Can IRS Debt Be Discharged in Chapter 13 Bankruptcy?

What is Chapter 13 Bankruptcy?

Chapter 13 bankruptcy is a legally codified financial process designed to help individuals facing overwhelming debt and economic difficulty. It allows qualified persons to pay off their debt in a structured manner over three or five years. The purpose of Chapter 13 is to help debtors regain control of their finances while repaying as many creditors as possible.

Chapter 13 repayment plans are designed to be manageable and are based on income, assets, type of debt, living expenses and an individual’s general financial situation. Chapter 13 repayment plans cover personal debt and certain business debt, as well as tax debt and money owed to the IRS. Each debt’s financial and legal status and how it needs to be repaid depends on that obligation’s specific terms, details and relevant laws and regulations.

How Does Chapter 13 Bankruptcy Differ from Chapter 7 Bankruptcy?

Unlike Chapter 7 bankruptcy, which requires individuals to sell off assets to meet their financial needs and obligations, Chapter 13 allows debtors to keep most of their property as long as they meet the conditions of their bankruptcy repayment plan. Chapter 7 bankruptcy is considered harsher and more disruptive to a person’s life as it often requires extensive liquidation. Chapter 7 is primarily for insolvent individuals with low incomes or high amounts of unsecured debts they can’t realistically pay back.

Conversely, Chapter 13 allows individuals with stable incomes to repair and improve their financial situation without losing their assets. Chapter 13 bankruptcy offers debtors a month-to-month repayment plan to manage their finances better, pay off existing debt, cover living expenses and achieve a fresh financial start. For otherwise financially healthy individuals, Chapter 13 generally offers a much better solution than Chapter 7 bankruptcy because it allows debtors to maintain their daily lives as they pay off their debt obligations in a slow, steady, and structured manner.

Can IRS Tax Debt Be Discharged in Chapter 13 Bankruptcy?

Many individuals struggling with personal and business debt also face challenges paying off tax and IRS debt. These tax debts can include current tax obligations as well as back taxes. Chapter 13 provides a path for paying off or eliminating tax debt as part of the structured repayment process. The good news is that in some instances, debtors may not need to repay all tax or IRS debts in full. Chapter 13 can sometimes fully or partially discharge IRS and general tax debt, depending on the situation.

The IRS collects many types of taxes, including personal and corporate income, payroll, estate, gift, and excise taxes. For many individuals in Chapter 13, IRS personal income tax debts are the primary concern. However, it’s essential to understand every tax obligation concerning the IRS and overall Chapter 13 proceedings.

How Are IRS Income Tax Debts Treated in Chapter 13 Bankruptcy?

How IRS income taxation debts must be repaid typically depends on whether the tax obligation is a priority or nonpriority tax debt. Priority debts and taxes must always be paid in full during the Chapter 13 process. On the other hand, nonpriority taxes may only need to be partially repaid as they are grouped with other unsecured debts such as credit cards and medical bills.

Unsecured nonpriority creditors each share and receive payment from the discretionary income portion of a Chapter 13 repayment plan. Discretionary income is the monthly amount that remains in a debtor’s payment plan after deducting allowed living expenses such as house and car payments.

Because each nonpriority debt receives only a limited part of the finite, remaining discretionary monthly income, some nonpriority debts – including nonpriority tax and IRS debts – will not be fully paid off when an individual completes the three or five-year Chapter 13 repayment timeline. These unpaid nonpriority debts, which can include nonpriority tax and IRS debts, will be permanently discharged and eliminated once the Chapter 13 bankruptcy payment plan concludes.

What Are Nonpriority Taxes?

Taxes are classified as nonpriority if they meet the following conditions:

The taxes are on income or gross receipts.

The tax deadlines (including legitimate extensions) were at least three years before the individual filed for bankruptcy.

The individual filed tax returns at least two years before they filed for Chapter 13 bankruptcy. If the individual did not file a tax return on time or the IRS filed a substitute one, those taxes may be considered priority.

The IRS formally assessed the tax as a liability at least 240 days before the individual filed for bankruptcy.

The individual did not commit unlawful tax fraud or invasion during the corresponding tax year.

Individuals who meet the conditions above may have certain IRS debts treated as nonpriority, meaning they can be fully or partially discharged upon completing the Chapter 13 repayment plan. However, if the conditions are not met, the outstanding tax obligation will be treated as a priority debt and must be fully repaid.

What Are Priority Taxes?

By definition, priority taxes are any taxation debts that do not qualify as nonpriority taxes. This category can include recent income and any taxes that don’t fulfill nonpriority requirements. However, certain IRS tax obligations are always priority taxes. IRS priority taxes that need to be paid in full during Chapter 13 repayment include:

Trust fund taxes, including Federal Insurance Contributions Act (FICA), Medicare, Social Security and any other federal income that employers withhold from their employee’s paychecks

Excise taxes on certain goods, activities or transactions, such as those related to alcohol, tobacco, gasoline, firearms and environmental regulations

Penalties such as Trust Fund Recovery Penalties (TFRP), late filing and late payment penalties, fraud penalties, penalties for underpayment of estimated taxes and other penalties for non-dischargeable taxes

Fraudulent or erroneous refunds or credits on non-dischargeable taxes

Secured debts such as tax liens filed by the IRS against the properties of individuals who owe significant tax payments.

Priority federal taxes must be paid in full to the IRS, along with any applicable fees and penalties. Individuals must also pay any additional priority taxes to the relevant taxing authorities.

In most cases, debtors must speak with their bankruptcy attorney or personal accountant to determine what counts as a priority or nonpriority tax and how best to proceed with Chapter 13 repayment. The Chapter 13 process is extremely helpful for individuals struggling with personal, business, general taxation and IRS debt. However, it can also be complicated and specific, so hiring an appropriate tax, legal or financial bankruptcy professional is always advisable. The good news is that under the right circumstances, it is possible for individuals to partially or fully discharge tax and IRS debt and move forward into a brighter and healthier financial future.