Bankruptcy by Example: Pay Off Taxes Based on What You Can Afford to Pay Instead of What the IRS and Oregon Department of Revenue Want You to Pay
Oct. 10, 2014
Chapter 13 gives you what you often most need if you owe back income taxes: unpressured time to pay based on your realistic budget.
Chapter 13’s Power over the IRS and the ODR
Although the IRS and the Oregon Department of Revenue (ODR) are treated much more favorably in bankruptcy than most other creditors, the bankruptcy laws still have a lot of power over them. That’s especially true in cases filed under Chapter 13, the 3-to-5-year “adjustment of debts” type of bankruptcy. One major power of Chapter 13 over tax debts is to make the IRS and the ODR wait to get paid on taxes on which they are entitled to be paid.
Flexibility in Paying the Income Taxes that Must Be Paid
In bankruptcy, income taxes can be “discharged”—legally written off—when they meet certain conditions, mostly tied into how old the tax is and how long ago the tax return was filed. If a tax doesn’t meet those conditions, it can’t be discharged.
Under Chapter 13, taxes that can’t be discharged must be paid during the 3-to-5-year payment plan. But the terms for payment of those taxes are usually tremendously flexible. Essentially, your plan just has to show that the taxes will be paid off by the end of the plan. In other words, payments to the IRS and/or ODR do not have to start right away or even at any particular point during the course of the plan. (This assumes, as does this entire blog post, that there’s no recorded tax lien—tax liens were discussed in our last four blog posts.)
Flexibility in Monthly Payment Amount
Under Chapter 13, each month you pay the amount of your “disposable income” to your trustee to be distributed to your creditors under the terms of your Chapter 13 plan. Your “disposable income” is essentially your net income minus allowed expenses. It is the amount that you, under your unique circumstances, can reasonably afford to pay each month to all of your creditors.
If at the beginning of your Chapter 13 case you are anticipating later changes in your income and expenses, and thus in your monthly “disposable income,” your payment plan can incorporate those changes. Or if in the midst of your case you experience significant changes in your income and/or expenses, your plan can usually be amended to account for those changes.
Flexibility in Paying Other Creditors Ahead of the Taxes
This flexibility is particularly important if you have other special creditors clamoring to be paid, ones even more time-sensitive than income taxes. Those especially time-sensitive creditors tend to have debts secured by collateral—especially vehicle loans or home mortgages, or are owed back child or spousal support. That’s because those kinds of creditors have a lot of legal leverage.
The reality is that Chapter 13 cases tend to have those kinds of creditors, because their kinds of debts are handled relatively well under Chapter 13. And most debtors can afford to pay only a limited amount “into their plan” each month for all the creditors, making it all the more important to divvy out this precious money in the order that it does the most good. So it’s critical to be able to make the tax creditors wait until later in the case to be paid.
Protecting You from the IRS and ODR
The IRS and ODR basically have no grounds to object to any of this as long as you are following the rules. And they generally have little say about when they get paid out of what you are paying into your plan to all of your creditors.
Most importantly, the IRS and ODR cannot take any collection action against you throughout the time you are in your 3-to-5-year Chapter 13 case. You don’t have to worry about them unexpectedly garnishing your wages or bank account, or grabbing your car or business equipment, or recording a tax lien against your home or other possessions. As long as you are following the Chapter 13 plan you and your attorney proposed and the bankruptcy judge approved, you can relax and not worry about what the tax collector might surprise you with. This protection gives you peace of mind that’s priceless.
An Example—A Seemingly Impossible Situation
We illustrate how this works with this example:
Gwen owes $4,000 in combined income taxes to the IRS and ODR for each of the following tax years while she operated a business and did not pay enough in quarterly estimated income taxes: 2010, 2011, 2012, and 2013, totaling $16,000. She closed her business in early 2014 and has been employed since then with enough taxes being withdrawn from her paychecks so she doesn’t expect to owe any taxes for 2014. During the 2010 through 2013 period Gwen filed all her income tax returns, always after getting an extension to October 15.
Gwen also owes $90,000 in credit card debts and unpaid medical bills from the time she ran her business and couldn’t afford medical insurance. She’s in default on most of the credit cards and medical bills. A collection agency on some of those medical debts sued and got a judgment against her a few months ago for $9,000, and has garnished her paychecks the last two months.
She has a debt of $4,500 on her car loan, with monthly payments of $350, on a car worth $3,500. Because of the wage garnishments Gwen has just fallen two months behind, and she’s appropriately afraid that her car will be repossessed any day now. She absolutely needs this car to commute to work.
Even before she was being garnished the total amount that her budget allowed her to pay all her creditors was $450, which included the $350 car payment. That left her way too little to make any progress towards her $16,000 of tax debt (especially with the ongoing interest and penalties), much less on all her other debts. The IRS and ODR are now both threatening to garnish her checking account and seize her car and the rest of her assets.
Gwen believed her situation is hopeless.
The Seemingly Impossible Problem Solved
At the urging of a close friend Gwen met with an experienced bankruptcy attorney, who recommended that she file a Chapter 13 case. She did so, and that filing accomplished the following:
immediately stopped the collection agency’s garnishment of her paychecks
protected her car from being repossessed by her lender
prevented the IRS and ODR from taking any action to collect on the back taxes, including garnishment of her checking account and levying on her possessions
allowed her to pay $450 per month to ALL of her creditors
paid off $3,500 of her $4,500 car loan through reduced monthly payments of $300 per month (out of the $450 plan payment, for the first year or so of her case), without having to catch up on the back payment and without needing to pay anything towards the $1,000 additional that she owed
avoided paying anything on the 2010 income tax debt because it met all the conditions for discharge
paid off her 2011, 2012, and 2013 income taxes totaling $12,000, most of which was paid after taking care of the car loan, and done so without paying any additional tax penalties and interest
finished her Chapter 13 case in four years, coming out of it owning her car free and clear, owing no income taxes, and being totally debt-free.