Some people mistakenly believe that overpayments of government benefits like unemployment and Social Security cannot be discharged in bankruptcy or are entitled to priority status, like recent taxes. In truth, these benefit overpayments aren’t entitled to any special treatment unless the government proves in a separate adversary proceeding that the overpayments were caused by fraud committed by the debtor. A recent Kentucky bankruptcy court decision ruled an overpayment of unemployment benefits was not a priority claim in Chapter 13 bankruptcy. The Kentucky Office of Unemployment Insurance had filed a proof of claim in the debtor’s Chapter 13 bankruptcy alleging that the debt owed for a benefit overpayment was a priority claim. Priority claims must be paid in full in a Chapter 13 bankruptcy. The debtor argued that the debt was instead just a nonpriority, unsecured claim that would be paid on a prorata basis like similar nonpriority, unsecured claims like credit card or medical debts.
The Kentucky bankruptcy court reviewed prior decisions defining the difference between a “tax” and a “penalty”. The Bankruptcy Code gives some taxes priority status but the court ruled that the unemployment benefit overpayment was more in the nature of a penalty than a tax. The Court ruled that unlike a tax, the benefits overpayment claim was not universally applicable to all recipients of unemployment benefits; would disadvantage private creditors with similar claims; and was not imposed for a public purpose, like defraying government expenses. Government fines, penalties, or license fees might be nondischargeable under certain circumstances but that does not make them a tax entitled to priority status in a Chapter 13 bankruptcy.
The Court’s analysis of unemployment overpayments should also apply to Social Security benefit overpayments. They too are not taxes but simply unsecured, nonpriority claims. If you owe an overpayment of benefits from either the Social Security Administration or Iowa Workforce Development contact us about how to address this overpayment in either Chapter 7 or Chapter 13 bankruptcy.