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Paying Your 2015 Income Taxes in an “Asset Chapter 7” Case

If you owe income taxes for 2015, pay all or part of it through an asset you don’t need.

An income tax debt that you owe for the 2015 tax year (and/or for 2013 and 2014) presents both challenges and opportunities.

The Challenge

You have a tax debt (or more than one) that you wish you didn’t owe. It can’t be written off (“discharged”) in bankruptcy because—among other requirements—three years first must pass after the due date of an income tax’s tax return. The 2015 tax return was just due on April 18 (or won’t be due until October 15 if you filed for an extension). So 3 years from then is a long time from now.

The Opportunity

Under the right circumstances your 2015 (and/or other recent) income tax debt(s) can be paid—in part or in full—through an asset or assets of yours that you do not want or need.

Under bankruptcy law recent tax debts are paid ahead of most of your other creditors. When that happens this leaves less or often nothing at all for those other creditors. But your tax is paid in full or in part, to your advantage.

This can happen under both Chapter 7 “straight bankruptcy” and Chapter 13 “adjustment of debts.” Today’s blog post shows how your taxes can be paid in an “asset” Chapter 7 case. The next one will how it works in Chapter 13.

The “No-Asset” Chapter 7 Case

Most Chapter 7 cases are “no asset” ones. This means that the bankruptcy trustee takes nothing of yours from you because everything you have is “exempt”—protected from your creditors and from the Chapter 7 trustee who stands in for your creditors. Or whatever isn’t fully exempt is not worth the trustee’s effort to collect.

In a “no asset” case none of your debts—including income taxes—are paid anything through your Chapter 7 case itself. In that situation, you would have to make arrangements to pay your 2015 (or 2013 or 2014) income tax with the IRS and/ or the state tax agency directly, most likely through a monthly payment arrangement.

The “Asset” Chapter 7 Case

On the other hand, an “asset” Chapter 7 case is one in which you own something that is NOT exempt. You give that to the bankruptcy trustee, who sells it and distribute its proceeds to your creditors.

Sometimes that’s not what you want—most people filing Chapter 7 bankruptcy want to keep everything they own and not have any of their assets go to their creditors. But in other situations, surrendering a particular asset or two may in fact be a very good strategy.

You may prefer to pay all or part of a tax debt that you would otherwise have to pay out of your own pocket after your Chapter 7 case is completed be instead paid for through an asset you don’t care about. If you didn’t owe the tax that asset would otherwise just go to pay other debts that would have been discharged in your case.

So that asset does you a lot more good paying the tax debt.

How This Works

Assume you own something that you really don’t need. A boat that has simply gotten too expensive and too much work to maintain. A snowmobile or jet ski or dirt bikes you or your family has outgrown. Or business equipment from a business you’ve given up on. And you owe some recent income taxes.

In a Chapter 7 case, if you don’t get to claim a property exemption on such recreational or the business equipment, you give them to your bankruptcy trustee. The trustee sells them, and then the recent income taxes are among the first debts that the trustee will pay out of the sale proceeds.

Although most debts would be paid pro rata—equally, based solely on their amounts—the “priority debts” are paid ahead of most other ones. So, assuming you do not have any debts that are even higher on the priority list (see Section 507 of the Bankruptcy Code), your 2015 (and other recent) income taxes would be paid in full before the trustee pays anything on any of your other debts. As a result you would not have this tax to pay after your Chapter 7 case is completed.

Notice what would happen in this scenario if you did NOT owe a recent income tax debt. The trustee would simply pay that same money towards all your other debts, all or most of which would likely be discharged in your bankruptcy case. So if you DO owe a “priority” tax debt, you use an asset that you don’t need in order to pay a debt that you would have had to pay after your bankruptcy. You are not using that asset to pay other debts that you would simply have been written off in the bankruptcy. You are putting your unnecessary asset to very good use when it’s used to pay off or pay down your taxes.

Careful

For this to work as described takes just the right conditions, with more considerations than can be fully explained here. So definitely discuss your own situation thoroughly with an experienced bankruptcy lawyer.

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