Tax Liens in Chapter 13
What is a Tax Lien?
The filing of an IRS Tax Lien or NYS Tax Warrant (hereafter collectively referred to as a “Tax Lien”) creates a lien in favor of the government against all of your all real and personal property (hereafter collectively referred to as the “Encumbered Property”), including any real estate you own in the county where the Tax Lien is recorded.
- A Tax Lien is essentially a forced legal claim secured by all of your Encumbered Property up to the dollar amount set forth in the Tax Lien, plus any subsequently accrued interest.
- Generally speaking, the life span of a Tax Lien is 10 years from the date of its assessment.
- To sell or refinance any of your Encumbered Property (usually real estate) you must pay off the government the amount set forth in the Tax Lien, plus accrued interest.
As disastrous as this may sound (and sometimes is), in many instances a Tax Lien can be favorably dealt with in a Chapter 13 Bankruptcy.
Bifurcating Tax Liens Into Secured & Unsecured Claims
When the government files a Proof of Claim they will assert the entire amount of their Tax Lien to be a Secured Claim. This can be fatal to many Chapter 13 Plans if not successfully challenged, since Secured Claims have to be paid in full in Chapter 13, with statutory interest. However, in Chapter 13 a Tax Lien can be bifurcated into a Secured Claim and an Unsecured Claim, with the Secured Claim being no larger than the value of the Encumbered Property it attaches to, calculated as follows:
- The value of a debtor’s assets, large and small, are set forth in their bankruptcy schedules. The larger assets are usually valued individually, whereas the smaller assets are usually lumped together and given a collective value.
- Any liens on assets (i.e., mortgages, car loans, etc.) that pre-date the Tax Lien are subtracted from the value of the particular asset.
- After subtracting the liens from the value of the asset, the difference (providing it is a positive number) represents that particular asset’s value as collateral for the Tax Lien.
- The same calculation is employed for every other item of Encumbered Property and, when the sum of each separate calculation is added together, the resulting cumulative sum is the value of the Secured Claim portion of the Tax Lien.
Simply put, the allowed value of a Tax Lien’s Secured Claim is limited to the value of the equity in your Encumbered Property (also referred to as “Cram Down”). Accordingly, if the asserted amount of the government’s Secured Claim is greater than the value of the equity in your Encumbered Property, the difference is reclassified to either an Unsecured Tax Claim or to a Priority Tax Claim, depending upon:
- If the delinquent tax year in question had a return that was due more than three years prior to the bankruptcy filing the taxes owed are a Priority Tax Claim.
- If the delinquent tax year in question had a return that was due more than three years prior to the bankruptcy filing the taxes owed are an Unsecured Tax Clam.
- This distinction is important because Priority Tax Claims (i.e., less than 3 years old) have to be paid in full in Chapter 13, whereas Unsecured Tax Claims (more than 3 years old) do not have to be paid in full.
- While Priority Tax Claims have to be fully paid they are, by nature, unsecured claims and, as such, are not required to receive interest on the amount they are paid.
The following examples illustrate how bifurcating a Tax Lien actually works. Both examples are based upon the following common facts:
- The IRS filed a Tax Lien for $120,000.00, asserting a fully Secured Claim;
- The debtor’s credit card debt totals $39,000.00
- The debtor owns a house worth $200,000.00 that is subject to a $195,000.00 mortgage with no past due payments, leaving equity of $5,000.00;
- The debtor owns a car with equity of $1,000.00;
- Debtor’s equity in his other assets is $3,000.00; resulting in
- The total equity in all of debtor’s Encumbered Assets amounts to $9,000.00.
- The debtor files a Chapter 13 Plan with a 60-month repayment term
Example #1: The IRS files a Secured Claim based upon a Tax Lien covering calendar years that had returns due more than 3 years prior to the bankruptcy filing, so there are no Priority Tax years in question. In debtor’s Chapter 13:
- The $120,000.00 Tax Lien could be bifurcated into an allowed Secured Claim of $9,000.00, which would have to be paid in full, plus interest, and an Unsecured Claim of $111,000.00, which would not require full payment.
- When coupled with the other $39,000.00 credit card / non-mortgage debt the allowed Unsecured Claim in this example would total $150,000.00, which would not have to be paid in full.
- No Priority Claims would have to be paid in this example.
- Accordingly, a Plan that pays approximately $200.00 per month for 60 months would be accepted by the Court and would result in the Secured Claim being paid in full, with interest, and the Unsecured Claims receiving at least something, albeit a fraction of what they are owed
The IRS files a Secured Claim based upon a Tax Lien covering calendar years which includes one Priority Tax year, for which $30,000.00 is owed. In debtor’s Chapter 13:
- The $120,000.00 Tax Lien could be bifurcated into an allowed Secured Claim of $9,000.00 and an Unsecured Claim of $111,000.00, of which $30,000.00 would be a Priority Tax Claim and $81,000.00 would be an Unsecured Claim.
- The Secured Claim of $9,000.00 would have to be paid in full, plus interest. The Priority Tax Claim of $30,000.00 would also have to be paid in full, although without interest.
- When coupled with the other $39,000.00 credit card / non-mortgage debt the allowed Unsecured Claim in this example would total $120,000.00, which would not have to be paid in full.
- Accordingly, a Plan that pays approximately $775.00 per month for 60 months would be accepted by the Court and would result in the Secured Claim and Priority claim being paid in full and the Unsecured Claims receiving at least something, albeit a fraction of what they are owed.
THE BENEFIT OF Tax Lien BIFURCATION
- In each of the above Examples, had the Tax Lien not been bifurcated, the entire $120,000.00 Secured Claim would have to be paid in full, with interest, before the Court would accept your Plan, meaning a monthly Plan payment in excess of $2,500.00 (when Trustee commissions are added in) would be required.
- Bifurcation of the Secured Claim creates a much smaller monthly payment obligation for the debtor.
For a debtor able to make all required Plan payments the end result is that the tax debt is extinguished and the Tax Lien is eliminated upon receipt of your Chapter 13 discharge. At said time you no longer owe the government any money, and the Tax Lien no longer attaches to your real and personal property.
Contact our skilled lawyers in Middletown, NY
For highly skilled legal assistance with Tax Lien issues please contact Michael O’Leary, Esq. at Hayward, Parker & O’Leary, Esqs., who for over 30 years has been assisting clients throughout Orange County, including the areas of Middletown and Newburgh.