What is Chapter 13 Bankruptcy?

Chapter 13 bankruptcy is quite a bit different than Chapter 7 bankruptcy.  When people think of bankruptcy, they probably think of Chapter 7.  Chapter 7 is known as “straight” bankruptcy, and it should be relatively quick and straightforward to navigate.  stock-photo-7386130-erasing-bankruptcy

Chapter 13 is much different than Chapter 7, but it still has the general benefits of bankruptcy.  Like any other bankruptcy, when the bankruptcy petition is filed with the court, the automatic stay goes into effect.  The automatic stay is like a door slamming shut on your creditors.  Once it is in place, your creditors cannot attempt to collect a debt in any way.  That means no more harassing phone calls and no more nasty collection letters.  If you have been sued by a creditor, the automatic stay will stop the lawsuit.  Not only that, but if you have a judgment against you, and the creditor is trying to enforce the judgment (either on your property or bank account), the automatic stay will stop the creditor from enforcing that judgment.

The main reason people file for chapter 13 is to save their home.  Chapter 13 bankruptcy can be an effective tool to avoid foreclosure and catch up on late mortgage payments.  If you fall on hard times, you may fall behind on your mortgage payments.  If you fall far enough behind, you will then face foreclosure on your home – meaning the bank will take possession of your home due to the late payments.  However, you can file Chapter 13, stop the foreclosure (remember the automatic stay?), and catch up on the mortgage arrears and fend off foreclosure.

There are other reasons to file Chapter 13.  For instance, Chapter 13 is a useful tool to pay off tax debts, whether it be the IRS, the PA Department of Revenue, or any local taxing authority.  How a tax debt will be treated in Chapter 13 bankruptcy depends on whether it’s a priority or nonpriority tax obligation. Priority tax debts are not dischargeable and must be paid in full through your Chapter 13 Plan.  In contrast, nonpriority tax debts are treated the same as your other, nonpriority unsecured debts (such as credit cards and medical bills) and eliminated when you receive your discharge.

The majority of taxes in bankruptcy are priority obligations.  This means that you cannot discharge these debts.  If you file a Chapter 13, you must pay off your priority tax debts in full through your repayment plan.  While this may not be as beneficial as discharging the taxes outright, Chapter 13 can provide for a convenient and affordable way to pay their tax debts over a three to five year period. In addition, priority tax obligations can also help reduce the amount you would otherwise be required to pay towards your nonpriority unsecured debts through your plan.

The following are some of the most common priority tax debts you may have to pay back through your Chapter 13 plan:

  • recent income tax obligations that don’t meet the necessary requirements to be considered nonpriority (discussed below)
  • property taxes incurred within one year before filing for bankruptcy
  • taxes you were required to withhold or collect (such as payroll taxes)
  • certain excise taxes, employment taxes, and customs duties, and
  • penalties related to nondischargeable taxes.

Nonpriority Tax Obligations

If you have older income tax obligations, you may be able to discharge them in Chapter 13 bankruptcy if they qualify as nonpriority tax debts. If a tax debt is considered nonpriority, it will be treated just like your other nonpriority unsecured debts in bankruptcy.

This means that if some of your tax debts are nonpriority, you probably will not have to pay off your entire tax debt through your repayment plan. How much you must pay will depend on your income, expenses, assets, and bankruptcy exemptions. When you complete your plan, any remaining nonpriority taxes will be discharged along with your other general unsecured debts.

In general, an income tax debt will be considered nonpriority if:

  • the tax return was due at least three years before you filed your bankruptcy (including any extensions you received)
  • you filed the return at least two years prior to filing for bankruptcy
  • the IRS has not assessed your liability for the tax debt within the 240 days before you filed for bankruptcy (but be aware that this 240-day limit can be extended if you previously submitted an offer in compromise or filed for bankruptcy and caused the IRS to stop its collection efforts), and
  • you did not commit fraud or willful tax evasion.

Tax Lien Treatment

Even if a tax debt is a nonpriority obligation, the discharge only wipes out your personal liability, and it doesn’t eliminate liens placed on your property as a result of your tax debt.  This means that if a lien has been placed on your property for unpaid income or property taxes (even if they are considered dischargeable nonpriority tax debts), your discharge will not eliminate that lien.  You will then have to pay the amount of the secured lien in order to release it.

There is much more to Chapter 13 bankruptcy, as these case can get quite complicated.  A good bankruptcy lawyer, well versed in the intricacies of Chapter 13, can guide you and educate you in this process.  If you have any questions about Chapter 13 bankruptcy, please call my office at (814) 240-1013 or email me at richarda@johnstownbankruptcy.com.

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