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9. Tax Claim Treatment in Chapter 11 and 13 Cases


Chapter 11 and 13 cases normally require the court to approve a repayment plan which repays all or a portion of the debts owed to creditors. Tax claims (as well as all other debts) will be classified as secured, priority or general unsecured, depending on the facts and circumstances. The classification of a debt as secured, priority or general unsecured will usually determine whether the taxpayer must pay all or none of the tax, and whether interest and/or penalty must be paid.

9.1. Secured Tax Claims. The tax debt will be classified as a "secured" debt If the taxing authority follows the procedures required to obtain a tax lien.        Index

9.1.1. Federal Tax Liens. Federal tax liens attach to a taxpayer’s equity in all of his property except for the very the limited amount of property exempt from seizure under federal tax laws. Almost no property is exempt from collection of federal tax debts except for wearing apparel and a limited amount of household furniture, personal effects and tools of trade. See Property Exempt from Federal Tax Collection for a list of property exempt from collection of federal tax debts.        Index

9.1.2. State Tax Liens.       Index

(a) Property Taxes. Tax liens securing the payment of real or personal property taxes attach only to the taxable property. For example, a tax lien will attach against a taxpayer's home with respect to unpaid taxes relating to the home, but will not attach to other land or personal property owned by the taxpayer.        Index

Property tax liens take priority over all other liens and mortgages, including mortgage taken by banks before the tax was incurred, and all liens held by homeowner’s associations for unpaid dues or assessments.

Example #9.1. Owner buys a home for $100,000 on 1/1/06. Bank takes a mortgage for $80,000 of the purchase price on the same day. On 1/1/07, Owner fails to pay his $500 yearly dues to HOA. As a result, a lien attaches to the home to secure payment of the unpaid dues. Owner then fails to pay $3,000 in 2008 property taxes owed to County, City and School District on 12/1/08. As a result, County, City and School District have a lien against the home to secure payment of the property taxes. Per state law, the property tax lien relates back to 1/1/08. The priorities of the lien claims are set forth below:

Priority

Lien Date

Lienholder

Amount

1

1/1/08

County, City and School District

$3,000

2

1/1/06

Bank

$80,000

3

1/1/07

HOA

$500

Per both federal and state law, the lien for property taxes trumps (has priority over) all other mortgages and liens, regardless of the fact that the other liens came before the property tax lien.

(b) State Sales, Excise, Use and Franchise. Tax liens securing the payment of most Texas state taxes (sales and unemployment taxes) attach to a taxpayer’s equity in all property except for the property exempt from seizure under Texas state exemption law. See the Exemptions page for a list of property exempt from seizure under Texas state law. Texas state law provides for fairly liberal exemptions compared to the exemption laws of most other states.        Index

9.1.3. Required Plan Payment of Secured Claims. Determining the required amount that must be paid on secured claims in a Chapter 11 or 13 plan is rather complicated. A comprehensive explanation is beyond the scope of this article. Only an experienced bankruptcy attorney can property analyze if you must pay a secured claim, and if so, how much.        Index

The required plan treatment of secured claims depends on several factors:

whether the debtor desires to retain or surrender possession of the property;

whether the property is the debtor's homestead (primary residence), or a rental or investment property;

the value of the property;

the payoff amount owed to each secured creditor;

the priority of the various liens (if there is more than one lien against the property); and

the interest rate specified by any applicable federal, state or local law.        Index

(a) Surrender. If the debtor desires to surrender the property, the plan will not be required to pay any portion of the secured claim unless the debt can also be classified as a priority claim. It is important to note: many tax claims can be classified as either a secured or priority claim, or as partially secured or partially priority, depending on the value of the property and the payoff amount due on the debt. If the debtor elects to surrender the property, and the claim can be wholly or partially classified as a priority claim, the plan may need to pay all or a portion of the claim.        Index

(b) Retain. If the property is debtor's homestead, the plan will virtually always need to pay the full amount due on all state or local tax claims (and all other mortgages and liens). Federal tax liens may not need to be paid in full depending on the value of the property. The scenarios are so varied and complicated that it is probably more instructive to provide several examples.        Index

Example #9.2. Taxpayer files for Chapter 13 bankruptcy on April 16, 2009. He owns a homestead worth $100,000. Assume the following tax and mortgage debts. The required bankruptcy plan treatment is specified in the right hand column. State and local tax liens will trump a pre-existing mortgage.

