Advantages of Paying Your 2015 Income Tax through Chapter 13

Law Office of Robert L. Firth May 30, 2016

If you owe income tax for 2015 (or 2013 or 2014), pay it by simply paying less to your other creditors.

If You Don’t Owe Too Much Recent Income Tax

If you owe income taxes from the last couple tax years, you most likely would not be able to discharge (legally write off) those taxes in bankruptcy. But it may STILL make sense to file a Chapter 7 “straight bankruptcy” case to get rid of all or most of your OTHER debts. Then you may be able to afford to pay off the remaining income tax through reasonable monthly installments payments.

If You Owe Too Much Recent Income Tax

But your tax debt may be too large for that. If instead you file a Chapter 13 “adjustment of debts” case to take care of recent income taxes, you would likely be able to do so without paying anything more than if you had not owed that tax.

Let’s see how that works.

Payment of Recent Income Taxes Under Chapter 13

Chapter 13 is a very flexible procedure, especially appropriate for taking care of income tax debts. Recent taxes that can’t be discharged must be paid in full during your 3-to-5-year Chapter 13 payment plan. But this requirement that you pay such taxes in full can be used to your advantage. You get certain benefits in every Chapter 13 case, and even bigger benefits in certain cases.

The Benefits of Paying Your Recent Income Tax Debt in Just About Every Chapter 13 Case

No matter what else is going on in your Chapter 13 case, you get three major benefits for paying your 2015 and other recent income taxes through this procedure:

  1. You are protected from the IRS (and your state income tax authority) throughout the repayment process against their collection procedures. This is often better than dealing with the IRS/state directly to set up and try to fulfill an after-Chapter 7 installment payment arrangement.

  2. You have much more flexibility in paying the taxes compared to complying with the IRS/state’s payment rules and regulations. You can often pay less on the tax debt at first so that you can focus on even higher priorities (such as catching up on your mortgage, vehicle, or child support).

  3. No additional interest or penalties are added to the tax you owe while you are in the Chapter 13 case (as long as there’s no recorded tax lien). As a result you pay less to get rid of the tax debt.

Paying Off Your 2015 Tax in Effect for Free

In addition to these benefits, often the fact that you owe recent income taxes costs you absolutely nothing beyond what you would have had to pay anyway to your creditors overall through your Chapter 13 case. The amount you pay towards the taxes simply reduces what you would have paid the other creditors. How could this be?

In a Chapter 13 case you are required to pay all your “disposable income” towards your debts during the required period of time. Some special debts—usually secured and “priority” ones—are paid first, and then whatever is left over is divided among the “general unsecured” debts. As long as the total “priority” income tax is no more than the total amount of “general unsecured” debts, then usually the tax is paid in full simply by reducing the amount that would have been paid to the “general unsecured” debts.

An Example

To make sense of this, assume that a debtor’s “disposable income” is $250 per month, she’s required to pay into her Chapter 13 plan for 36 months, and has “general unsecured” debts totaling $15,000. She would be paying $9,000 (36 months times $250 per month) towards the $15,000 in “general unsecured” debts. So those creditors would receive 60 cents on the dollar. (This assumes no trustee or attorney fees, for the sake of simplicity.)

But now assume that this same debtor also owes a 2015 income tax debt of $6,000. She would still pay $250 per month for 36 months, a total of $9,000. But now the $6,000 income tax would be paid out of that first, reducing the amount left over for the “general unsecured” debts. Those creditors would now receive only $3,000 ($9,000 minus $6,000) out of the $15,000 owed to them, only 20 cents on the dollar.

So, in this example having the $6,000 in 2015 income tax debt does not change how much the debtor is would need to pay during the life of the Chapter 13 case. The “general unsecured” debts would simply receive that much less. And at the end of the case the remaining debts would be discharged, and the debtor would owe nothing.