The Surprising Benefits: Chapter 13 AFTER the Recording of an Income Tax Lien

Chapter 13 protects you from a recorded tax lien in crucial ways, and can reduce how much you pay on the underlying dischargeable tax debt. 

 

Last week’s blog post was about dealing with a recorded tax lien by filing a Chapter 7 “straight bankruptcy” case.  Usually the IRS’ or state’s recording of a tax lien against you effectively requires you to pay the underlying tax. That’s true even if that tax otherwise qualifies for total discharge—legal write-off in bankruptcy. That’s because a recorded tax lien converts that tax debt from being unsecured to being fully secured by your property and possessions. You pay the tax—sooner or later—to avoid losing what you own.

When Chapter 7 Might Help

Last week we outlined some circumstances in which Chapter 7 might satisfactorily deal with a recorded tax lien. Those circumstances were when the tax lien either failed to apply to any assets you own or the assets were worth much less than the tax debt at issue. For example, the IRS/state may record a lien on your home which in the process of getting foreclosed. If you’re letting the house go then that tax lien has no leverage over you. Your Chapter 7 case would discharge the income tax debt and the subsequent home foreclosure would undo the tax lien.

But these situations are quite rare. Usually a recorded tax lien (or more than one) covers everything you own. Usually the value of your assets encumbered by the lien(s) well exceeds the amount of the tax at issue. Or even if your assets’ value is less than the tax(es) owed, you don’t want to lose those assets. So you have no choice but to pay the tax owed. That’s true even if that tax otherwise qualified to be fully discharged.

However, if filing a Chapter 7 case takes care of all your other debts, maybe that’s okay. It would have been better to file before the tax lien’s recording so you could have just discharged the tax. But if it’s too late for that, clearing the deck of all or most of your other debts so you can concentrate on the tax debt afterwards may be your best option.

When Chapter 13 Could Be Much Better

The last paragraph assumes you could afford to pay the tax covered by the tax lien. But what if after finishing your Chapter 7 case you still didn’t have enough money each month? The protection from creditor collections (the “automatic stay”) you get from filing bankruptcy disappears when the case is over. That’s only about 3-4 months after your bankruptcy lawyer files your Chapter 7 case. With the tax lien putting your assets at risk you’d have tremendous pressure on you to pay the tax. So if you couldn’t afford to pay as fast as the IRS/state would demand you’d have a serious problem.

Filing a Chapter 13 “adjustment of debts” case could significantly help.

First, the automatic stay protection against the IRS/state usually lasts the 3 to 5 years that a Chapter 13 case takes to complete. That alone greatly reduces the constant tension of being at the mercy of the tax authorities. During the Chapter 13 case your assets that are encumbered by the lien are protected from seizure. And your income and other assets are protected from any other tax collection efforts.

Second, you usually have much more flexibility in your payoff of the underlying tax. You have much more control over the amount and timing of payments on the tax debt. Your monthly Chapter 13 plan payments are based on your realistic budget. In earmarking where the money from those payments goes you can often pay other even more urgent debts (such as catching up on a home mortgage or child suport) ahead of the tax debt. You can sometimes delay paying the tax until some future event, like the sale of your home or other asset.

When Chapter 13 Is Even Better

When the assets covered by the tax lien have no present value, Chapter 13 is particularly powerful.

Consider a tax lien on a home with no present equity beyond the prior liens. After a Chapter 7 case the IRS/state could just sit on that recorded tax lien until you built up equity in the home. You’d pay down the obligations and the property would rise in value until there was equity to cover the tax lien. The IRS/state would have huge leverage over you. But under Chapter 13 the bankruptcy judge would declare that there’s no present equity secured by the tax lien. The tax would effectively be unsecured—as if there was no tax lien. You’d lump that tax debt in with your general unsecured creditors. You would likely pay only a small portion of that tax debt. Often you would actually pay no more into your Chapter 13 payment plan as a result of that tax.

For example, assume you owed $10,000 in dischargeable income tax.  The IRS recently recorded a tax lien on your home for that tax. Your home is worth $250,000, has $5,000 in property taxes, $210,000 on a first mortgage and $40,000 on a second mortgage. Owing $255,000 you have no equity in the home. But as you pay down the property taxes and the mortgage, and assuming the property value increases, there’d soon be equity securing the tax lien. But Chapter 13 allows you to freeze the present equity situation. The tax lien presently does not cover any equity in your home, the tax debt is thus unsecured, and would be treated just like the rest of your unsecured debt. Adding the tax debt to your other unsecured debt would usually result in you paying no more than you would have otherwise.

