Kentucky Bankruptcy Law

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Chapter 13 and Tax Debt: The surprise at the end of the rainbow

I have often written about Chapter 13 and how it is a great mechanism for resolving tax debt. And it is! When looking at income tax debt, there are basically two kinds: that which can be discharged and that which cannot be discharged. Simple enough.

The basic rules of figuring out which tax debts can be discharged are also simple, but the various times and ways the time-frames of these rules get “tolled” gets tricky:

  1. The most recent date (remember extensions) the filing was due is over three years ago.
  2. The tax was assessed at least 240 days ago.
  3. The tax return was actually filed more than two years ago.
  4. The tax return was not fraudulent.
  5. The taxpayer was not willfully trying to evade the taxes.

So, in a Chapter 7 or 13, the income tax debts that meet these rules get discharged. If there are tax debts that are not discharged, then in a Chapter 7 they keep on accruing interest and penalties and must get paid. In a Chapter 13, these non-dischargeable tax debts must be paid in full. So, if you have enough disposable income to accomplish it, then in three to five years the tax debt PRINCIPAL is paid in full on tax debt that cannot be discharged.

Ahhh, the rainbow is at hand! Oh, but wait, Federal tax debt can still accumulate 4% interest while in bankruptcy and Kentucky income tax can accumulate 5% interest. You see, 11 USC Sect. 1322(b)(10) has a little catch. A debtor in Chapter 13 can ONLY pay the accruing interest on these income tax debts IF AND ONLY IF all the claims filed by creditors are paid at 100%.

There is nothing for it other than to give plenty of advance notice to Chapter 13 debtors. There is no way to change the fact that the interest can accumulate and there is no way to make it get discharged. So, unless you have a 100% Chapter 13 plan, be prepared to have to pay the accumulated interest on your income tax debt EVEN after the Chapter 13 is closed out. Don’t fret too much though. When you have gotten that far, you are going to be much more freed up financially to take care of that last issue.

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September 25, 2013 - Posted by | Additional Debt, Bankruptcy, Chapter 13, Chapter 7, Discharge, Disposable Income, Plan, Priority debt, Tax Debts | , , , , , , , , , , , , ,

2 Comments »

  1. Interesting and thank you!
    Two questions:
    1. Even if you have a 100% plan, would you get hit with the interest and penalties if your debt is non-dischargeable, such as in a Ch 7 + Ch 13 = Ch 20, in which the Ch 13 was soon after the Ch 7 meaning the Ch 13 debt would be non-dischargeable?
    2. I saw in http://www.unclefed.com/AuthorsRow/Daily/Fwdcsea.html that the two year filing limit does not apply to Chapter 13 but only Chapter 7. Is that true?

    Comment by John | October 1, 2013 | Reply

    • Penalties are halted in a Chapter 13 bankruptcy whether or not unsecured creditors are paid at 100%. If your plan pays 100% of unsecured debt, then your attorney needs to add a provision to the plan that post-petition interest on the tax debt shall also be paid in full through the plan.

      The 240 day rule is in Section 507(a)(8)(A)(ii). Essentially, if this rule is not met in a Chapter 13, it is still a priority tax, but it does get slightly different treatment in that if it meets the other criteria, the post-petition interest is discharged. However, the principal still must be paid in full in the Chapter 13.

      Comment by G.A. Napier | October 1, 2013 | Reply


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