 

Example #9.2.1

Priority

Lien Date

Lien Type

Amount

Required Plan Treatment

1

1/1/2007

Property Taxes

$10,000

Full payment at 12% interest

2

1/1/2005

1st Mortgage

$60,000

Full payment – contract rate

3

1/1/2008

Federal Income Tax Lien

$20,000

$20,000 at current IRS interest rate

Total

$90,000

The IRS is last in priority but still must be paid in full because the value of the property is less than the full amount of all liens and mortgages.

 

Example #9.2.2

Priority

Lien Date

Lien Type

Amount

Required Plan Treatment

1

1/1/2007

Property Taxes

$10,000

Full payment at 12% interest

2

1/1/2005

1st Mortgage

$60,000

Full payment – contract rate

3

1/1/2008

Federal Income Tax Lien

$50,000

$30,000 at current IRS interest rate; $20,000 at 0% (if classified as priority) or $0 if classified as general unsecured)

Total

$120,000

The IRS is last in priority and can be partially stripped away because the value of the property is less than the full amount of all liens and mortgages.

 

Example #9.2.3

Priority

Lien Date

Lien Type

Amount

Plan Treatment

1

1/1/2007

Property Taxes

$10,000

Full payment at 12% interest

2

1/1/2005

1st Mortgage

$95,000

Full payment – contract rate

3

1/1/2008

Federal Income Tax Lien

$50,000

$0 at current IRS interest rate; $50,000 at 0% (if classified as priority) or $0 if classified as general unsecured)

Total

$155,000

The IRS is last in priority and can be fully stripped away because the value of the property is less than the full amount of all other liens and mortgages.

 

Example #9.2.4

Priority

Lien Date

Lien Type

Amount

Plan Treatment

1

1/1/2007

Property Taxes

$10,000

Full payment at 12% interest

2

1/1/2005

1st Mortgage

$120,000

Full payment – contract rate

3

1/1/2008

Federal Income Tax Lien

$50,000

$0 at current IRS interest rate; $50,000 at 0% (if classified as priority) or $0 if classified as general unsecured)

Total

$180,000

The IRS is last in priority and can be fully stripped away because the value of the property is less than the full amount of all other liens and mortgages. The 1st mortgage can never be either fully or partially stripped away, nor can any of the other terms of the mortgage be altered.

9.2. Priority Taxes. A "priority" tax is any income, employment, sales or property tax which can not be discharged in a Chapter 7 case.       Index

9.2.1. Required Payment on Priority Tax Claims. A Chapter 11 or 13 repayment plan must propose full payment of all "priority" tax debts. The bankruptcy court may not approve a plan that fails to satisfy this requirement.        Index

Example #9.3. Under the situation described in Example #10, the payment plan must propose full payment of any income taxes owed for the 2006, 2007 and 2008 tax years. The bankruptcy plan may propose no payment of the taxes owed for the 2005 tax year if Taxpayer’s budget shows that he can not afford to pay the older taxes.

9.2.2. Interest and Penalty on Priority Tax Claims. A priority tax claim includes all accrued interest though the bankruptcy filing date, but excludes all accrued penalties. The plan will not need to pay post filing interest on any priority claim, including priority tax claims.        Index

Example #9.4. Taxpayer files for Chapter 13 bankruptcy on April 16, 2009. On that date he owes the following amounts for 2005 federal income taxes: principal: $10,000; interest: $1,000; penalty: $2,000. The amount of the "priority" claim is $11,000, which includes all principal and accrued interest. The $2,000 penalty is not part of the priority claim, but is instead a "general unsecured" claim. The Chapter 13 plan must provide for full payment of the $11,000 priority claim, without the payment of further interest. The Chapter 13 plan must pay the $2,000 general unsecured claim only if Taxpayer’s budget shows that he can afford to pay it.

9.3. Unsecured Tax Claims. All tax claims not classified as "secured" or "priority" claims are classified as "general unsecured" claims. All general unsecured claims must be treated equally, and will receive a pro rata share of any funds leftover after the payment of priority and secured claims. The plan must propose to pay general unsecured claims between 0 and 100 percent of the claim amount, depending on how much the debtor can afford to pay. If the budget shows that the debtor can't afford to pay any portion of the general unsecured claim, the plan may propose a 0 percent payout. If the budget shows that the taxpayer can afford to pay some or all of the general unsecured claim, the plan must propose to pay the full amount the taxpayer can afford to pay.        Index