 

The Surprising Benefits: Chapter 7 AFTER the Recording of an Income Tax Lien

Under certain circumstances a recorded tax lien does NOT require you to pay a dischargeable tax after Chapter 7, or at least not in full.

 

The last two blog posts have been about the benefits of preventing an income tax lien recording by filing bankruptcy. That’s especially helpful if the tax at issue is an older one that can be discharged—legally written off. The recording of a tax lien can turn such a tax debt from one you don’t have to pay at all into one that you have to pay in full. (See the IRS Notice of Federal Tax Lien form.)

But what if the IRS or state has already recorded a tax lien against you, before you could file bankruptcy? You’re likely in even more financial distress after that tax lien recording than you were before. Could filing bankruptcy still help with that tax debt even after the lien recording?

Yes, both Chapter 7 “straight bankruptcy” and Chapter 13 “adjustment of debts” could help. They could each do so in different ways. And they could each help whether the tax at issue met the conditions for discharge or instead was a newer tax that did not.

Today’s blog post covers how Chapter 7 can help with a recorded tax lien on a dischargeable tax debt. We’ll cover how Chapter 13 helps in this same tax situation next week.

The Effect of a Tax Lien Recording

In most situations the recording of a tax lien on an otherwise dischargeable tax requires to pay that tax. Again, it turns a tax that you wouldn’t have had to pay into one you have to pay in full.

How does it do that? Basically, IRS’/state’s recording of a tax lien turns an unsecured debt into a secured one. The tax meets the conditions for discharge (mostly by being old enough), but the IRS/state now has rights over your assets. You have to pay the otherwise dischargeable tax if you don’t want to lose those assets.

What assets? Which of your assets would you lose after the recording of a tax lien if you didn’t pay the tax? That’s a crucial question. That’s because under certain circumstances you might not need to pay all the tax, even after a tax lien recording.  You might not have to pay any of the tax. It depends on which of your assets, if any, the tax lien attached to.

Assets Attached by the Tax Lien

Let’s be clear. Most of the time the recording of a tax lien results in you having to pay the tax. That’s because that tax lien attaches to your assets or property that you don’t want to lose. A recorded IRS Notice of Federal Tax Lien, for example, applies to “all property and rights to property belonging to this taxpayer for the amount of these taxes… .”  So if it applies to everything that belongs to you, you pay the tax to avoid losing those assets.

But sometimes the tax lien might attach to little, or even nothing, of value. Or what it attaches to is worth much less than the tax debt. Then you may not end up paying the whole tax debt amount, or even any of it. (See the IRS’ Guidelines for Processing Notice of Federal Tax Lien Documents, including about lien releases and withdrawals.)

Examples

For example, assume you owe $10,000 in old, dischargeable income taxes but own very little—say a total of $2,500 fair market value in household goods and personal effects. There’s a recorded tax lien on that $10,000 debt covering all your property. With a Chapter 7 case you discharge the $10,000 debt, but recorded tax lien on the $2,500 in property survives. The IRS/state has limited leverage in making you pay any more than $2,500. So there’s a good chance you could settle the matter by agreeing to pay around that amount.

Another example: the IRS/state has recorded a tax lien in your county real estate recorder’s office, placing a lien on your home. (Under many state’s laws that recorded lien would only apply to real estate, not to any other personal assets.) But what if you do not own a home or any other real estate in that county? What if you recently lost your home to foreclosure? Or what if your home has no equity at that time and likely won’t for many years? In these scenarios the IRS/state would have to concede that its lien is essentially worthless. Your bankruptcy lawyer may well be able to convince the IRS/state to release or withdraw its lien as being of no collection value.  

 

The Surprising Benefits: Chapter 13 Stops the Recording of an Income Tax Lien

Chapter 7 and 13 can both prevent the recording of a tax lien. But if the tax qualifies for discharge Chapter 7 is quicker and less risky. 

 

Last week we showed how detrimental the recording of an income tax lien can be for you. It can turn a tax that you could fully discharge (legally write off in bankruptcy) into one you’d have to fully pay. We showed how Chapter 7 “straight bankruptcy” could prevent recording of the tax lien and could discharge the tax.

How about a Chapter 13 “adjustment of debts” case? Would filing one also stop an income tax lien recording?  If so, what would happen to that tax debt?

Chapter 13’s Automatic Stay

The filing of a Chapter 13 case stops the recording of a tax lien by the IRS or state just like a Chapter 7 would. Any voluntarily filed bankruptcy case by a person entitled to file that case imposes the “automatic stay” against almost all creditor collection activities against that person and his or her property. (See Sections 301 and 362(a)  of the U.S. Bankruptcy Code.) Those “stayed” or stopped activities specifically include “any act to create, perfect, or enforce” a lien. (See Section 362(a)(4) and (5).)

So filing under Chapter 13 stops a tax lien recording just as fast and just as well a Chapter 7 would.

But Would Chapter 13 Be Better than Chapter 7?

That depends. It depends at the outset on whether the tax is one that qualifies for discharge. If it does qualify (mostly by being old enough) then a Chapter 7 is actually often better.

Under Chapter 7 the automatic stay protection lasts only the 3-4 months that the case is active.  But that’s long enough since the discharge of the tax debt would happen just before the case was closed. Once the tax debt is discharged the IRS/state could no longer do anything to collect that tax. It would certainly have no further ability to record a tax lien on that tax.

What would happen in this situation under Chapter 13, with a tax debt that qualifies for discharge? It would get discharged like under Chapter 7, but with two big differences.

First, the discharge would happened not 3-4 months after case filing but usually 3 to 5 years later.  The automatic stay protection usually lasts throughout that time, preventing tax collection, including the recording of a tax lien. But that long period of time under Chapter 13 does create more opportunities for things to go wrong. That’s all the more true because throughout that time you have various obligations, such as to make monthly Chapter 13 plan payments. If for any reason you don’t successfully complete your Chapter 13 case, the otherwise dischargeable tax debt still won’t get discharged.

Second, under Chapter 13 you may have to pay part of the tax debt before it is discharged. This is in contrast to usually paying nothing on it under Chapter 7. (This assumes that you’d have a “no-asset” Chapter 7 case—in which all of your assets would be “exempt”, protected.) Whether  you’d pay anything on a dischargeable tax debt in a Chapter 13 case, and if so how much, depends on many factors, mostly the nature and amount of your other debts and your income and expenses. But why risk paying something on a tax debt under Chapter 13 if you wouldn’t have to pay anything under Chapter 7?

So Chapter 7 Is Usually Better at Dealing with a Dischargeable Tax Debt?

The answer is likely “yes” if you focus only on this one part of your financial life.

But you may have other reasons to file a Chapter 13 case. For example, you may owe a more recent income tax debt that does not qualify for discharge, in addition to the one that does qualify. Chapter 13 provides a number of significant advantages in dealing with the nondischargeable tax. These could make Chapter 13 much better for you overall.

Or you may have considerations nothing to do with taxes, such as being behind on a home mortgage, a vehicle loan, or child support. Chapter 13 gives you huge advantages with each of these kinds of debts. Your bankruptcy lawyer and you will sort out all the advantages and disadvantages of each legal option to choose the best one.

 

The Surprising Benefits: Chapter 7 Stops the Recording of an Income Tax Lien

The recording of a tax lien often immediately turns an unsecured debt into a secured one, forcing you to pay what you could have written off.

 

If you owe income taxes, stopping the IRS or state record a tax lien can be a huge benefit of filing bankruptcy. How much of a benefit turns on details about the taxes you owe and the type of bankruptcy you file. Today and in our next blog post we’ll look at income taxes that would be discharged (forever written off in full). Today we focus  on the benefits of filing Chapter 7; next week we’ll do the same for Chapter 13.

Secured and Unsecured Debts in Bankruptcy

The leverage that any creditor has over you depends a lot on whether its debt is secured by your property. For example, if a debt is secured by your home, the home is collateral on that debt. In most situations even after filing bankruptcy you have to either pay the debt or you could lose the home.

The Effect of a Tax Lien

If you can’t pay an income tax, that tax debt is an unsecured one. It’s not secured by anything you own. The IRS and state taxing authorities have some powerful collection techniques they can use to collect the tax. But they can’t simply take anything of yours to pay off the tax debt. That’s because that tax debt is not secured by anything you own.

This completely changes when the IRS/state records a tax lien against your tax debt. The recording legally converts the unsecured tax debt into a debt secured by your property. Which property becomes security against that particular tax debt depends on the details of 1) the tax lien itself and 2) your state’s property laws.

But regardless of these details, IRS/state tax liens can potentially turn pretty much everything you own into security on that tax debt. That means that if you don’t pay the tax, the IRS/state can often take whatever you own in payment of that tax debt. Usually the practical result is not that they take everything, or even anything. Rather, you end up paying the tax debt, sooner or later.

Unsecured Older Income Tax Debts in Bankruptcy

Contrast that from what would happen to that tax if there was no recorded tax lien.

Most ordinary unsecured debts can be legally forever written off in bankruptcy. This is true of some income tax debts as well, if they meet certain conditions. Basically, bankruptcy discharges (writes off) income taxes for which the tax return:

  • was due more than 3 years before your bankruptcy case is filed, AND
  • was in fact filed more than 2 years before bankruptcy.

An Older Income Tax Debt WITHOUT a Tax Lien Under Chapter 7

If you meet the above 2 conditions (and a couple other seldom applicable ones), filing Chapter 7 will simply forever discharge that tax debt. Within about 3-4 months after you file the case, it will be legally gone. You will not have to pay it.

You filed bankruptcy in time to stop the IRS/state from recording a tax lien. And after discharge they’ll never be able to record a lien, or collect in any other wayr.

An Older Income Tax Debt WITH a Tax Lien Under Chapter 7

But it’s completely different if you did not file bankruptcy until after the tax lien recording.

If the tax debt meets the timing conditions, your Chapter 7 filing would technically discharge the tax debt itself. However, the IRS/state would still have a lien on your property after the bankruptcy case was completed.

Because of this surviving tax lien, the IRS/state would at that point be able to exert its rights under the lien. That means it could take and sell whatever property the lien attached to. That would usually be all your personal property or your real estate, or possibly both.

To prevent this from happening, you’d want to contact the IRS/state to make payment arrangements. As mentioned above, the result is usually that you have to pay the tax in full, along with its continually accruing tax penalties and interest.

The Lesson

The lesson is very clear. If you owe income taxes, file bankruptcy before the tax authorities record a tax lien. If the tax you owe meets the timing conditions, you’ll be able discharge the entire tax and pay nothing on it.

 

The Surprising Benefits: Fraud Debt Collections in Bankruptcy

Being accused of defrauding a creditor is unusual in consumer bankruptcy cases. A creditor would have to jump through significant hoops. 

 

Most Debts are Discharged (Permanently Written Off) in Bankruptcy

The federal Bankruptcy Code has a list of the kinds of debts that are not discharged. This list details the conditions under which these kinds of debts don’t get discharged. (See Section 523 on “Exceptions to discharge.”)

Essentially, all your debts get discharged unless any of them fit one of the listed exceptions.

The Fraud Exception

One of the most important exceptions to discharge is the one stating that debts, “to the extent obtained, by… false pretenses, false representation, or actual fraud,” might not be discharged. (Section 523(a)(2)(A) of the Bankruptcy Code.)

This is an important exception to discharge because it could apply to many different kinds of debts. The other exceptions to discharge apply to very specific categories of debts. For example, these other exceptions include child and spousal support, various taxes, and student loans. But the fraud exception could apply to just about any debt if it was incurred in a fraudulent way.

What Makes for a Fraudulent Debt?

Your creditor would have to demonstrate that its debt should not be discharged because you incurred that debt fraudulently. If the creditor fails to do so the debt WILL get discharged and you’ll no longer legally owe it.  

To avoid discharge of the debt, the creditor would have to present evidence and prove EACH of the following:

  1. you made a representation
  2. which you knew at THAT time was false
  3. you made that representation for the purpose of deceiving the creditor
  4. the creditor relied on this representation
  5. the creditor was damage by your representation.

For example:

  1. a person gets a loan by representing that he or she has a certain amount of income
  2. while knowing that income amount was inaccurate
  3. with the purpose of fooling the creditor into making the loan
  4. resulting in the creditor relying on this income information in making the loan
  5. and losing money when the person didn’t pay back the loan

What Happens When a Creditor Alleges Fraud

Proving all five of these necessary elements often isn’t easy. So creditors tend not to object unless they believe they have a strong evidence of fraud. In the vast majority of consumer bankruptcy cases no creditors raise any fraud-based challenges.

When a creditor does raise such a challenge it does so in a specialized lawsuit in the bankruptcy court. This “adversary proceeding” usually focuses directly on whether the creditor can prove the five elements of fraud.

Such adversary proceedings almost always get settled. That’s because the amount of money at issue doesn’t justify the expense in attorney fees and other costs that can accrue quickly for both sides.  

Staying Allegedly Fraudulent Debts

The “automatic stay” imposed against virtually all creditor collection action also applies to allegedly fraudulent debts. If the creditor has alleged fraud prior to your bankruptcy filing, the filing will at least temporarily stop all collection on the debt. The “automatic stay” stops “any act to collect, assess, or recover a claim against the debtor.”  (Section 362(a)(6) of the U.S. Bankruptcy Code.)

Then, as mentioned above, the debt will either get discharged or not. If the creditor doesn’t file an adversary proceeding in time, the debt DOES get discharged. If the creditor files an adversary proceeding but then doesn’t prove fraud, the debt is discharged.

On the other hand, if the creditor does prove fraud the debt is not discharged and the creditor can then pursue the debt. It gets a judgment stating that the debt is not discharged and collectible. Then the creditor can use all the usual collection methods to collect the debt.  

However, because these matters are usually settled, the settlement usually includes an agreed payment plan. So in the unlikely event that a creditor DOES allege fraud against you, files a timely adversary proceeding, AND convinces the bankruptcy judge that all the elements of fraud were present, you would still very likely have a workable way to pay the debt without worrying about being hit by unexpected collection actions.

 

The Surprising Benefits: Deal with Student Loan Collection with Chapter 13

Qualifying for “undue hardship” to discharge (write off) student loans is not easy. But Chapter 13 gives you powerful help over the timing.

 

The Much Better Chapter 13 “Automatic Stay”  

Last time we explained how bankruptcy’s “automatic stay” immediately stops student loan collections against you. But if you file a Chapter 7 bankruptcy this protection from collections lasts only the 3-4 months that the case lasts. If you qualify under “undue hardship,” you could discharge (write off) your student loan debt during your case. Then the student loan creditor could no longer collect that debt.

But if you can’t show “undue hardship,” Chapter 13 buys you much more time, and more timing flexibility.

Chapter 13 Simply Buys More Time

Chapter 13 buys more time because a typical case lasts 3 to 5 years. The “automatic stay” prevents collection actions this entire length of time.  A student loan creditor could try to persuade your bankruptcy judge to allow it to collect before the end of your case.  But usually this doesn’t happen. So regardless of anything else, Chapter 13 puts off your student loan creditor(s) for a fairly long time.

Chapter 13 May Buy Time Until You DO Qualify for “Undue Hardship”

To discharge a student loan you (or your dependent) must be experiencing an “undue hardship” at that time.  Chapter 13 gives you the flexibility of waiting for up to 5 years until you meet that condition. You file the case, and throughout its life your student loan creditor(s) is (are) prevented from collecting. Then, as soon as you do qualify for “undue hardship,” your bankruptcy lawyer would file the discharge petition.

For example, assume you or a financial dependent had a worsening chronic medical condition. But that condition was NOT YET preventing you from working, so that you were not yet in the circumstances that your student loan(s) was (were) preventing you from maintaining even a minimal standard of living. You could not petition for “undue hardship” discharge yet. But Chapter 13 would allow you to wait as long as 5 years after filing the case. This would give you time for your condition to worsen until you did met this requirement.   

Conclusion

Chapter 13 prevents your student loan creditor(s) from chasing you for years. And it also allows you to delay asking to discharge your student loan debt(s) until the point when you’d qualify. In the right circumstances these could be huge advantages.

 

The Surprising Benefits: Stop Student Loan Collection

Chapter 7 “straight bankruptcy” stops student loan collection actions for a few months. Sometimes it can stop these actions permanently. 

 

Bankruptcy gives you tools to deal with special debts—including those you can’t easily write off. Last week we got into income taxes. Today we discuss student loans, focusing on this special kind of debt in Chapter 7 “straight bankruptcy.” Next week, we’ll cover student loans under Chapter 13 “adjustment of debts.”

Let’s assume you owe a student loan that you can’t afford to pay. Here’s how Chapter 7 can help.

Student Loan Collection

Student loan creditors and collectors have extraordinary collection powers. Often they don’t need to sue you first and get a legal judgment against you, as most creditors must. These creditors and their collections have very aggressive collection procedures available to them. Besides the usual garnishment of bank accounts and paychecks, these special creditors can often grab your tax refund or a portion of a Social Security benefit check.

The “Automatic Stay” from a Chapter 7 Filing 

Student loans are special in a number of ways. However, just like ordinary debts, student loan collections are immediately stopped by the “automatic stay” imposed by your bankruptcy filing. It doesn’t matter whether or not the student loan would be discharged (written off) in your Chapter 7 case.

The “automatic stay” stops “any act to collect, assess, or recover a claim against the debtor.”  (Section 362(a)(6) of the U.S. Bankruptcy Code.) (A “claim” is a “right to payment”—essentially, a debt. See Section 101(5).) More specifically, the “automatic stay” stops “the commencement or continuation…  of a[n]..  .   administrative…  proceeding against the debtor. (Section 362(a)(1).) “Administrative proceedings” include the non-judicial collection actions mentioned above that don’t include a lawsuit. The Chapter 7 filing also specifically stops “the setoff of any debt” owed to you, such as a tax refund or Social Security setoff. (Section 362(a)(7).)  So, filing bankruptcy stops all student loan collection actions.

This break from collections lasts throughout the 3-4 months that most consumer Chapter 7 cases take to finish. But unless you deal with the student loan appropriately in the meantime, after that its collection can continue.

