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Bankruptcy by Example: How Chapter 13 Resolves an Income Tax Lien on Your Home-Part 1

Sept. 27, 2014

If the IRS or Oregon has recorded a tax lien on your home, Chapter 13 gives you many advantages for getting rid of that lien.

The Basics

First, let’s start by making clear that we’re talking about income tax liens, not the lien from your real estate property taxes. Property taxes also create a tax lien, one that is always in first position on your title—ahead of even your mortgage(s), and definitely ahead of any income tax liens. Instead here we’re talking about the tax lien that the IRS and the Oregon Department of Revenue (ODR) can record against you at some point if you do not pay your income taxes.

Second, a debt is either “secured” or “unsecured.” That’s true of income tax debts, too.

That is, a debt can either be secured by an asset of yours—home, vehicle, furniture—or it is not. Income taxes are unsecured debts, until the recording of a “tax lien notice” for federal taxes, or a “tax warrant” for Oregon taxes, can turn them into secured debts. For real estate, that recording takes place in the county recording office of the county in which your home is located in order for the federal or state tax lien to attach to the home.

Third, a debt, including a tax debt, can also be partially secured and partially unsecured. If you owe $300,000 on your home mortgage but your home is worth only $250,000, then that mortgage is secured only to the extent of the value of its collateral, the home, $250,000, and is unsecured as to the rest of the balance, $50,000. Similarly, a tax lien on your home is secured only to the extent there is equity in your home for that lien to attach to.

And finally, under Chapter 13 most secured debts have to be paid in full if you want to keep the collateral. Income taxes that can’t be discharged—legally written off in bankruptcy—must be paid before the completion of the Chapter 13 case. So a tax that is secured by a tax lien against equity in your home has to be paid during the 3-to-5-year Chapter 13 plan, so that you can be tax-debt-free when your case is done.

Treatment of Tax Liens under Chapter 13

This means that there are two major considerations that determine how Chapter 13 handles an income tax on which the IRS or ODR has recorded a tax lien:

  1. whether or not the tax upon which the lien was recorded is old enough and otherwise meets the conditions for discharge in bankruptcy; and

  2. whether there is any equity in the home to which the tax lien can attach, and if so how much equity compared to the amount of the tax owed.

Dischargeable Income Tax Debt Secured by Home Equity

If the tax debt is old enough and otherwise meets the conditions that it can be legally written off in bankruptcy—it can be discharged. If there is no recorded tax lien that tax would be treated as a “general unsecured” debt just like a medical debt or credit card.

So in a Chapter 13 case that tax would usually only be paid as much as your budget says you can afford to pay it during your 3-to-5-year payment plan, AFTER paying other higher priority debts and costs. So, often “general unsecured” debts, including such taxes, are paid very little or even nothing.

But the result can be totally different if there is a tax lien recorded against your home.

IF you have equity in your home beyond your mortgage(s) and beyond any liens that legally come ahead of the tax lien, that home equity attaches to the tax owed. That equity “secures” the tax debt.

(Disregard any homestead exemption when calculating your amount of equity—the homestead exemption doesn’t apply to most recorded liens, and definitely not to tax liens.)

If the amount of equity is more than the amount of the tax owed, then the tax is fully secured, and it must be paid in full in your Chapter 13 case, along with ongoing interest.

If the amount of equity is less than the amount of tax owed, the tax is only partially secured, to the extent of that amount of equity. So only that portion must be paid, with ongoing interest. The remaining amount is treated as a “general unsecured” debts and is paid only as much as the such debts are being paid, often little or nothing.

The Example

James owns a home worth $300,000, with equity of $10,000. He owes the IRS and ODR a total of $15,000 in income taxes that meet the conditions for discharge. But tax liens were recently recorded by both the IRS and ODR on these taxes.

Now because of these tax liens, James can no longer simply discharge the entire $15,000 tax debt. That’s because the taxes have become secured by the $10,000 of equity in the home. So in James’ Chapter 13 plan he has to pay $10,000 of the tax, plus ongoing interest on that amount. The remaining $5,000 is paid the same percentage as his other “general unsecured” debts are being paid, which is often little or nothing (depending on his budget and other considerations).

Because of the tax liens that were recorded before James filed bankruptcy, he has to pay more than $10,000, when otherwise he may not have needed to pay anything!

Dischargeable Income Tax Debt with No Home Equity

If your tax debt meets the conditions for being discharged, and IF you have NO equity in your home, then no part of your home secures the tax debt in spite of the recorded tax lien. That tax is still completely unsecured, and so is treated as a “general unsecured” debt, just as if there had been no tax lien recorded. (This assumes there was no additional tax lien recorded against your personal property with the Oregon Secretary of State. If there was then those liens would attach to whatever value or equity you had in all your non-real estate assets—vehicle(s), furniture, etc.)

Back to the Example

In the example with James above, if he had NO equity in his home beyond his mortgage(s), any property taxes owed, and any other liens ahead of the IRS and ODR, then his full $15,000 of dischargeable income tax debt would be treated as a “general unsecured” debt. As we said earlier, he would pay that tax in his Chapter 13 plan at the same percentage as the rest of “general unsecured” debts, often little or nothing. And almost always he would not have to pay any ongoing interest.

So for instance, if James was paying his “general unsecured” debts 5% in his plan, than the $15,000 tax debt would be paid $750, without any interest. That’s a heck of a lot better than $10,000 plus interest in the first example above.

Next Week

Chapter 13 handles tax liens relatively well whether the tax lien is on a tax that could be discharged or one that could not. Today we’ve covered how Chapter 13 attacks tax liens on dischargeable taxes. Next week we’ll cover how it does so with tax liens on taxes that can’t be discharged.