Chapter 12 Bankruptcy and Taxes: Requirements & Details

chapter 12 bankruptcy and taxesChapter 12 bankruptcy is designed for family farmers and fishermen. In this type of bankruptcy, generally the courts allow you to repay a portion of your debt over three to five years, and the remaining debt is discharged.

Qualifying for Chapter 12

To qualify as a fisher, at least half of your income from last year must come from fishing. For farmers, at least half of your income from the previous three years must come from farming. If you are married, that rule applies to your combined income as a couple.

Chapter 12 Bankruptcy and Taxes

In a Chapter 12 bankruptcy, tax debts are classified as priority debts. That means they get paid first. Tax debts are prioritized over other types of debts such as equipment loans or credit cards.

When creating your repayment plan, the courts use all of your disposable income toward the repayment plan. If there are not enough funds to cover your tax debts, the leftover tax bill is eliminated.

Exceptions to Priority Claims

There is one major exception to the rule about tax debts as priority debts. If you owe taxes due to the sale of farm assets, those taxes are not a priority. Instead, they are considered to be unsecured debts.

So for example, let’s say you sold a big piece of farming equipment and the sale created a capital gain. If you owe taxes on the capital gain, those taxes are considered part of your unsecured debts. In a Chapter 12 bankruptcy, unsecured debts are the lowest priority.

Here’s how that works. After the repayment plan covers your priority debts, the payments are applied to your secured debts. Finally, any remaining money is applied to the unsecured debts. Tax bills in this category are much more likely to be erased than priority tax debt.

Taxes Incurred After Petition

If you incur taxes on the sale of farm assets after putting in your bankruptcy petition, those taxes cannot be discharged. They will also not be included as part of your bankruptcy claim.

In addition, if those taxes get behind, you can’t apply for an installment plan. The IRS does not allow that when you are in bankruptcy proceedings.

Current Taxes Owed

As a small fisherman or farmer, you typically pay income taxes throughout the year. When the bankruptcy court sets up your repayment plan, it takes those tax payments into account along with your other essential expenses (housing, food, clothing, etc). You must continue to pay current taxes throughout the repayment plan.

Bankruptcy can be a useful tool in some cases, and it’s designed as a consumer protection. However, it can put a huge stain on your credit report that will make it difficult to obtain financing for personal or business purchases in the future. Before you make your final decision, you may want to look at other ways of dealing with tax debt such as an offer in compromise or installment plans. Contact us today for a free consultation.