Tag Archives: taxes

Bankruptcy Alphabet - P is for Priority Debt

What is Priority Debt?

The bankruptcy code actually categorizes each and every type of debt into a pecking order. One of these categories is what is called a priority unsecured debt. This means they are special. Priority debts include taxes, criminal restitution, child support and spousal support, among others. Generally that means they are non-dischargeable (not forgiven). If you meet certain technical requirements, taxes are dischargeable.

Priority is much more than about dischargeability. It is about reorganizing your financial affairs in a manner that eliminates a nondischargeable debt. I know. You’re probably asking “How do I eliminate something you just said I could not get rid of”? Through Chapter 13. I love using Chapter 13 for someone that owes a pile of debt that includes priority unsecured debts.

Let’s say you owe $15,000 in arrears for child support, $10,000 for income taxes incurred last year, and $100,000 in credit card debt. We calculate your income and expenses and determine that you can afford to pay $500 a month for 60 months, i.e., $30,000. Since the priority debts in this case (child support and taxes) are not dischargeable, they must be paid in full.

Here, that works out pretty well because you are going to pay the Chapter 13 trustee $500 each month. The trustee in turn is going to take that money and distribute it to your creditor based on priority. The child support arrears are considered highest priority and would be paid first, followed by the taxes. Since the child support and taxes add up to $25,000, our five year, $30,000 plan will cover these priority debts.

If there is any money available after the priority debts are paid, they go to less important creditors such as general unsecured debts like your credit cards. In this example, the credit cards would get the remaining $5,000 (5% of what you owe them) during the final months of the plan. Since credit cards are dischargeable, the remaining $95,000 or 95% of the debt would be discharged upon completing all Chapter 13 plan payments.

Please note that the plan payment calculation I used as an example is oversimplified. Plan payment calculations are much more sophisticated than this example, but it serves to illustrate the general goal of dealing with priority debts.

Photo courtesy of Leo Reynolds.
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Dealing with back income tax in bankruptcy

By: Jeena Cho, San Francisco bankruptcy attorney

Did you know you can get rid of certain back income taxes (both Federal and State) in bankruptcy? Oftentimes, clients falsely believe they can never discharge taxes through bankruptcy. As the saying goes… “death and taxes.”

In general, taxes can be discharged in bankruptcy if it has been at least:

  • Three years from due date of the return;
  • Two years from actual filing of the return (Substitute for Returns do not count);
  • 240 days from an assessment;
  • Returns must not be fraudulent and there must be no evasion.

As you can see, timing is critical when performing the above analysis. File on the wrong date - you might get stuck with tax debt that otherwise could have been discharged had you waited. In addition to reviewing your returns, requesting a tax transcript is critical in determining the timeline.

If you have recent tax debt that we can’t discharge, Chapter 13 can be a good alternative. In Chapter 13, you can get up to 5 years to repay the portion of the income tax that is non-dischargeable.

Photo credit: alancleaver