Filing bankruptcy with or without your spouse, and under Chapter 7 or Chapter 13, may affect what protection you each receive.
The last few blogs have been about what happens if you file bankruptcy with or without your spouse, and whether you file under Chapter 7 or 13. Today’s blog addresses the protections you and your spouse get or don’t get from collection activity by the IRS (and any pertinent state income tax agencies) under those options.
The “automatic stay” which you get with any bankruptcy filing stops the IRS and state agencies from any further collection actions just like any other creditor. But to get this protection, whoever owes the tax has to be in on the bankruptcy filing. The co-debtor stay of Chapter 13 does not apply to income taxes, so that does not give any help to a non-filing spouse.
The “Automatic Stay” Applies to Income Tax Debts
Some people have the misimpression that the IRS and other income tax authorities are exempt from the “automatic stay,” the protection from creditor collection you receive immediately when your bankruptcy is filed. Not true. If the IRS continues to pursue a tax debt after being given notice of a bankruptcy filing, it is breaking federal law just like any other creditor. And the bankruptcy court can order the IRS to pay damages if it does break the law. Since the IRS and similar state agencies have been punished in this in the past, they tend to follow the law and stop collections right when you file bankruptcy, like most other creditors.
There ARE some exceptions to the “automatic stay” that apply to taxing authorities—actions that they can still take in spite of a bankruptcy filing, but these actions are very limited.. They can “assess” a tax (determine the amount of tax) and send out a notice about it, make a demand for tax returns, send a notice of tax deficiency (but not act to collect on that deficiency), and conduct an audit (but again not act to collect any debt arising from the audit). So these permitted actions do not involve actual collection activity.
The “Automatic Stay” Applies Only to the Filing Spouse(s)
The “automatic stay” protects only the debtor—the person or persons filing the bankruptcy case, and his or her, or their, assets. On a jointly owed tax, if only one spouse files the bankruptcy, the IRS or state agency can continue pursuing the non-filing spouse as if the bankruptcy was not filed. And because the tax debt is jointly owed, the non-filing spouse can be required to pay the debt in full.
Chapter 13 “Co-Debtor Stay” Does Not Apply to Income Taxes
The lack of protection for the non-filing spouse is true both under Chapter 7 and 13, because the usual protections for non-filing “co-debtors” in Chapter 13 under the “co-debtor stay” do not work. As discussed a couple blogs ago, the ‘co-debtor stay” provides a way to protect even non-filing spouses from consumer debts owed jointly with a spouse filing under Chapter 13. But it’s inapplicable to income taxes owed to the IRS or other tax agencies, basically on the rationale that the “co-debtor stay” applies only to “consumer debts,” and courts have determined that income taxes are not “consumer debt.”
Applying the Stay Rules to Income Taxes
Because the tax agencies can pursue a non-filing spouse who jointly owes an income tax—under both Chapter 7 and 13—both spouses need to file bankruptcy whenever there is any significant joint tax debt.
Usually this means a joint filing—two spouses filing together on one bankruptcy case. But sometimes—when their financial circumstances are different enough, or perhaps when the marriage is not stable—they may find worthwhile for each to file a separate case, and maybe for one to file a Chapter 7 case and the other a Chapter 13 one.
Lastly, the IRS has been known to not pursue a non-filing spouse if the taxes are being paid in full through the other spouse’s Chapter 13 plan. But this would be done purely at the discretion of the IRS and so depends on the circumstances and should not be counted on unless first carefully discussed with your attorney. But even in these situations, usually the plan avoids payment of the initial penalties as well as the accruing penalties and interest—a potential significant savings—which the non-filing spouse would be liable for and almost certainly be required to pay. This is yet another reason to include both spouses in the Chapter 13 filing and avoid this kind of liability coming to roost just when the Chapter 13 is completed and you think you are tax-free.