Bankruptcy does not write off newer income tax debt, but Chapter 7 and Chapter 13 can still help.
Our last blog post was about older income taxes that can be “discharged” (permanently written off) in bankruptcy if they meet certain conditions. Now this blog post is instead about those, generally newer, taxes that can’t be discharged.
Whether a Debt Can be Completely Discharged Should Completely Not Determine Whether You File Bankruptcy
It’s easy to get fixated about whether a debt—a tax or otherwise—is or is not going to be discharged in bankruptcy, and then using that to decide whether you should file a bankruptcy case or not. As in, if you owe one year of income taxes, whether that particular tax debt is going to be discharged or not determining whether bankruptcy will be worthwhile or not. Or if you owe more than one year of income taxes, not being willing to file bankruptcy unless all your taxes are going to be discharged.
The reality is that even if none of your income tax debt(s) will be discharged in bankruptcy, you should look closely at the options there. And definitely, if some of your income taxes would get discharged but one or more would not, you should check out how bankruptcy could help.
How Chapter 7 Bankruptcy Would Help with a Tax You Can’t Discharge
There’s a number of distinct ways Chapter 7 “straight bankruptcy” can help, depending on your circumstances, even if it can’t discharge a penny of your tax debt.
First, the “automatic stay,” the federal law that stops virtually all collection activity against you and your assets the moment you file your bankruptcy, applies to the IRS and state tax agencies in most ways just like any other creditor. So if you are being garnished or are under threat of garnishment by the IRS/state, or are afraid of a levy on your vehicle or a tax lien on your home, a Chapter 7 case will stop those activities, at least for a few months. That’s not very long (especially as compared to a Chapter 13 case) but it may well be long enough to do one of the other tactics we’ll tell you about next.
Second, a Chapter 7 case may well discharge all or most of your other debts so that you can afford to enter into a reasonable monthly payment plan with the IRS/state for the tax that isn’t being discharged. The IRS in particular, as well as many state’s tax agencies, are willing to enter into relatively long payment plans, resulting in relatively low monthly payments, making this option a more sensible one. With interest rates currently quite low, the long term cost to you may be manageable, and so would perhaps be your best option.
Third, if after discharging all or most of your other debts you truly can’t afford to pay anything towards your remaining taxes, you may be able to enter into an “offer and compromise” with the IRS or some other similar settlement with a state tax agency. If you can successfully show that a modest payment to them (arranged with a relative of yours, for example) is all that the IRS/state can realistically get out of you, it may well administratively write off the difference. Or, the IRS/state may simply decide to label the tax you owe as uncollectible, which can remain that way indefinitely if your financial circumstances don’t change, until it becomes permanently uncollectible under tax law.
Fourth, if you have assets that are NOT “exempt”—not protected—so that the Chapter 7 trustee would collect and sell those assets, and distribute them to your creditors, there is a good chance that much of the funds being distributed would go towards your surviving tax debt. Debts which are “priority debts”—including non-discharged income taxes—get paid in full before anything gets paid to other “general unsecured” creditors. After that, if and to the extent that there would still be some taxes owed, you could pay that in a monthly payment plan, get it administratively written off through a settlement, or avoid paying it by having it go into uncollectible status.
How Chapter 13 Bankruptcy Would Help with a Tax You Can’t Discharge
Chapter 7 helps in only limited situations with taxes that survive a Chapter 7 discharge—when you are a good candidate for a reasonable monthly payment plan, for a settlement, or for being deemed uncollectible. If, as is often the case, none of these apply to you, Chapter 13 “adjustment of debts” may instead be the best option.
First, as mentioned above, the “automatic stay” usually lasts for the whole 3-to-5-year length of a Chapter 13 case, providing protection that can give you a tremendous amount of flexibility when combined with what else Chapter 13 can provide.
Second, the IRS/state essentially must allow you to pay the non-dischargeable income tax at whatever terms fit within your budget, and also allow you to pay other even higher priority debts (such as child support arrearage, or even vehicle and home mortgage payments) ahead of the taxes.
Third, usually you don’t have to pay any ongoing interest or penalties on the taxes you’re paying once you file a Chapter 13 case. Besides enabling you to pay off the taxes for significantly less money, it allows you to pay other higher priority creditors (on which you are often paying interest) ahead of the taxes without being financially penalized for doing so.
Fourth, if the IRS/state recorded a tax lien against you and your home and/or other assets before you filed bankruptcy, Chapter 13 provides an excellent mechanism for getting a release of that tax lien, by paying nothing or relatively little on that lien.
Fifth, if you owe some income taxes that do not meet the conditions for discharge but also some that do, you can often deal with both favorably with a Chapter 13 case. The income taxes that couldn’t be legally discharged would be paid under the flexible means outlined above. And then the taxes that could be discharged would be paid only if and to the extent that your budget allowed for it during the course of your 3-to-5-year payment plan. Often the dischargeable tax is paid little or nothing because under your budget you have only enough money within the payment period to pay off the non-dischargeable tax.