcy filing discharged in the past 180 days.

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.

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Andrea Miller
Expert Contributor
Last Updated: