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How Does Chapter 13 Treat Tax Debts?

Nothing secures most tax debts, which is why if they’re able to discharge them in chapter 7, New York bankruptcy debtors choose to do so. I’ve discussed how that works in a post about how bankruptcy courts were becoming less forgiving of late tax returns, so I won’t repeat it now. However, there are times where debtors are better served by filing in chapter 13, even if they still owe tax debts. How does this work?

First of all, to clarify, I’m not discussing taxes after filing in chapter 13, which would focus on how to file tax returns and deal with post-petition tax debts. Instead, I’m interested in prepetition tax debts, which debtors bring into bankruptcy.

In chapter 13, priority claims must be paid in full. However, the chapter splits taxes between priority and nonpriority status if they meet certain rules. If a tax is nonpriority, then it does not need to be paid in full, but in New York bankruptcy debtors must dedicate some portion of their repayment plans to nonpriority, unsecured creditors. The rules for whether a tax debt is nonpriority are the same that make them dischargeable at all in chapter 7:

  • The taxes must be due no fewer than three years before the bankruptcy.
  • The debtor must have filed a tax return including the tax debt no fewer than two years before the bankruptcy petition.
  • The tax debt must have been assessed, if ever, at least 240 days before the bankruptcy.

And, of course, the debtor must not have engaged in some kind of fraud against the government in not filing taxes, e.g. tax evasion.

This leaves priority tax debts, which are otherwise ineligible. What advantage is there to paying them back in chapter 13 rather than paying them on one’s own? The answer is that chapter 13 stops the government from charging interest or other penalties. Compared to a three-to-five-year repayment plan, this can amount to a substantial sum of money.

Finally, chapter 7 does not allow debtors to discharge loans that were incurred to pay tax debts, which some people try to do. Chapter 13, by contrast, does allow debtors to discharge these debts, giving debtors another advantage.

If you are struggling financially, and you owe old tax debts, then talking to an experienced New York bankruptcy lawyer will help you assess your options, which can include bankruptcy or making an offer in compromise to the IRS.

For answers to more questions about bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced Brooklyn bankruptcy attorney Bruce Weiner for a free initial consultation.

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