Tax Debt? Know the Difference Between Chapter 13 and Chapter 7 Bankruptcy

Owing the IRS is never pleasant, but with a stubborn high inflationary period settling in, it may be an option to deal with your tax debt in a bankruptcy.

Fortunately, it is possible to discharge tax debt by filing for protection using any of the options available under the federal bankruptcy code. These include Chapters 7 and 13 for most individuals, Chapter 12 for family farms and fishing operations, and the Chapter 11, which is used mostly for businesses.

The IRS reports that Chapter 13 is the most common type of individual bankruptcy filing when tax debt is involved.  Chapter 13, known as a reorganization bankruptcy, involves making arrangements with creditors to pay off debts over a period of three to five years. Conversely, a Chapter 7 bankruptcy wipes out many debts, meaning they never have to be repaid.

A successful Chapter 13 filing depends on the Debtor fulfilling their obligation under the Chapter 13 plan.  Taxes that are paid off under the reorganization plan and some tax debts – depending on the type of taxes owed – over three years old at the time of filing will be discharged. During the payoff period, the taxpayer should file timely returns and pay all new income taxes that come due.

Depending on the facts of an individual’s case, interest and penalties may be discharged with a Chapter 13 filing. Interest on a dischargeable tax also will be erased. Penalties are dischargeable if they are more than three years old.

In a Chapter 7 filing, the Chapter 7 trustee will look to sell off most assets and give the proceeds to creditors. If there are insufficient or no assets to pay creditors, then eligible debts still get discharged by Chapter 7 and creditors receive nothing. Some tax debts can be cleared away by Chapter 7 if they are at least three years old and the taxpayer has filed returns for the last four tax periods.

If you need to speak with a bankruptcy lawyer to file a Chapter 13 or Chapter 7 petition in the Eastern District of Virginia or the Western District of Virginia, please call us at Winslow, McCurry & MacCormac, PLLC at (804) 423-1382.