Dischargeability of Student Loans

Bankruptcy permanently discharges some student loans. A dischargeable student loan must meet just one condition, albeit a tough and confusing condition. The student loan must cause you an “undue hardship.” As the Bankruptcy Code puts it, you can’t discharge a student loan unless that loan “would impose an undue hardship on the debtor and the debtor’s dependents.” (Section 523(a)(8).)

What does “undue hardship” mean? How much harder must it be than just a simple “hardship”?

You may feel like your student loans are causing you a great financial hardship. However, the federal courts have interpreted this phrase very narrowly.  The details are beyond the scope of today’s blog post, but just keep in mind this condition is challenging to meet.

During the Chapter 7 Break in Collections      

During the 3-4 months of your Chapter 7 case you want to take steps to make the temporary break in collections a permanent one. Here are three ways to accomplish this.

  • If you and your bankruptcy lawyer believe you meet the “undue hardship” condition, your bankruptcy lawyer would file an “adversary proceeding” during your Chapter 7 case. That’s a specialized lawsuit designed to determine whether you qualify for “undue hardship.” If you persuade the bankruptcy judge that you do, the student loan debt would be permanently discharged. Then the temporary break in collections would become permanent. There would be no more collection on a debt once you no longer legally owe it.
  • The bankruptcy judge may give you only a partial discharge of your student loan(s). In this situation the judge is determining that repaying all of the loan(s) would cause you an “undue hardship.” But paying back only a portion would not. So you’d make arrangements to pay the remaining student loan debt, probably at a reduced monthly payment. As long as you made the payments your student loan creditor would take no further collection action against you.
  • If you don’t qualify for a full or partial “undue hardship” discharge, your Chapter 7 case would still at least discharge all or most of your other debts. That should leave you better able to pay the remaining student loans. Hopefully you’d be in a position to make payment arrangements. This may be done through a payment-reduction program which are available for various student loans. If so, then your situation would hopefully be resolved by the end of your Chapter 7 case. Then, at the time that the automatic stay would expire you won’t be facing any more student loan collections.

Avoiding Default and Preserving Options

Even if you don’t qualify for “undue hardship,” the bankruptcy pause in collections can be extremely helpful. It could maybe even be critical. That’s because you can only qualify for most student loan workout programs before you are too far behind on payments. So filing a Chapter 7 case before you’ve fallen too far behind could allow you to take advantage of these programs. But if you waited too long you could lose out, and be seriously disadvantaged.

Conclusion

It’s really crucial to talk with an experienced bankruptcy lawyer about all this. Student loans are complicated and often very challenging to deal with. This is true both outside and inside bankruptcy. You need a lawyer on your side who deeply understands both bankruptcy law and student loans.

 

The Surprising Benefits: Stop Income Tax Collection

Income tax debts can be handled in bankruptcy more than you think. This is true even with those taxes that are too new to be discharged. 

 

The Automatic Staying, and the Discharge, of Income Tax Debts

Sometimes people are surprised to learn that filing bankruptcy gives you power over income taxes. It does so in two big ways. First, filing bankruptcy stops the IRS and state from collecting your tax debts—either temporarily or permanently. This is the “automatic stay” applicable to pretty much all of your creditors. Second, bankruptcy permanently writes off (“discharges”) some income tax debts—generally older taxes.

If all the income taxes you owe qualify for discharge, then your situation is quite straightforward. You file a Chapter 7 “straight bankruptcy” case, which stops any ongoing tax collection during the case. Then 3-4 months later, near the end of the Chapter 7 case, your tax debt is discharged. The “automatic stay” protection against tax collection ends. But you no longer need to worry about tax collection because you no long owe any taxes.

Or if instead you file a Chapter 13 “adjustment of debts” case (for reasons other than the tax debt), there’s a similar result. The dischargeable income taxes are treated just like your other “general unsecured” debts. They only get paid to the extent you can afford to do so, if at all, during your case. Often, during the 3-5-year Chapter 13 payment plan most or all of your available money goes elsewhere. It goes towards priority debts like child/spousal support or more recent taxes. Or it goes to catch up on a home mortgage or vehicle loan payments. Regardless how much, if any, you pay on the dischargeable taxes, at the end of your case the rest is discharged. So, as with Chapter 7, you then owe no more on those taxes so you don’t need to worry about any more tax collection.

The Expiring Automatic Stay and Nondischargeable Income Taxes

But what happens if some or all of your income tax debts do not qualify for discharge?  The “automatic stay” does still go into effect as to those nondischargeable taxes. Your filing of a Chapter 7 case gives you a break from most collection actions of the IRS and/or state. If you are being garnished, that would stop. If the IRS/state was about to record a tax lien against your home, that would be prevented. If you are being pressured to enter into a monthly tax payment plan, that pressure would stop.

