Tax debt is one of the common reasons people file for bankruptcy relief under Chapter 13. Most income tax debts are non-dischargeable debts in bankruptcy. What does that mean for you? That means you cannot get rid of most income tax debts by filing for bankruptcy relief. You must pay that tax debt even though you file for bankruptcy under Chapter 7 or Chapter 13.
A benefit of filing Chapter 13 bankruptcy instead of Chapter 7 bankruptcy is that you can pay your tax debt over a five-year plan. However, that debt repayment plan must be through your Chapter 13 bankruptcy instead of an IRS installment plan.
One question I would have for you is whether having the installment agreement in the Chapter 13 would force a dismissal because the costs are too high. If you are interested, we built the debt resolution options calculator to help estimate options if your bankruptcy does go to dismissal.
How Is an Existing IRS Installment Plan Treated in Chapter 13?
If you are currently paying your tax debts through an IRS installment plan, you will not be allowed to continue with that installment plan if you file for bankruptcy relief under Chapter 13. Instead, you will pay the IRS through your bankruptcy plan over three to five years.
The tax debt is considered a priority debt, meaning that it must be paid in full through your Chapter 13 plan. Some benefits of including income tax debt in a Chapter 13 plan instead of continuing an IRS installment plan include:
- You may have longer to pay the tax debt through Chapter 13 than through an IRS installment plan (depending on how much time you have left on your install agreement)
- Some of your income tax debt may be dischargeable, so you might be able to get rid of that portion of the debt for pennies on the dollar instead of full payment of the debt
- The IRS cannot charge additional interest unless it has an IRS tax lien for the debt owed
- A Chapter 13 bankruptcy may stop the IRS from charging additional penalties on tax debts
- The bankruptcy automatic stay prevents the IRS from taking further action to collect the debt as long as you are in Chapter 13 bankruptcy and making your bankruptcy payments
Another benefit of filing Chapter 13 bankruptcy to get rid of tax debt is that you can get rid of other debts. If you owe credit card debts, medical bills, and other unsecured debts, you may be able to discharge those debts for a small percentage of what you owe. Therefore, when you complete your Chapter 13 plan, you do not owe any tax debt, and most, if not all, of your unsecured debts are discharged. You could end your Chapter 13 bankruptcy and only owe your mortgage payments.
Requirements Regarding Income Taxes During a Chapter 13 Bankruptcy
During your Chapter 13 bankruptcy, you must file all required tax returns as they become due. Failing to file required tax returns could result in a dismissal of your Chapter 13 bankruptcy. You are also required to pay your taxes as they become due. Therefore, you cannot include post-petition taxes in your current Chapter 13 plan.
What Happens if I Owe Income Taxes During My Chapter 13 Bankruptcy?
If you owe income taxes, you likely did not have enough payroll taxes withheld from your income. Talk to your bankruptcy lawyer about increasing your withholding before filing a Chapter 13 bankruptcy. If you increase your payroll withholding amount, you may need to wait a few months before filing Chapter 13 so that your income decreases on the Means Test. You might have less income in your paycheck each week, but it can prevent owing income taxes in the future. It also lowers your average monthly income, which can lower your Chapter 13 plan payments.
If you find that you owe income taxes during your Chapter 13 plan, immediately notify your Chapter 13 bankruptcy attorney. You might be able to receive permission to enter an IRS installment agreement for post-petition income tax debt. Your attorney may also petition the court to amend your monthly budget to allow for the tax payments, which could lower your Chapter 13 plan payment for the remainder of your Chapter 13 bankruptcy.
However, it is best for you to take steps before filing Chapter 13 to avoid owing income tax debts during your Chapter 13 bankruptcy. The goal is to complete your Chapter 13 plan to receive a fresh start. You do not want to exit Chapter 13 with more tax debt than you had when you filed for bankruptcy relief.
Get Help with Debts You Cannot Afford to Pay
Ascend can help you find a bankruptcy lawyer near you to discuss bankruptcy options during a free consultation. We also have several resources you can use to decide whether bankruptcy or non-bankruptcy debt relief options are best for your situation.
There is hope for a fresh start. Our mission is to help you find the best way to get that fresh start that is affordable and efficient for you.