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Stripping of IRS or State of New Jersey Tax Debt in Bankruptcy

June 10, 2020 Anthony Gramuglia Chapter 13, Debt Management, Chapter 11, Business Bankruptcy

Liens can be a complicated problem for many individuals dealing with heavy debt issues. A lien is a claim or legal right against assets, most often property or real estate, which are utilized as collateral. Pay the lien, and you reclaim all rights to your possessions and settle your debts. However, if you fail to pay off your liens, the organization that filed said debt can then repossess your property, auction it off, and collect on the income to pay off the debt.

These liens are typically established by creditors, but legal judgements can also establish liens. In a typical situation, liens serve to assure that guaranteed payments, such as repayment of a loan or taxes, are satisfied. After all, it’s either you pay your debts, or you lose property of equal financial value. Both the IRS and State of New Jersey can file a lien against a taxpayer for unpaid taxes. If you don’t pay your taxes, the IRS can repossess your home as a penalty.

While liens threaten to seize the roof from over your head, there is hope. If you are burdened by the weight of liens, it is possible to strip off or deconstruct an IRS or State of New Jersey tax lien when filing for bankruptcy. It’s commonly believed that liens are not eliminated when you declare bankruptcy. However, in a Chapter 13 or Chapter 11 Bankruptcy, you can strip that lien off or break the lien into secured and unsecured portions. By doing so, you can potentially wipe it out, securing your property as you financially restructure your assets.

How Tax Liens Work

Liens filed by the IRS and State of New Jersey function a little differently than typical liens filed by unpaid contractors, banks, or court judgements. Tax authorities are granted the legal power through tax laws to put liens on property owned by taxpayers who do not pay the full amount of their taxes.

If a taxpayer ignores their owed taxes and allows outstanding debt to collect, the IRS can file a lien against any of that taxpayer’s property in order to pay off the outstanding tax debts. The property, be it the taxpayer’s vehicle, personal bank accounts, or even home, will then be publicly auctioned off in what is sometimes called a sheriff’s sale. Once the property is sold, the money earned through the auction is then used to pay off the outstanding debt. Ignoring a tax lien will result in the IRS seizing all your assets, which they will then liquidate to produce the money necessary to pay off any outstanding debt.

While it’s bad enough that your personal property can be sold off without your consent, the impact of tax liens extends beyond simply that. Tax liens can directly affect your ability to sell your current assets or obtain credit, such as bank loans or even credit cards. This can be particularly devastating to anyone undergoing bankruptcy or reorganizing their financial status.

The Rules for Discharging IRS/State of NJ Debt

Thankfully, many tax debts can be wiped out upon declaring bankruptcy. While there is still reason to tread carefully, which will be discussed below, debt to the IRS or State of New Jersey can be discharged under the following conditions.

In a Chapter 7 bankruptcy, only income tax debt can be discharged. Other varieties of tax debt, such as payroll tax, cannot be discharged in this manner. Your debt cannot be a product of willful tax evasion or fraud. Correlating to this, there must be a tax filing for the late tax payments that is at least two years old by the time you declare bankruptcy. The debt must be at least three years old and the IRS must have assessed the income tax debt at least 240 days before you file your bankruptcy petition.

In addition, when declaring Chapter 7 bankruptcy you can strip down the tax lien where the taxes are dischargeable. For example, assume you have an IRS tax lien for $100,000. Let’s assume also that you only own real estate worth $100,000 with a $100,000 mortgage loan against the property. If that IRS lien can be wiped out or discharged because it satisfies the elements of being general unsecured debt, then you can file a motion or adversary action to void the lien and discharge the debt.

Unsecured vs. Secured Claims

When dealing with claims, you will hear about “unsecured” and “secured” claims. To the uninitiated, the differences between the two will seem vague and hard to define. However, in short, a secured claim is one that has a lien, while an unsecured claim does not.

When filing for Chapter 11 or Chapter 13 Bankruptcy, the IRS and State of New Jersey unsecured tax claims can be restructured so you can pay your debt over the course of 60 months.

However, this is not the situation for secured claims. While filing for bankruptcy can negate outstanding unsecured debts to the IRS and the State of New Jersey, for secured claims it is a different matter. When filing for bankruptcy, you can walk away from your debt to the IRS. However, the lien that grants them possession over your property remains, which means they still have possession over your belongings and auction them off. So, what can you do to avoid that?

Dealing with Secured Claims

There are multiple strategies you can employ in order to deconstruct a lien claim. Under certain circumstances, you can make a deal with the IRS or tax department’s lien resolution department. You can sell the property the claim is laid against if the property’s worth is less than that of the lien. For example, you can sell a home to pay off some of the lien if the lien has claimed your home as collateral for its payment. This will greatly reduce the amount of money owed. However, you have other options when declaring Chapter 11 or Chapter 13 Bankruptcy.

Liens function as a secured claim against an individual’s property. As a secured claim, it is necessary that the individual pays it off. However, the manner through which an individual can pay off a lien can be restructured or reworked. Under Chapter 11 Bankruptcy, liens can be restructured so those in debt can instead choose to pay them off over a longer period of time. The lien is paid much the same way a mortgage is paid – over the course of years, bit by bit.

A Matter of Time

It might be apparent upon even a cursory read-through of the above, but much of the above can only occur under certain circumstances of how long the debt is filed. In some cases, you might already find yourself falling into these circumstances without doing anything. However, other times, you might find that not enough time has passed to wipe out the lien or tax debt.

Some clients will be unable to file taxes because they do not have the money to pay for it. However, deliberately not paying your taxes or evading taxes will make it impossible for you to wipe out your liens. It’s therefore essential to pay taxes, then wait a period of time in order to properly pay off taxes. This calculated one-two punch is essential to knocking out liens.

In situations like this, however, it’s vital to have someone on your side. Many people think they can balance the complicated games surrounding debt and taxes, believing they can walk away without paying. However, if you make a single mistake, you could lose your worldly possessions. That’s why it’s best to not wait and put yourself at an unnecessary risk.

If you are considering filing bankruptcy for tax related debt burdens or any other type of debt, contact the New Jersey bankruptcy attorneys at Scura, Wigfield, Heyer, Stevens & Cammarota, LLP today for a FREE Consultation or give us a call at 973-870-0434, or email us at Info@scura.com.

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