But this break from collection would not last long.  The “automatic stay” expires in a Chapter 7 case at “the time a discharge is granted.” (See Section 362(c)(2)(C) of the U.S. Bankruptcy Code about the expiration of the “automatic stay.”) In just about all consumer Chapter 7 cases the bankruptcy court grants the discharge only 3-4 months after case filing. So you get a break but not much of one.

So what do you do if you have income taxes that would not be discharged in a Chapter 7 case?

The Chapter 7 Solution

If you filed a Chapter 7 case, it may discharge enough of your other debts that you could afford to enter into a monthly installment payment plan with the IRS/state for the remaining tax debts. The discharged debts may include some older, dischargeable income taxes, leaving you with less tax liability to still pay.

If discharging other debts leaves you in a position to pay your remaining tax debts over time, you (or your lawyer) should contact the tax authority immediately after the discharge to make payment arrangements. It may make sense to make contact even earlier so that the IRS/state knows your intentions. Ask your bankruptcy lawyer about the best timing.

You might also qualify for a reduction in the surviving tax debt amount. The IRS has a procedure for “offers in compromise” to settle a tax debt by paying less than the full balance. Most states have similar procedures. These are somewhat complicated to go through. You should not enter into such an attempt without getting solid legal advice about your chances of being successful.  

The Chapter 13 Solution

Your financial situation after a Chapter 7 discharge may not allow you to pay off the remaining income tax debts through a tax payment plan. You may not have enough cash flow to pay it off fast enough to qualify. Furthermore, interest and tax penalties will continue to accrue, requiring you to pay substantially more over time.

You may also not be a good candidate for getting a reduction in the tax amount through a “compromise.”

So if instead you file a Chapter 13 case, the protection of the “automatic stay” remains in effect throughout the 3-to-5-year length of the case. This gives you up to 5 years to pay off the nondischargeable income taxes without any tax collections against you. This allows you to pay off those taxes under very flexible terms. You can often pay other even more urgent debts—like child support or home mortgage arrearages—ahead of the taxes.

Usually you don’t have to pay any additional interest and penalties. That alone could save you a significant amount, enabling you to pay off the tax faster and easier.

Also, the IRS/state can’t record a tax lien against you during the Chapter 13 case. That takes significant leverage away from the taxing authority. And if a tax lien had already been recorded against you, Chapter 13 usually can deal with it very favorably.

Overall, if a Chapter 7 would leave you too much at the mercy of the IRS/state, Chapter 13 is often a good alternative.

 

The Surprising Benefits: Stop Collection of Support Arrearage

Ongoing child or spousal support is a very special type of debt in bankruptcy. So is support arrearage. Here’s how bankruptcy handles them. 

 

Most Debts

Filing bankruptcy stops—or “stays”—the collection of most debts. (See Section 362(a) of the U.S.  Bankruptcy Code about the “Automatic Stay.”) Then at the end of the bankruptcy case most debts are discharged—legally written off. (Sections 727 and 1328 of the Bankruptcy Code.) At that point the creditor is permanently forbidden to collect the debt.

Special Debts

However, filing bankruptcy doesn’t stop the collection of certain specific types of debts. And it only temporarily stops the collection of other types. These tend to be the types of debts that bankruptcy does not discharge.

Also, with some debts, whether collection is stopped depends on whether you file a Chapter 7 “straight bankruptcy” or instead a Chapter 13 “adjustment of debts” case.

The special debts for which collection does not stop or may stop only temporarily include:

  • ongoing monthly child and spousal support
  • child and spousal support arrearage
  • recent income taxes
  • student loans
  • debts incurred through fraud

Again, these tend to be debts that do not get discharged in bankruptcy. However, bankruptcy does provide tools for resolving such special debts permanently. Today we’ll show how this works with ongoing child/spousal support and support arrearage. We’ll cover the rest in the next couple of weeks.

Ongoing Child and Spousal Support

We need to distinguish between ongoing child and spousal support and support arrearage.

Ongoing support is what the divorce court requires you to pay on a regular basis, usually monthly. It is a type of obligation treated with more respect than likely any other consumer debt in bankruptcy.

Accordingly, filing bankruptcy does not stop the collection of ongoing support. If you are paying support voluntarily you need to continue paying it.  If you are paying through a payroll deduction or a garnishment, it will continue.

This is true whether you file a Chapter 7 or a Chapter 13 case. Neither affects your continued obligation to pay ongoing support. The “automatic stay” does not apply. (Section 362(b)(2).) The discharge of debts does not apply. (Sections 523(a)(5), 1328(a)(2), and 101(14A).)

