File Your Tax Returns Late, Owe IRS Interest Later: What Creditors Need to Know
For over 25 years, I worked as a debtor’s attorney, filing over 4,000 consumer bankruptcy cases under Chapter 7 and Chapter 13. Now, as an attorney representing creditors in Texas, I see the impact that tax issues can have on a debtor’s financial recovery. One such issue involves the accrual of IRS interest when tax returns are filed late. This is a potential “gotcha” for debtors, and it can complicate the process of bankruptcy, even when debts are paid in full in a Chapter 13 plan.
IRS Interest Continues to Accrue
In a Chapter 13 bankruptcy, priority debts like taxes are typically paid in full over the life of the plan. However, if tax returns are filed late, the situation changes. Even if a debtor proposes a plan that pays the tax debt in full, interest continues to accrue during the life of the bankruptcy plan. As a result, the debtor will still owe this interest when the bankruptcy case is complete.
This issue can be especially complicated for creditors seeking to recover tax debts in bankruptcy cases, as the interest on late-filed tax returns is not dischargeable. This means that while the tax debt itself may be resolved in a Chapter 13 plan, the interest will continue to accrue and remain the debtor’s responsibility after the plan is complete.
Priority Debts and Taxes in Bankruptcy
Priority debts are those that the bankruptcy code mandates be paid before unsecured debts like credit cards and medical bills. Among these, certain income taxes are considered priority debts, meaning they must be paid in full in the Chapter 13 plan. The main categories of priority taxes include:
- Taxes from the last three tax years: These must be paid in full.
- Taxes assessed by the IRS within 240 days of filing: These also must be paid in full.
However, while the tax debt is a priority, interest and penalties that accrue after the bankruptcy filing are not included in the Chapter 13 plan. The debtor is only responsible for paying the taxes owed up to the filing date. The interest that accrues after the filing continues to be a liability for the debtor once the case is completed.
What Happens When You File Your Tax Returns Late?
If tax returns are filed late, the IRS considers the taxes owed from those returns to be non-dischargeable in bankruptcy. This means that even if the tax returns are from the last three years or were assessed within the 240-day period, the taxes owed from late-filed returns remain a priority debt and cannot be discharged.
For creditors, this means that the debtor is still required to pay these taxes in full during their Chapter 13 plan. However, it also means that the interest that accrues on these late-filed taxes is not discharged and will continue to be owed after the bankruptcy case is concluded. While penalties associated with late tax returns are typically discharged, the interest remains the debtor’s responsibility.
The Impact on Debtors and Creditors
From a creditor’s perspective, this can be a favorable outcome, as it ensures that the debtor will continue to owe the interest on the taxes even after their bankruptcy case is over. However, from the debtor’s point of view, this is an additional cost that they must contend with once their bankruptcy is completed. While the principal tax debt may be paid off through the Chapter 13 plan, the continued accrual of interest can complicate the debtor’s financial recovery.
For debtors, the good news is that in most cases, the penalties associated with the late-filed taxes are discharged. While the accrued interest may add to the total amount owed, the debtor’s tax liability should be significantly reduced once the Chapter 13 plan is completed.
Seeking Legal Advice
Navigating tax issues in bankruptcy can be complex, particularly when dealing with late-filed returns and the ongoing accrual of interest. As an attorney who has spent years representing debtors and now represents creditors seeking to recover debts from Texas debtors, I highly recommend seeking experienced legal counsel to understand your rights and obligations in these cases.
If you are a creditor looking to recover tax debts in a Texas bankruptcy case, it’s crucial to work with an attorney who understands the nuances of tax liability in bankruptcy, including how late-filed returns can impact the outcome.
