Discharging Taxes in Bankruptcy
Discharge in Chapter 13
D. King, Esq.
Of the California Bar
Originally appearing in the San Francisco Recorder in three parts
a. In general
Chapter 13 of the Bankruptcy Code provides a mechanism for discharging an overdue tax bill that in many cases has important advantages over a Chapter 7 discharge. In some cases it is easier to qualify for a Chapter 13 discharge of taxes than for a Chapter 7. This advantage is often called the Chapter 13 "Super-discharge," discussed further, below (but The Bankruptcy Reform Act of 2005 has taken way much of the advantage of the Super-Discharge).
A key advantage of Chapter 13 over Chapter 7 is that it does not require a liquidation of assets. Accordingly, it is ideal for the asset-rich debtor or the business having assets, because the debtor may pay off debt through Chapter 13 while retaining control and ownership of property. This makes Chapter 13 a powerful tool for debt relief. One Oakland Chapter 13 trustee has remarked that more small businesses would take advantage of this remedy if they knew what it had to offer.
b. The rules for discharge
The five rules to qualify an income tax in Chapter 7 apply more or less equally in Chapter 13, as well. A claim for personal income taxes is dischargeable (i.e. capable of being wiped out) in Chapter 13 to the same extent as any general unsecured claim (such as credit cards) if it meets all of the following criteria:
These rules are interpreted the same way as the equivalent rules in Chapter 7. Briefly, the three-year period for the tax year in question starts on the most recent date the return is due, including extensions; The 240-day assessment period starts when the tax is formally assessed by, in the case of I.R.S. claims, the entry of Form 23-C in the taxpayer's tax file.
The "tolling" events which may result in a stretch-out of any of these time periods in a Chapter 7 apply, as well, in a Chapter 13.
c. The super-discharge
One advantage to discharge in Chapter 13 is that, unlike Chapter 7 which requires that a tax penalty be more than three years old before it can be discharged, no such requirement exists in Chapter 13. Tax penalties in Chapter 13 are dischargeable to he same extent as credit cards, medical bills, back rent, and etc. the only tax requirement in Chapter 13 is that priority claims be paid in full, and penalties are never priority under § 507(a)(8). Hence, even a very recent penalty is dischargeable in Chapter 13 to the same extent as other general unsecured claims.
d. Key advantage: No interest on unsecured dischargeable taxes
Another advantage arises where the tax is a priority and must be paid through the Chapter 13 plan. That is, in the case of unsecured tax claims, such claims are ordinarily paid through the Chapter 13 plan without interest. Frequently this makes Chapter 13 the preferred remedy for paying off a priority tax, as opposed to a voluntary payment plan with the I.R.S., where interest always continues to run and can easily double or triple the total amount of money paid to satisfy the claim. However, payment of payroll taxes (the trust-fund portion) does accrue non-dischargeable interest.
Read about protecting a small business by using Chapter 13.
Proceed to Part IV - Discharge in Chapter 11