Penalties for unpaid federal taxes are still dischargeable when filing for bankruptcy, but they will accrue post-petition interest that is owed to the IRS. Debt limit amounts have changed for Chapter 13 cases, as of April 1, 2016.
Editor: We recently discussed the changes in the bankruptcy laws with Christopher Holmes, Jess M. Smith, III, partners at Tom Scott & Associates, P.C., along with associate attorney Andrew DeYoung. Below is Part 3 of 3 of the transcript of the conversation.
Q. What else is new in bankruptcy law?
Chris Holmes: Some of our clients have received letters from the IRS. We thought certain taxes or certain penalties or certain interest on taxes were going to go away, upon discharge. But now the IRS is coming after people—after discharge—for non-dischargeable penalties and interest on taxes that were fully paid through the Chapter 13 plan. In the good old days we would tell people that once you’re done with that Chapter 13 plan, you’re done with the IRS; you’re done with the Indiana Department of Revenue; you have no more tax worries. Now we’re finding out that is not always true, depending upon when the tax returns were filed. So, in affect, the IRS is punishing people for not filing their tax returns in a timely fashion. So, if tax returns are not timely filed and they’re filed within two years of the filing of a bankruptcy case, those taxes are not dischargeable nor are the penalties and interest thereon. Previously, you would throw those taxes in the plan, pay them in full, and then the penalties and interest would be discharged.
Jess Smith, III: Now they’re boarding up the penalties, but accruing post-petition interest.
CH: So the penalties are still dischargeable; it’s just the interest that’s still accumulating, and will be there at the end of the road. So, now we get these calls from our clients saying, "Hey, what’s going on? I got this letter from the IRS," and we have to give them the sad news that when the law changed back in 2005, there was a provision in there that allows the IRS to collect these interest charges on debts that were otherwise fully-paid through the plan.
Andrew DeYoung: Starting April 1 of this year, and this only relates to Chapter 13 cases, the debt limits are going up. That means the amount of unsecured debt that you have is increasing about $10,000. Debtor’s going into bankruptcy are able to have another $10,000 owed out and still will qualify for a Chapter 13 case. It’s now $394,725, up from $383,175. For secured debt, the amount is now $1,184,200, up from $1,149,525. It changes every three years and it can be found in the Federal register if you use the code words "109(e)" or "Chapter 13 debt limit."
CH: It’s pretty rare that someone would have debts of that amount.
AD: One case that we worked on the debtor had purchased some vacant real estate in Florida, when the market was doing very well. He purchased the property for roughly $300,000 to $350,000 per parcel. The value then went down to under $50,000 per parcel. We ran up against the debt limits on that issue. We were luckily able to negotiate with the creditor to work a solution in the Chapter 13, but if the creditor had not agreed to work with us we would not have been eligible for a discharge in Chapter 13 because the secured debt of the debtor was too high. In a case I’m working on now the problem is where the debtor has student loans totaling $370,000. The rest of their unsecured debt is not very high, but with the debt limits only around $390,000, absent an agreement with the Department of Education, we’re not eligible for a Chapter 13.
CH: The consequence would be that they have no choice but to resort to a Chapter 11, which is primarily designed for corporations and individuals with really, really complicated situations — and those cost a whole lot more for attorneys fees and court costs.
AD: In talking to the U.S. trustee, I was advised two days ago that you would be a fool to take a Chapter 11 for under $10,000 (as the attorney fee), which in comparison to our Chapter 13 fee would be a total fee over 60 months of $4000. $10,000 up front in one sum or $4000 over 60 months is quite a big difference.
CH: It’s rare, but once in a while you get a debtor who has that kind of debt, and then you have to really go into how much the really totals out to be. You think it might be a certain amount, but the hope is that it falls under those thresholds so you can just barely make it into a Chapter 13.
Part 1 of Interview: What’s New in Bankruptcy Law in Indiana
Part 2 of Interview: Property You Can Protect When You File for Bankruptcy