How does Chapter 13 bankruptcy work?

You pay creditors, including the IRS, as much as 100% and as little as 0%. What percentage you pay depends on [A] How much, if any, disposable income is left after deducting monthly expenses; and [B] The type of debt you are trying to eliminate.

In Chapter 13, unsecured “non-priority” debt, such as IRS tax debt and credit card debt, may be paid a small fraction or nothing at all. Chapter 13 instantly stops foreclosure or repossession, and lenders may be forced to wait 60 months to get caught up on loan payments. You make payments to a Trustee, and the Trustee pays the bank the regular monthly payments as well as a monthly amount to bring the loan current over the time the Chapter 13 is open, which is typically 36 to 60 months.  It’s also possible to “surrender” property, like a home or car, and pay the lender nothing.

Chapter 13 offers flexibility. Under certain circumstances, it makes wise financial sense to choose Chapter 13 even if you qualify for Chapter 7. Here are some examples of when that could happen: 

Example: Let’s assume you owe the IRS $100,000 in income tax for multiple years. $80,000 of your tax liability is old enough to discharge in bankruptcy, and $20,000 is not old enough. Even if you qualify for Chapter 7, you could file under Chapter 13 and discharge $80,000 of the tax, and yet pay the other $20,000 over five years interest free.

Example: Your house is in foreclosure. You also have older tax debt that could be wiped out in Chapter 7. Even though you qualify for Chapter 7, you could choose to file Chapter 13 instead, and stop the foreclosure, save your home, and wipe out the tax debt.     

An experienced tax attorney will work with the client to create a “plan” that spells out exactly who gets paid and how much. And under certain circumstances it may be wise to start in Chapter 13 and later convert to Chapter 7. For example, if foreclosure forces you to file Chapter 13 to stop the foreclosure lawsuit, it’s possible to modify the mortgage after the case is filed, and dismiss the Chapter 13 case or convert to Chapter 7.

In extraordinary circumstances, Chapter 13 can be filed as a temporary measure to get the IRS off the tax payer’s back. Remember, bankruptcy creates the “Automatic Stay.”  

Get a copy of the Faith Firm free book, How to Get Tax Forgiveness. It will shed some more light on solving tough tax problems.