Chapter 12 Bankruptcy and Taxes: Requirements & Details

Chapter 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 liability over three to five years, and the remaining amount owed 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, taxes owed are classified as priority liabilities. That means they get paid first. Taxes are prioritized over other types of liabilities 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 taxes, the leftover tax bill is eliminated.

Exceptions to Priority Claims

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

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 liabilities. In a Chapter 12 bankruptcy, unsecured liabilities are the lowest priority.

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

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 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. You should reach out to a bankruptcy attorney if you are considering bankruptcy.