Why You Should File a Chapter 13 Case BEFORE an IRS Tax Lien or Oregon Distraint Warrant is Recorded

Chapter 13 is often a great way to deal with income tax debts, even with tax liens, but try to file one before being hit with a tax lien.

An Awesome Way to Deal with Tax Debts

The Chapter 13 “adjustment of debts” is a remarkably good tool for attacking income tax debts, particularly if you owe for multiple tax years and/or a substantial amount of taxes.

Taxes that are old enough often do not have to be paid anything. Newer taxes can be paid under very favorable conditions. Those conditions usually include the freezing of any further interest and penalties, and payment terms based on how much you can afford to pay, often allowing for other more important debts to be paid ahead of the taxes. And very importantly the IRS and the Oregon Department of Revenue can’t take any collection action in the meantime—they can’t contact you (except for sending you very specific correspondence), can’t garnish wages and bank accounts, can’t levy on any of your property, and can’t record a tax lien or distraint warrant to put a lien on your home, car, or other possessions.

The Bad Effect of Tax Liens/Distraint Warrants

As discussed thoroughly in our last blog post, the IRS’s recording of a tax lien or the Oregon Department of Revenue’s recording of a distraint warrant converts a tax debt from an unsecured debt into a secured one. From one that has no collateral securing it to one that is potentially secured by every single property and possession that you own. From one that could be easily discharged (legally written off forever) in full to one that you would have to pay in full.

(For the sake of convenience we will refer in the rest of this blog post to both the federal tax lien and Oregon distraint warrant by the term “tax lien”.)

Tax Liens under Chapter 13

Tax liens are handled relatively well under Chapter 13.

As mentioned above, if the tax entity hasn’t recorded a lien before your Chapter 13 case is filed, then it can’t do so during the 3 to 5 years that your case will likely take (as long as you follow the rules of your payment plan).

If a tax lien has been recorded on a tax debt which is not old enough or otherwise does not meet the conditions for discharge, that tax debt will have to be paid off during the life of the Chapter 13 case as usual, but with interest. (The interest rate for the IRS is 3% during the 1st quarter of 2014, and is 4% for Oregon during 2013 and 2014.) But the usual benefits of Chapter 13 continue to apply—the tax debt can be paid based on your budget—as long as it is paid in full within the 5-year maximum length of a Chapter 13 case, and can be paid after other more important debts are paid—although the accruing interest may encourage a faster payoff than otherwise.

Tax Liens on Taxes that Could Otherwise Be Discharged

As made clear in our last blog post focusing on tax liens under Chapter 7 “straight bankruptcy,” the recording of a tax lien can turn a tax debt that you would not have to pay at all—because it meets the conditions for being discharged—into one that you would have to pay in full—because the tax lien attaches to property you want to keep.

In many situations dealing with such otherwise dischargeable debts is better under Chapter 13 than under Chapter 7.

First, a tax lien may be recorded only against your home (a common situation) in which you have no equity. Under a Chapter 13 plan you can legally establish that the tax lien does not attach to anything of value, and thus treat the debt as if there was no recorded tax lien. That tax debt would be treated like any other “general unsecured” debt, and so would be discharged at the successful end of the case along with the rest of such debts. The tax lien would then be released based on the bankruptcy court determination that it didn’t attach to anything. In contrast, under Chapter 7 the tax entity would have the discretion whether or not to release the tax lien, potentially leaving you in a more unsettled situation, and potentially needing to pay something to get the lien released.

Second, a tax lien may be recorded only against your home and/or your personal property which have relatively little value or equity. Under a Chapter 13 plan you can legally establish that the tax lien attaches to a specific, low amount of property value. You can treat only that portion of the tax debt as secured, pay it through the Chapter 13 plan, and the remaining portion of the tax debt is treated like any other “general unsecured” debt, to be discharged at the successful end of the case, and the lien released. The tax entities can object to your proposed value, but they often don’t; if they do, the issue still gets resolved. In contrast, under Chapter 7, with the value of the lien unresolved after the completion of the case, the tax entities tend to have more leverage in negotiations about determining the value of the surviving lien and paying it off.

Third, a tax lien may be recorded on your home and/or personal property in which the equity and/or value of the property attached exceeds the amount of the tax at issue. In other words, the recording of the tax lien before the filing of bankruptcy turns a tax debt that could have been completely discharged into one that is fully secured. Even here, being in a Chapter 13 case is likely better than in a Chapter 7 one. Even though the tax will have to be paid either way, with interest, at least under Chapter 13 you have the benefit of being protected from the tax entities during the payment process. You also have the usual benefits of making payments based on your budget, and of having some discretion about the order in which your important creditors are paid.

Conclusion

In many scenarios in which a tax lien was recorded before you file bankruptcy, Chapter 13 gives you significant advantages over Chapter 7. Regardless of that, it is almost always far better to file bankruptcy BEFORE a tax lien is recorded against you and your assets. There are many complicated timing issues involved in the interplay between bankruptcy and taxes. It is crucial that you meet with an experienced and conscientious bankruptcy attorney as soon as you know that you owe any significant amount of taxes that you can’t pay.