Most people will pay all of their tax debt in a Chapter 13 repayment plan, but exceptions exist. Here’s how it works:
Learn about the differences between Chapter 7 and Chapter 13 bankruptcy.
Most taxes are “priority debts” afforded special treatment in bankruptcy. You can’t eliminate them merely by filing for bankruptcy and receiving a discharge. Not only do priority debts get paid before other obligations, but if you file for Chapter 13 bankruptcy, you must pay off your priority tax debts in full through your repayment plan.
The following are some of the most common priority tax debts you might have to pay back through your Chapter 13 plan:
While this might not sound ideal, Chapter 13 bankruptcy provides debtors a convenient and affordable way to pay their tax debts over a three- to five-year period. Because priority debts must be paid first, priority tax obligations can help reduce the amount you would otherwise be required to pay towards your nonpriority unsecured debts.
Example. After deducting funds for monthly living expenses, Charlotte has $1,000 each month remaining, or $60,000 total to pay creditors through her five-year Chapter 13 plan. She owes $50,000 in priority taxes, $20,000 in medical debt, and $30,000 in credit card debt. Her plan will pay off the $50,000 priority tax debt (it gets paid before the other debts receive anything) and $10,000 toward the medical and credit card debts. Once complete, she’ll receive a discharge for $40,000 and be free of any tax obligation. If Charlotte didn’t have tax debt, she would have paid the $50,000 medical and credit card debts in full.
If you have older income tax obligations, you might be able to discharge them in Chapter 13 bankruptcy if they qualify as nonpriority tax debts. Nonpriority tax debt would get thrown into the same pot as other nonpriority debt, like medical bills and most credit card balances. The Chapter 13 trustee assigned to the case pays out the debtor’s disposable income on a pro-rata (percentage) basis, and any balances remaining after the plan ends get wiped out (with some exceptions, student loans being the most notable).
So if some of your tax debts are nonpriority, you might not have to pay it all off. In general, an income tax debt will be considered nonpriority if:
Learn more about how unsecured debts are treated in Chapter 13 bankruptcy and how to calculate a Chapter 13 plan. How much you'll pay will depend on your income, expenses, assets, and bankruptcy exemptions.
Even if a tax debt is considered nonpriority, your discharge only wipes out your liability for the obligation. It doesn’t eliminate liens placed on your property as a result of your tax debt. If a lien has been placed on your property for unpaid income or property taxes, your discharge will not eliminate that lien—even if it’s considered a dischargeable nonpriority tax debt.
Taxes in bankruptcy can be tricky to navigate, and explaining all potential issues is beyond the scope of this article. In some cases, waiting to file your bankruptcy can turn a priority tax debt into a nonpriority obligation—but the chances that a lien will be filed can increase, as well. If you want to file for bankruptcy to eliminate or reorganize your tax debts, consider talking to a knowledgeable bankruptcy attorney in your area to learn about your options.