If you used a payday loan to pay off a tax debt and then file for bankruptcy, you may or may not be able to discharge (get rid of) that debt in bankruptcy. Whether you can wipe out the payday loan depends on:
- whether the underlying tax debt would have been dischargeable in bankruptcy, and
- whether you file for Chapter 7 or Chapter 13 bankruptcy.
To learn more about what happens to taxes in bankruptcy, visit our Tax Debts & Liens in Bankruptcy topic page.
Tax Debts in Bankruptcy
Many tax obligations receive special treatment in bankruptcy. In most cases, tax debts are priority claims -- meaning that they are nondischargeable and get paid before most other debts in bankruptcy.
Some of the most common priority tax debts include:
- recent income tax obligations
- taxes you are responsible for collecting or withholding
- recent property taxes, and
- certain excise taxes, customs duties, employment taxes, and tax penalties.
Depending on whether you file for Chapter 7 or Chapter 13 bankruptcy, if a tax obligation is not dischargeable in bankruptcy, debts you incur to pay that obligation may also be considered nondischargeable.
Loans Used to Pay Nondischargeable Tax Debts in Chapter 7 Bankruptcy
If you take out a payday loan to pay your tax bill, you can’t discharge that loan in Chapter 7 bankruptcy if the tax obligation you paid was nondischargeable. In general, debts you incur to pay nondischargeable taxes are also considered nondischargeable in Chapter 7 bankruptcy.
If you file for Chapter 7 bankruptcy, the payday loan company will likely file a complaint (called an adversary proceeding) in your case and ask the court to declare the loan nondischargeable. But keep in mind that the loan company still has to trace the funds and show that you used the loan proceeds to pay a nondischargeable tax bill.
Loans Used to Pay Nondischargeable Tax Debts in Chapter 13 Bankruptcy
There are many types of debts you can eliminate in Chapter 13 bankruptcy that you can’t discharge in a Chapter 7. Debts you incur to pay nondischargeable tax obligations are one of them. (To learn more about debts you can eliminate only in Chapter 13 bankruptcy, see Debts Discharged in Chapter 13 But Not in Chapter 7.)
This means that if you take out a payday loan to pay a tax bill, you can discharge that obligation in Chapter 13 bankruptcy. Most payday loans are unsecured debts just like your credit card obligations and medical bills. Whether you will have to pay back a portion of the loan through your repayment plan will depend on your disposable income.
But in most cases, unsecured creditors receive little or nothing in Chapter 13 bankruptcy and their remaining debts are discharged when you complete your repayment plan.
For more information on how Chapter 13 bankruptcy works, see our Chapter 13 Bankruptcy topic area.