Liquidating Tax Debt: Overview of Bankruptcy – Chapter 13 and Why to File, Part 4

Series: #9 0f 13

In our last article, we took a look at “cramming,” a way to protect an automobile or other personal property in a Chapter 13 bankruptcy. Another primary reason to choose to file Chapter 13 rather than Chapter 7 is to help reduce a debtor’s tax load.

Chapter 13 can Help Reduce Taxes

Liquidating tax debts.
A chapter 13 is a very effective tool for liquidating large tax and other priority obligations, as it sometimes provides the debtor with more time than a non-bankruptcy setting would allow. If the debtor is self-employed, part of the confirmation order may include the requirement that the debtor make regular ongoing monthly estimated tax payments to the IRS. If this becomes part of a confirmation order and is later breached, the IRS can move for dismissal for breach of the order.

  1. Secured tax claims
    A tax liability is secured to the extent that the debtor has equity in property if the taxing agency has filed a lien in the debtor’s county of residence. One should always verify that the lien was recorded in the correct county. In determining the amount of the secured claim, the equity that the debtor lists in schedules A and B is totaled.

    Special note: the IRS asserts that their claims are also secured to the extent that the debtor has any interest in a retirement fund or a 401k, even though this is an asset that is generally excluded from, or exempted out of the bankruptcy estate. See In re Wesche, 193 B.R. 76 (Bankr. M.D. Fla. 1996) stating that federal tax lien attaches to all interests in pension, not just current benefits. This is very important because if the debtor has a retirement fund, the IRS secured claim that may have appeared to be minimal based on the equity in personal property can become unmanageable, even in a Chapter 13.

    To the extent that the secured claim extends beyond the equity available to support it, the balance will fall to priority or general unsecured under 11 USC § 507 – Priorities*(a)(8) analysis.

    Also remember, that the equity is applied to oldest liabilities first. This means that if the debtor has priority tax liability and general unsecured tax liability (and the tax authority has a lien) the lien will attach to the general unsecured portion first thus increasing the overall amount that must be repaid.

    Secured real estate taxes are also paid through the plan. Generally only the pre-petition amount due is paid, but if the next semi-annual installment is due shortly, and the taxing agency agrees, that post-petition obligation may also be included. Real estate taxes are paid with interest of 8%.

  2. Priority tax claims
    Again, taxes are prioritized in §507(a)(8), but briefly they include income taxes, trust fund taxes and some property taxes.One thing to be aware of in determining the priority afforded personal income tax liabilities is the term of art “tolling”, which has now been codified at the end of §507(a)(8).

    Tolling is a rule that provides that any time previously spent in a bankruptcy (any chapter) or when the government unit was prohibited from collecting a tax under applicable non-bankruptcy law will extend the reach back period for pulling tax years into priority status; an additional 90 days is added to time period. Tolling applies only to pre-petition debt, but you need to be aware of any previous bankruptcies, as it can be a rude surprise to find that taxes due in 2002 retain their priority status in a 2008 filing.

    For example, the debtor previously filed a chapter 13 bankruptcy in March, 2004. In this bankruptcy, 2002 taxes are priority under §507(a)(8)(A)(i) due three years before the date of the filing of the petition. The 2004 bankruptcy was dismissed in December, 2006. Thus the debtor was in the bankruptcy for 34 months. Taxes originally due April 15, 2003 plus three years is April 15, 2006 plus an additional 37 months is May 15, 2009!!

    So, a bankruptcy filed anytime before May 16, 2009 will pull the 2001 debt into priority status.Other priority taxes that must be fully paid inside the plan include trust fund taxes (that portion that the employer withheld but did not remit to the taxing agency), and personal property taxes due within one year prior to the current bankruptcy filing. A word about trust fund taxes — they are attributable to the responsible party of the employer. This determination is made by the IRS.

  3. General unsecured taxes
    ”Stale taxes”, those that are older than three years, and the penalty portion of priority taxes are general unsecured liabilities and are paid with the pro rata distribution afforded to other general creditors.

Next: Avoiding Liquidation of Non-exempt Assets

* Source: Cornell University Law School Legal Information Institute


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*Disclosure required by 11 U.S.C. § 528(a)(3): We, the law office of Tom Scott & Associates, P.C., are a debt relief agency. We help people file for bankruptcy relief under the Bankruptcy Code.