Chapter 13 bankruptcy provides a powerful tool for individuals who need to reorganize their debts, protect essential assets, and return to solid financial footing. However, the impact of a lien—especially a tax lien—within a Chapter 13 case can present some unique challenges for the taxpayer. The Bankruptcy Code defines a lien as a “charge against or interest in property (not a “security interest” which is a lien created by agreement) to secure payment of a debt or performance of an obligation.”

Whether you’re dealing with tax, judgment, or mechanic’s liens, understanding the treatment of the lien in bankruptcy is critical to your financial recovery, particularly when the lienor is undersecured and an opportunity exists to lien strip.

At the Tax Workout Group, we specialize in tax lien representation and are experts at determining their proper treatment in Chapter 13 cases.

Understanding Tax Liens in Chapter 13 Bankruptcy

If no lien has been recorded, then, of course, the tax is unsecured for purposes of the bankruptcy case. How the unsecured claim will be treated in Chapter 13 then depends on whether it is a priority or a non-priority tax claim or dischargeable or non-dischargeable under section 523 of the US Bankruptcy Code. Note that to the extent that a lien attaches to property that is not property of the estate (such as an ERISA-qualified retirement plan), the weight of legal authority is that the claim must be treated as unsecured in a Chapter 13 plan.

Priority Tax Claims – Bankruptcy Code section 507 defines a priority tax as an unsecured claim that falls into specific categories of tax claims. Thus, if the priority tax claim is protected by a properly filed tax lien, it is no longer a priority tax claim since only unsecured claims can be priority tax claims. Fully secured valid tax liens are entitled to post-petition interest, and most Bankruptcy Courts follow Internal Revenue Code section 6621(a)(2) as the Chapter 13 interest rate which is tied to the Federal short-term interest rate.

Determining what property tax liens attach to is the first step in determining the treatment of the underlying tax claim in Chapter 13. A valid filed tax lien attaches to all property and rights to property of the debtor, including tangible and intangible, legal and equitable, present, and contingent, liquidated or unliquidated assets, and exempt or nonexempt property. Commissions realized post-petition, if automatic upon renewal, is a deferred right to payment – a property right to which the notice of federal tax lien (NFTL) attaches. If not automatic, i.e., the debtor must or is expected to perform post-petition services to assure renewal, the commission are after-acquired property.

Treatment of Tax Claims In Chapter 13

When the tax lien is undersecured, there is an opportunity for lien stripping. An undersecured tax claim is a tax claim secured by property, but the value of the property is less than the underlying tax claim. An undersecured tax claim may be bifurcated, that is, stripped down to the value of the collateral (i.e., the value of the equity in the debtor’s assets); if the tax is dischargeable, the secured portion is treated as a secured claim and is ordinarily paid with interest, with the unsecured balance discharged like other general unsecured debt, without interest. The unsecured portion is listed in Schedule “F.”

Where the tax is a priority tax secured by a lien on property, the value of which is less than the claim, it is also bifurcated, with the secured portion in Schedule “D” but the unsecured portion listed with other priority claims in Schedule “E.”

Tax Workout Group’s Expertise in Attacking Tax Liens

Ensuring the proper treatment of tax liens in Chapter 13 requires a deep understanding of tax and bankruptcy law and their interrelationship.

The Tax Workout Group can challenge invalid tax liens and avoid valid ones. Avoidance is the process of extinguishing a valid tax lien. In contrast, an invalid lien is not avoided but is declared invalid by filing an adversary proceeding, which we can initiate in the Chapter 13 bankruptcy case.

There are essentially three (3) procedures for attacking tax liens:

• File a Motion to fix the value of a tax lien or avoid a valid but improperly filed tax lien.
• Objection to Proof of Claim for a secured tax claim.
• File an Adversary Complaint to determine the extent or validity of a defective tax lien.

Thus, at least three different ways to challenge a secured claim exist. The amount of the claim can be challenged by objecting to its allowance. The value of the lien can be put into issue by a request for determination of its secured status. Third, the validity of the lien can be directly attacked. The first two are contested matters and the third requires an adversary proceeding. If a secured claim is challenged due to questions concerning the validity of a lien (the existence or legitimacy of the lien itself), its priority (the lien’s relationship to other claims to or interests in the collateral), or its extent (the scope of the property encompassed by or subject to the lien) an adversary proceeding is required. Note that the main difference between an adversary proceeding (separate lawsuit within bankruptcy) and a contested matter (less formal motion) is how they are initiated and the length of time to complete.

Defective tax liens. Unless an apparent defect can be found in the filing of the tax lien, or it is invalid as a matter of law (e.g., recorded in the wrong county, or it is being asserted against after-acquired real property for a discharged tax claim, etc.), about the only avenue of relief for a tax lien on property is to strip the lien down to the value of the equity through a Chapter 13 with a plan providing for payment of substantially less than 100% of the unsecured portion. Of course, this only offers meaningful relief in most cases if the unsecured portion of the tax claim is dischargeable in the Chapter 13 case and there is a relatively small equity in the property.

Choose Tax Workout Group for Tax Lien Resolution

When filing a Chapter 13 bankruptcy case with tax claims, hiring a tax-bankruptcy law firm is essential if there are tax claims. Our tax-bankruptcy attorneys focus on representing clients in tax-motivated bankruptcy filings. A “tax-motivated” bankruptcy filing is one where ​a principal claim in the case includes a substantial tax debt, related interest, and penalties. If there are also tax liens in the case, we will ensure that we effectively resolve the tax claims, ensure their proper treatment, and attack the recorded tax liens whenever possible.

Reach out today and let our team of professionals resolve your tax claims and show you the difference that comes with working with our tax-bankruptcy attorneys.