Chapter 13 and Tax Debt

Tax debt is one of the more stressful and confusing debt types. Many assume that it can’t be handled in a bankruptcy, but this isn’t true. Chapter 13 bankruptcy gives you a path to restructure, reduce, and sometimes even eliminate tax debt. 

However, because tax debt issues are often nuanced and complex, it helps to have the expertise of a skilled bankruptcy attorney on your side. Erin Lane, a founding partner of Washington State Bankruptcy Lawyers, helps individuals across Washington State get out from under debilitating debt.

Erin helps honest, hardworking Washington residents regain control of their financial situation and pave the way to a more stable future. She is known for her practical and client-first strategies for helping with complex debt, especially tax debt. 

How Chapter 13 Bankruptcy Treats Tax Debt

Chapter 13 bankruptcy is also commonly referred to as a reorganization plan. It is designed to give you time to address your debts in a more structured way. Instead of wiping out all of your debt at once, you propose a repayment plan that typically lasts between three and five years. 

Your plan lays out how each of your creditors will be paid, then the court reviews the proposed plan under 11 U.S.C. § 1322 and 11 U.S.C. § 1325. Once the court confirms the plan, you and your creditors are bound by those terms. 

When tax debt is involved, Chapter 13 bankruptcy sorts it into different categories. Each category is handled differently, and the distinction between the categories determines how much you repay and what might be left behind at the end of your bankruptcy case.

Priority Tax Debt (Must Be Paid in Full)

This type of tax debt always comes first, as it typically includes recent income taxes and other obligations that the law treats as more urgent. Under 11 U.S.C. § 507(a)(8), priority debts are paid through your repayment plan. 

Payroll and trust fund taxes also fall under this category. These are amounts employers withhold from your wages, such as Social Security and Medicare payments. They are not eligible for discharge because these funds were never intended to belong to the business or individual. 

The advantage of Chapter 13 for priority tax debt is the time you are given to pay them in full. Instead of facing immediate collection actions, you spread these payments out over three to five years without any ongoing levies or wage garnishments. 

Non-Priority Tax Debt (Potentially Dischargeable)

This tax debt is treated similarly to general unsecured debt and typically includes older income taxes that meet filing and timing requirements. Instead of paying the full balance, you may only need to repay a portion of it based on your income and the plan’s structure. If your remaining balance after completing the plan is eligible, it can be discharged. 

Specific rules determine whether a tax debt moves out of priority status and becomes eligible for a discharge. These timing requirements are often referred to as the 3-2-240 framework. While this isn’t detailed in only one statute, it is spread out over several sections of the Bankruptcy Code. 

• The 3 Rule (Three Years): The tax return must have been due at least three years before filing for bankruptcy. This includes any extensions. For example, a 2020 tax return that was due in April 2021 is eligible after April 2024. 

• The 2 Rule (Two Years): You must have actually filed the tax return at least two years before filing. While late-filed returns can still qualify, the timing matters. If you recently filed, the clock resets. 

• The 240 Rule (240 Days): The tax must have been assessed by the IRS at least 240 days before filing, which is when the IRS formally records the debt. This period may be extended if you file an Offer in Compromise, have a prior bankruptcy filing, or have experienced certain collection delays. 

If your tax debt meets all three rules, it can move out of priority status and become a non-priority unsecured debt, where you may only need to pay a portion of it, and the rest can be discharged after plan completion. 

Secured Tax Debt (Tax Liens)

This debt type involves tax liens. When the IRS or Washington Department of Revenue records a lien, it attaches to your property. In Chapter 13 bankruptcy, the secured portion of the debt is assessed based on the value of the asset attached to the lien. You pay that amount through your repayment plan, and any unsecured portion left may have to be treated separately. 

The most important thing to understand is how the repayment process works. Once your plan is approved, you make your Chapter 13 payments to a bankruptcy trustee assigned to your case. The trustee then distributes the funds to your creditors according to the court’s orders. This structure provides consistency and reduces the back and forth that might otherwise occur between you and the taxing authorities. 

Liens don’t just disappear when you file for bankruptcy. While Chapter 13 can help you better manage debt, the lien itself survives if the case isn’t fully satisfied. 

Tax Payment Structure Within Chapter 13 Bankruptcy Plan

Once your plan is confirmed, you no longer have to deal with creditors. Your debt becomes part of a single court-approved plan that outlines how and when to pay your obligations. 

The Payment Structure Within the Plan

Your payment is based on your overall income, necessary living expenses, and total debt amount. All confirmation standards under 11 U.S.C. § 1325 must be met, including showing your commitment to using all your required disposable income to continue making payments.

