tax debt

The previous installment of our series “Basics of Bankruptcy” discussed some of the reasons to file a Chapter 13 bankruptcy vs. Chapter 7 as they relate to cars and other personal collateral. This last installment looks at reasons why Chapter 13 might be the better choice for personal bankruptcy than Chapter 7 when it comes to liquidating tax debt and protecting co-debtors.

Liquidating Tax Debts

Summary: Chapter 13 is an effective tool for liquidating large tax and other obligations, as it can provide the debtor with more time than a non-bankruptcy setting would allow.
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.

• Generally, we see large income and trust fund taxes paid through the plan, and in the last few years, child support cures have become more common.
• Also, 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.

a) 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 13. To the extent that the secured claim extends beyond the equity available to support it, the balance will fall to priority or general under the §507(a)(8)^* analysis. Also remember, that the equity is applied to oldest liabilities first.
Secured real estate taxes are 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%.
b) Priority tax claims: Again, taxes are prioritized in §507(a)(8), but briefly they include income taxes due within the prior three years, trust fund taxes and some personal 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 spent in a prior 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 2003 retain their priority status in a 2009 filing.
As an example: The debtor previously filed a chapter 13 bankruptcy in April, 2004. In this bankruptcy, 2002 taxes (due April 15, 2003) are priority under §507(a)(8)(A)(i) due three years before the date of the filing of the petition.

• If the 2004 bankruptcy was dismissed in April 2007 (the debtor was in the bankruptcy for 36 months). So, taxes originally due April 15, 2003 would retain priority status for three years, plus three years that the debtor was in the bankruptcy plus an additional 90 days.
• Starting from the due date of April 15, 2003 the 2002 tax year retains priority status until July 16, 2009! So, a bankruptcy filed anytime before July 16, 2009 will pull the 2002 debt into priority status.
• Furthermore, if the debtor asked for an extension until October 15, 2003, theses tax debts would be a priority claim until January 16, 2010. These facts may be confusing, but remain extremely important.
• 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.
c) 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.

Protecting a Co-debtor

11 U.S.C. Section 1301^* is otherwise known as the “co-debtor stay”, and prevents a creditor from pursuing a co-debtor on a consumer debt. In order to prevent the creditor from seeking relief from stay, the Debtor must propose in his or her Chapter 13 plan to pay the co-signed debt in full. There is no equivalent provision in Chapter 11 or Chapter 7.

* Source: Cornell University Law School Legal Information Institute (opens in new windows)