Tax Debt


Tax Debt In Chapter 13 and Chapter 7 Bankruptcy

Tax debts are treated differently in the two bankruptcy chapters: Chapter 7 & Chapter 13. Tax debt may be classified as secured, priority or unsecured debt.  Secured means that the taxing service has a lien on your property, and thus you have no exemptions for the IRS debt.  Priority means it is non-dischargeable in a chapter 7 but you can stop interest and penalty in a chapter 13 and could pay the tax off in a 3 to 5 year plan.  Unsecured means it can be discharged in a  chapter 7 and you have no liability left after the discharge: though, in a chapter 13, you would pay it through the repayment plan. To discharge tax debt in a Chapter 7 bankruptcy following requirements must be met:

  • The taxes are income-based.  The tax debt must be for federal or state income taxes or taxes on gross receipts.
  • The return was due at least three years ago. The taxes must be from a tax return that was due (including all valid extensions) at least three years before you filed for bankruptcy.
  • You filed the return at least two years ago. You must have filed the tax return at least two years before filing for bankruptcy
  • The taxes were assessed at least 240 days ago. The taxing authority must have assessed the tax (entered the liability on the taxing authority’s records) against you at least 240 days before you filed for bankruptcy. This time limit may be extended if there was an offer in compromise between the taxing authority and you or if you had previously filed for bankruptcy
  • No fraud or willful evasion. The tax return must not be fraudulent or frivolous and you must not be guilty of any intentional act of evading the tax laws. If you file a joint return, the taxing authority must prove that both you and your spouse committed an act of fraud related to the applicable return or willfully attempted to evade the tax in order for the court to deny the discharge of the tax debt

If you have a tax lien against you and consequently file a chapter 7, the lien would attach only to the property you own till the date of the bankruptcy and would not be attached to the after-acquired property. The lien will not be discharged but only be enforceable against your property that you owned till the file date of the bankruptcy.  Thus, a Chapter 7 discharge eliminates your personal obligation to pay the tax and will prevent the taxing authority from attaching your bank account or wages.  Although you would no longer be personally liable for the tax debt, your property will remain subjected to the amount of the tax lien.

Chapter 13 Bankruptcy and Tax Debt

The unsecured tax debt is treated as a credit card and get pennies on the dollar, while the tax debt less than 3 years old will be treated as a priority creditor.  Priority debts must be paid in full but do not receive interest nor do accumulate penalties.   On the tax debt that has liened up on you, payment equal to the value of all of your property must be made, but you can cram tax liens just like you cram a car, the difference is that you have no exempt asset for the purposes of IRS. Thus, if you owe IRS $25,000 but your property is valued at $20,000, then you would have to pay back $20,000 but the $5,000 would be unsecured and will receive a percentage on the dollar.

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