How Interest and Penalties Are Treated

One of the primary benefits of Chapter 13 for tax debt is that it limits the debt from growing over time. While your underlying balance is still important, your repayment plan reduces the impact of any ongoing penalties. Unsecured portions of tax debt, in many situations, do not grow at the same rate they would if you didn’t file for bankruptcy.

For secured tax claims, the interest may still apply, but it is handled within the repayment plan’s structure instead of through any ongoing enforcement and collection actions. 

The Role of Your Disposable Income

Your monthly repayment plan is based on your disposable income, which is what is left after covering all reasonable and necessary expenses. The calculation determines how much you can pay toward your tax debt and other obligations over the course of your bankruptcy case. 

Since your disposable income determines how much you pay, even small changes in your income or expenses can influence the outcome. 

Washington State Tax Debt Considerations

In Washington State, tax debt follows certain rules, especially when the Washington State Department of Revenue (DOR) is involved. While Chapter 13 can restructure your debt, it doesn’t remove the state’s authority to secure and collect what you owe. 

WA Department of Revenue Collection Powers

The Department of Revenue collects unpaid taxes. One of the primary tools they have is the tax warrant, which is very similar to a judgment. Under RCW 82.32.210, once a warrant is issued and recorded, it becomes a lien against your real and personal property.

RCW 82.32.240 makes it clear that any unpaid taxes are a legal debt owed to the state. This means the DOR can collect through liens and other enforcement actions. 

When you file Chapter 13, all these collection efforts are paused. The automatic stay under 11 U.S.C. § 362 stops collection efforts immediately, but any existing warrants or liens must still be addressed in your repayment plan. 

Personal Liability for Business Taxes

Many are surprised to learn that certain tax obligations of business owners and corporate officers can become personal responsibilities. Under RCW 82.32.145, if you have or had control over financial decisions such as collection or paying taxes, you may be held responsible for unpaid amounts. 

In a Chapter 13 bankruptcy case in Washington, these obligations may be included in the repayment plan, giving you time to address the balance while protecting your income and other assets from immediate collection actions. 

Filing Requirements and Compliance During Chapter 13

Staying current on taxes is not optional in a Chapter 13 case. Before the court can even approve your plan, you must be up to date. Under 11 U.S.C. § 1308, all required tax returns from the four years before filing must be completed. This even applies if you can’t afford to pay what you owe. 

Filing and paying are treated as separate issues, but Chapter 13 can help with the payment side, as long as your filings are current.

Key filing and compliance requirements for Chapter 13 include:

• File all federal tax returns for the past four years.
• Provide copies of those returns to the Chapter 13 trustee upon request.
• Stay current on all new tax filings during your repayment plan.
• Pay ongoing tax obligations as they are due, even those outside of the plan, as required.
• Avoid filing gaps, even if you cannot pay all balances in full.
• Respond right away to any IRS or Washington Department of Revenue notices.
• Keep accurate records of your income, especially if you are self-employed or have variable earnings.

Staying up to date and compliant with these key requirements helps your Chapter 13 case run smoothly and stay on track. It also helps you avoid unnecessary setbacks. 

Your bankruptcy attorney can guide you and ensure your repayment plan remains workable over the three- to five-year timeframe. 

Your Tax Refunds in a Chapter 13 Case

When you file for Chapter 13, your tax refunds may be used to fund your repayment plan or may be partially protected through Washington State and federal exemptions (11 U.S.C. § 522). How a tax refund is treated varies from case to case. 

Here are some of the main factors that may affect what happens to your tax refund:

• Whether your confirmed plan requires a turnover of funds over three to five years
• If your monthly payment already accounts for those projected funds
• The timing of the refund (before filing vs during your case)
• Whether any of the refunds may be protected using exemptions
• The type of income tied to the refund (earned income credits, over-withholding, etc.)
• Instructions from your Chapter 13 trustee regarding your annual tax filings and refunds

Tax refunds can significantly impact your plan and the amount you pay, so they are reviewed very closely. Under 11 U.S.C. § 541, which defines the bankruptcy estate, tax refunds, including those based on your pre-filing income, are considered property of the estate.

With the right structure, you may keep more of your refund while still meeting all plan requirements.

Finding the Best Way Forward

Erin Lane at Washington State Bankruptcy Lawyers has extensive experience handling tax-heavy bankruptcy cases across the state. Instead of a one-size-fits-all approach, she reviews each case carefully, tailoring a strategic plan that works best for your circumstances. 

Chapter 13 isn’t just a repayment plan. It’s a powerful tool you can use to help get yourself back on track. Contact Erin Lane today for a consultation to discuss your discharge eligibility, plan structure, and the best time to file.