Chapter 13- Under-appreciated tax tool

Chapter 13 of the Bankruptcy Code offers powerful and inexpensive solutions for the individual with tax troubles. The debtor can 

  • discharge tax penalties; 
  • eliminate tax liens or reduce liens to the present value of his assets; 
  • impose an interest free repayment plan for recent taxes

In contrast to installment plans and offers in compromise,  Chapter 13 plans need only to meet statutory requirements to be accepted by the court, require minimal paper work, and are arbitrated by a judge in the event of disagreements between debtor and taxing authority.

A working knowledge of Chapter 13 allows tax professionals to evaluate all the options for their tax delinquent clients.

Overview of Chapter 13 

Chapter 13 is a repayment plan, available only to individuals with regular income and debts below statutory caps. The debtor proposes a repayment plan based on his actual and reasonable current living expenses; when approved by the court, the plan binds all creditors to accept its terms as payment in full of their claim.

The Plan The debtor constructs a plan for monthly payments to the Chapter 13 trustee extending over a minimum of three and a maximum of five years. Whether unsecured creditors get nothing, a fraction, or all of their claim is a function of the disposable income available to the debtor after payment of current living and business expenses, the size of the priority claims which must be paid ahead of  unsecured creditors; and the value of the debtor=s non exempt property.

Plan Confirmation  To be confirmed a plan must be proposed in good faith and must meet certain statutory tests:

  • it must give creditors at least what they would have gotten had the case been filed as a Chapter 7; 
  • if creditors are to get less than 100% of their claims, the debtor must devote all of his disposable income to the plan for at least 3 years to 5 years.
  • the plan must provide for payment in full of priority claims, including priority taxes.

Confirmation does not require creditor approval; creditors in Chapter 13 are limited to objecting on the grounds that the plan does not satisfy the statutory requirements for confirmation. Thus, in effect, there is a presumption that the plan will be confirmed, which the creditor must refute.

Taxing authorities have no greater voice in Chapter 13 than any other creditor.

Taxes in 13

Priority claims Priority taxes are, broadly, 

  • those taxes which first came due within 3 years of the filing of the bankruptcy; 
  • those assessed within 240 days of filing or assessable at the date of filing; and 
  • trust fund taxes of whatever age for which the debtor is liable. 

The priority amount includes the tax and the interest to the date of filing on the tax; penalties associated with a priority tax are not priority claims and are treated just as any other unsecured debt, which means they may get little or nothing through the plan. 

Interest on all unsecured claims in bankruptcy stops running upon the filing of the case. Unsecured priority taxes are paid, then, without interest accruing after the filing of the bankruptcy.

The bankruptcy court also has jurisdiction to decide tax disputes related to Chapter 13 cases.

Taxes discharged Non priority taxes, unpaid interest and tax penalties, are discharged at the completion of the plan. The exception deals with tax years more than three years old for which a return has not been on file for two years: under BAPCPA, those taxes are neither discharged nor paid as priority, unless they were assessed within 240 days of the filing.

Tax liens  Liens in Chapter 13 are valued as of the commencement of the case, and generally paid through the plan, so that the debtor emerges from bankruptcy entitled to a release of lien for all taxes of record. The value of the lien that must be paid through the plan is the present value of the equity in the debtor=s assets to which the lien attaches. 

If the lien exceeds the value of the assets available to secure the tax, the portion of the tax exceeding the value of the assets is treated as either a priority claim, if recent, or an unsecured claim, if older. 

The result is that tax liens that have grown huge over years can be stripped down to the actual value of current assets, locked in as to value as of the commencement of the case, and paid over 3-5 years through the Chapter 13 plan. After the bankruptcy discharge, the pre filing lien does not attach to newly acquired property.

Advantages of 13  

How should tax professionals love Chapter 13? Let=s count the ways:

1.Realistic payment schedule  Payment of tax debts through the plan is based on financial reality : monthly payments reflect what is actually available in the debtor=s budget after current living expenses, as opposed to arbitrary national standards.

2. Old taxes and all penalties discharged Non priority taxes and all tax penalties are relegated to the same status as other unsecured debts and may be paid pennies on the dollar.

4. Tax liens frozen Future appreciation of assets subject to tax liens is put beyond the reach of the lien, since the value of the secured lien claim is fixed with reference to the value of the property at the filing of the case.

5. Other creditors discharged Non tax creditors are stayed from collection action during the pendency of the case, thus protecting the debtor=s cash flow for payments into the plan.

6. Discharge unconditional All tax liability that is discharged at the completion of the case is gone forever; in contrast to offers in compromise, there is no condition on the discharge tied to future tax filing.

7. Quick and inexpensive Plans are confirmed within a few months of filing, getting clients prompt closure on the terms of the plan.  Attorneys fees in Chapter 13 typically range from $2500-5000, and are payable in part from the payments the debtor makes to the trustee.

8. No added tax consequences Discharge of debt in bankruptcy does not trigger cancellation of debt income.

Bankruptcy should not be the first choice for the delinquent tax payer, but it may offer significant advantages over installment plans and offers in compromise for the client with tax troubles.

Cathleen Moran
Moran Law Group

More on taxes in bankruptcy | How Chapter 13 works | Bankruptcy basics |

1.  11 United States Code Chapter 13

2.  Debt limits for Chapter 13 are $1,010,650 in secured debt and $336,900 in unsecured debt. They are adjusted every three years.

3.  Defined at 11 U.S.C. 507(a)(8)



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