Many people who are suffering from burdensome debt also count, among their creditors, the Internal Revenue Service and the Wisconsin Department of Revenue. They wonder what – if anything – can be done about their tax debt.
To answer this question, we look to 11 U.S.C. § 523 – the statute that describes the types of debts that cannot be discharged. § 523(a)(1) describes certain types of taxes that cannot be discharged in bankruptcy – the most common of which are being income taxes that are further described at 11 U.S.C. § 507(a)(8). When you boil away the excess verbiage, § 507(a)(8) is basically describing income taxes owed for tax returns that were due within 3 years of filing.
For example – today is July 7, 2014. Taxes owed for 2011, 2012, and 2013 would generally be considered priority taxes, and therefore non-dischargeable. Notwithstanding any tax liens that may exist, any remaining tax debt would be considered non-priority, and dischargeable.
Now, there are a handful of ways for older tax debts to still retain priority status (the excess verbiage we boiled away) – such as any new assessments in the past 8 months, if the tax returns were filed late, or if there was a prior stay of collections.
So what does all of this mean? Well, in Chapter 7 – the result is fairly simple. Priority tax debts are non-dischargeable and will survive. Non-priority tax debts are dischargeable (though tax liens will survive) and will go away after bankruptcy.
BUT – just because your tax debts are non-dischargeable doesn’t mean you can’t do anything about them in bankruptcy. In Chapter 13, priority tax debts can be rolled into the plan. Generally, they are paid in full with no additional interest (the taxing authority may – in rare cases – stipulate to be paid less than in full of their priority claim, though that stipulation will usually include a provision asserting that the unpaid portion will remain non-dischargeable and survive the bankruptcy).
By the way – what’s true of priority taxes is also true of other priority debts, such as domestic support obligation (child support, alimony, or maintenance) arrears. Other non-dischargeable debts can also be folded into Chapter 13 bankruptcy, such as student loans. But since student loans are not a priority debt, they do not have to be paid in full (though the unpaid balance would survive the bankruptcy).
If tax liens have been filed against you, those would also have to be paid in full in a Chapter 13 Bankruptcy (and with nominal interest), but they are secured only to the extent that there is equity in property. For example, say that a person has a $100k house with an $80k mortgage, a $20k car with a $15k lien, and $10k in personal property – the available security would be ($20k + $5k + $10k) = $35k. If the amount of tax lien is less than $35k, then the whole amount is treated as secured. If the amount of the tax lien is more than $35k, then only $35k of it is treated as secured.
It’s a lot to digest, and worthy of a detailed discussion with your bankruptcy attorney. But the main points to take away are that (1) some tax debts can be discharged in bankruptcy, and (2) tax debts that cannot be discharged can be addressed in Chapter 13.