To Win the Chapter 13 Tax Prize, You Have to Finish the Race

A Chapter 13 case can be such a good tool for dealing with income tax debt, especially if you owe more than just a year or two of taxes. BUT, you lose those benefits if you don’t successfully finish paying off the Chapter 13 plan. So, go into it only if you have both a burning desire to make it all the way and a truly feasible plan with which to do so.

Chapter 13 often enables you to tame the tax debt beast in a very tidy package. Often you can discharge (write off) some of your tax debts, and pay substantially less on the taxes you must pay, by avoiding or reducing interest and penalties. And you can usually do all this while paying less per month and while being protected from all the nasty collection mechanisms in the tax authorities’ arsenal.

However, the truth that you need to keep in the front and center of your mind is that it’s all conditional: you don’t get the prize until the end of the race. And if you don’t get to the end of the race, no prize for you. The prize is the discharge—the discharge of the debts for the tax years that can be discharged, and of the interest and penalties that you would owe if you weren’t in a Chapter 13 case. You have to get through the whole race–pay your plan payments as scheduled and meet the other requirements of your plan (such as sending yearly tax returns to your trustee, and keeping current on any ongoing child or spousal support payments).

Now this doesn’t mean that your Chapter 13 case is inflexible. Depending on the situation, an experienced attorney will likely be able to build some flexibility into the terms of your original plan. Or if your circumstances change, your plan can usually be amended accordingly.

But look at it this way: the IRS and any other tax authorities are put on hold and have to accept the reductions and the write-offs while your Chapter 13 case is proceeding. But in the background they continue tracking what you would owe—including accrued interest and penalties–if you weren’t in a Chapter 13 case.  If at any time during your case you do not comply with the terms of your plan and, after appropriate warnings, your case gets dismissed (thrown out), leaving the tax authorities no longer be prevented from chasing you. At that time all those taxes, interest and penalties that your Chapter 13 case would have avoided would come roaring back at you.

This is something you want to avoid at all cost. How do you avoid getting your Chapter 13 dismissed?

  • Be fully engaged in the process of putting your Chapter 13 plan together at the beginning of your case, so that you understand its terms and truly believe that you can consistently comply with them.
  • Keep track of your progress throughout your case, both to stay motivated and to catch any potential problems early.
  • Inform your attorney if your financial circumstances change, whether they improve, so that you can account for increased disposable income, or if they deteriorate, so that you can reduce your required plan payments or take other appropriate action.