Child and Spousal Arrearage

As for support arrearage, neither Chapter 7 nor 13 can discharge this kind of debt either.

However, the automatic stay can stop collection of support arrearage, but only in a Chapter 13 case. Filing a Chapter 7 case will not stop support arrearage collection actions.

This ability to stop support arrearage collection through Chapter 13 can be extremely helpful. If you are behind on support payment, especially if you are significantly behind and its collection is financially hamstringing you, filing the more complicated Chapter 13 may well be worthwhile for this reason alone.

It’s extremely important to be aware that after filing your Chapter 13 case you can lose this automatic stay protection about collection of support arrearage. To prevent renewed collection, 1) you must keep current on your ongoing support, 2) your Chapter 13 plan must show how you will pay all the support arrearage during the case, and 3) you must consistently make your Chapter 13 plan payments so that you are in fact making continued progress towards paying off the support arrearage. If you don’t do any of these, your ex-spouse or support enforcement agency can quickly get the bankruptcy court to give permission to re-start collection of the support arrearage.

 

The Surprising Benefits: Break a Tax Payment Plan through Chapter 13

Use Chapter 7 to stop paying an unaffordable income tax payment plan when the tax owed is dischargeable. Use Chapter 13 when it’s not. 

Tax Agreement Payments Too High

We laid out the problem last week. You’d entered into a monthly payment plan with the IRS or your state because you couldn’t pay what you owed. But now you don’t have the money to make the payments. Or you’re in a payment plan but will owe more income taxes soon, putting you then in violation of your payment agreement.  

If you violate your tax agreement the IRS/state could then take aggressive collection action against you. Or you might be able to add an upcoming new income tax owed into your current tax payment agreement. But the increased monthly payment may well push you over the financial edge. But even if you think you could afford it, you’d be going backwards instead of making progress.

Chapter 7 Makes Sense When Your Tax Owed Can Be Discharged

If all, or most, of the income tax debt in your present monthly payment plan is dischargeable, Chapter 7 likely makes sense. You’d discharge (forever write off) all or most of the taxes you owe. You’d either owe no taxes or owe a small enough amount to be able to handle it with a new smaller payment plan.

But if you can’t discharge all your income taxes, or enough, through Chapter 7, Chapter 13 “adjustment of debts” is likely the better tool.

Chapter 13 Plan

A Chapter 13 payment plan wraps all or most of your debts into a single monthly payment. This payment includes any tax debts. This single Chapter 13 monthly plan payment is based on your actual budget. Some debts—such as taxes, and secured debts such as a home mortgage and vehicle loan—get prioritized. Usually you pay less on your other debts, often not much, sometimes nothing.

Advantages

Dealing with income tax debts with Chapter 13 gives you the following advantages over Chapter 7:

  • Income taxes that don’t qualify for discharge do need to be paid in full, but on a very flexible schedule. You and your bankruptcy lawyer create a new plan incorporating all of your debts. This plan focuses your resources on your most important debts, including nondischargeable income taxes.
  • Usually you don’t pay ongoing interest and penalties. This saves you potentially lots of money. That’s particularly true if tax interest rates will rise in the near future along with other interest rates.
  • Other even more important debts—such as child/spousal support, or unpaid mortgage or home mortgage payments—can often be paid ahead of income tax debts.  
  • The budget you enter into earmarks enough money to withhold from your paycheck or pay quarterly for the current year’s taxes. This enables you to break out of the endless cycle of being behind on your income taxes.
  • Chapter 13 handles income tax liens much better than Chapter 7. If there’s no equity supporting the lien, you can often get rid of the lien without paying anything for it. If the lien is partially secured, you will likely pay less to get rid of it than otherwise. Chapter 13 takes away much of the leverage of tax liens from the tax authorities.
  • You are protected throughout your entire 3-5-year Chapter 13 payment plan from tax collection. Bankruptcy stops all tax collection, including the recording of tax liens. In Chapter 7 this protection lasts only 3-4 months. Then you’re on your own dealing with any remaining tax debts. With Chapter 13 the protection lasts until the end of your Chapter 13 case. At that point you should owe absolutely no tax debt.

Conclusion

Filing bankruptcy allows you to unilaterally break your monthly payment agreement with the IRS and/or state. With Chapter 7 you may be able to discharge all or most of your tax debts. Or, discharging all or most of your other debts may make it possible to stay in your tax payment plan, if that’s your only significant debt. However, if Chapter 7 doesn’t help you enough, Chapter 13 gives you many other significant advantages (some listed above). Talk with an experienced local bankruptcy lawyer to figure out which is better for you.