How Bankruptcy Can Rid You Of Tax Penalties

Get in tax trouble and the tax penalties often grow huge.

What starts as a manageable problem can soon tower over you.

Breathe deep; there is a solution.

Chapter 13 bankruptcy can cut tax penalties down to size.

All tax penalties discharged in 13

Old or new, large or small, Chapter 13 discharges all unsecured tax penalties.

In contrast, Chapter 7 discharges some tax penalties.

Discharged are penalties for taxes that are themselves dischargeable.

Also dischargeable in Chapter 7 are penalties where the transaction or event that triggered the tax occurred more than three years before filing, whether or not the tax itself is dischargeable. 523(a)(7)(B).

That’s good, but if you are eligible, Chapter 13 is better. All penalties are discharged.

Who can file Chapter 13

Chapter 13 is available to individuals (no corporations or LLC’s), with regular income, whose debts total less than $2.75M. It no longer matters how your debt is divided between secured and unsecured claims.

Tax liens don’t go to the head of the line just because they are debts owed to the government. They fall in line behind any other lien holder who perfected their lien prior to the tax lien.

Recent taxes must be paid

Chapter 13 plans are written by the person who has filed the bankruptcy case. The Bankruptcy Code requires, however, that recent income taxes be paid in full through the plan.

Note that it is the TAX and the INTEREST on that tax that have to be paid during the life of the Chapter 13.

Penalties get treated just like personal loans, medical bills, and credit card debt: what that class of creditors gets in the Chapter 13 is driven by the means test and the best interests of creditors test. In most Chapter 13 plans, that’s little, or nothing.

Chapter 13 cuts those penalties down to size.

Tax liens whittled down

The discussion above deals with unsecured taxes and tax penalties. The rules change when a tax lien is filed.

At its simplest, a Chapter 7 discharge eliminates the IRS’s ability to levy your bank account or garnish your wages for taxes that have been discharged.

However, the Chapter 7 discharge doesn’t alter any tax lien recorded before the bankruptcy, even if the taxes themselves are discharged.

If the tax liability is discharged, any lien in place will not attach to assets you acquire after your bankruptcy is filed.

More about tax liens after bankruptcy

Chapter 13 does alter tax liens. (See why I’m a fan of 13?)

Chapter 13 treats as a secured claim only that part of a lien that attaches to real value in the taxpayer’s assets.

Put bluntly, if you don’t have any assets, then the lien is worthless and will be voided at the conclusion of your Chapter 13 plan.

Oh, technically, the tax lien may attach to your household goods, all right. But those things have very little market value.

Pay the resale value of your pots and pans through the Chapter 13 plan, and the lien is deemed satisfied.

If you can’t cut a deal with the IRS that eliminates the tax penalties as part of an offer in compromise or payment plan, you have bankruptcy options for tax penalties.