Chapter 13 Plan Sunk By Taxes

10 Aug Chapter 13 Plan Sunk By Taxes

Failure to withhold enough for taxes due during a Chapter 13 bankruptcy can kill the case.

Some of the things that interfere with a debtor’s ability to fund a Chapter 13 plan are outside their control:job loss andillness come immediately to mind.

But the preventable cause of many case dismissals is failure to pay on time the income taxes due in years following the filing of the case.

How Chapter 13 works

Chapter 13 is a reorganization chapter. The debtor’s obligation to old creditors is measured by what’s left in the budget after paying current living expenses.

If you can’t pay both this month’s cost of living and make the plan payment, you don’t qualify for Chapter 13 relief. Your case will be dismissed or converted to Chapter 7.

I explain it to clients this way: the bankruptcy system is willing to protect you from existing creditors through a Chapter 13 if you straighten up and fly right. But if you continue to live above your means, the system will wash its hands of you.

The tax hole

In trying to avoid filing bankruptcy, many folks decrease their tax withholding in an attempt to get more cash to pay debts. Of course, this often just ends up substituting the IRS for the credit card company as the most insistent creditor.

Once a bankruptcy case is filed, the debtor needs to revisit their withholding and see if it will be adequate to pay the taxes that are due the following spring. If not, withholding needs to be increased.

Taxes change with life

Loss of the mortgage interest deduction when a property is sold, foreclosed or a lien is stripped can upset withholding that was perfectly proper under old facts.

Debtors need to be mindful of the tax impact of changes in their lives and their holdings, and adjust withholding accordingly.

Bankruptcy “reform” in 2005 handed the IRS the right to move to dismiss a case if tax returns aren’t filed timely or an extension requested.

Just like a wage order for Chapter 13 plan payments, withholding enough for taxes from each check increases the odds of making it across the discharge “finish line”.

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Cathy Moran, Esq.

I'm a certified specialist in bankruptcy law (California State Bar Board of Legal Specialization) practicing in the San Francisco Bay Area for more than 30 years. In addition to practicing bankruptcy law, I train new practitioners at Bankruptcy Mastery.
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