Tax Season: The Many, Many Ways Bankruptcy Can Cure Your Income Tax Headache

Wasson and ThornhillTax Debts

Bankruptcy can do so much more than write off old taxes and buy time to pay newer ones. So if you owe lots of taxes, it’s worth considering.

 

You may have heard that bankruptcy can permanently write off income taxes that are old enough and meet certain conditions. But that is just the very beginning of the ways that bankruptcy can help. This blog post introduces many of the other ways. Sometimes used in combination, these can often solve tax debt problems that otherwise seem hopeless.  

Chapter 7 “Straight Bankruptcy”

The basic “liquidation” type of bankruptcy can help you in more ways than you may think.

As mentioned above, bankruptcy can simply discharge some income tax debts. The tax at issue has to meet a number of conditions, but most of those are met simply by filing the tax return and waiting for enough time to pass. When the required conditions are met, the tax can be permanently written off just like any credit card or medical bill.

If you owe one or more income tax debts that do NOT meet those conditions and so can’t be discharged, a Chapter 7 bankruptcy may STILL make sense. The IRS and most state tax authorities have monthly payment plans if you owe a tax you can’t pay in a lump sum. If you can discharge all or most of your OTHER debts by filing bankruptcy, then you may well be able to afford a sensible installment payment plan on the tax debt that remains.

Avoid spending many more months or even years in an impossible situation, falling further and further behind, worrying about what the IRS and/or state are going to do to you. Instead within about 4 months from today, you could have already completed a Chapter 7 case and be entering into a sustainable monthly payment plan on the taxes. You would have to pay ongoing interest and some penalties, and would have to religiously make the agreed installment payments. But you’d be on a reasonable path to solving your tax problem.

You may owe some tax debts that DON’T meet the required conditions for discharge, but also owe some other tax debts that DO meet them. A Chapter 7 case would discharge those taxes that meet the conditions and most or all of your other debts, leaving you with less tax debt to pay off in a monthly installment plan.

You may even have the rare combination of owing an income tax debt that cannot be discharged and having assets which are not “exempt”—not protected from the Chapter 7 trustee. If so, then surrendering those assets to the trustee could well result in the proceeds of the trustee’s liquidation of those assets being paid towards that tax debt. That would reduce or eliminate what you would have to pay yourself on the tax debt after the Chapter 7 case is finished.

Chapter 13 “Adjustment of Debts”

This 3-to-5 year procedure can provide advantage after advantage in getting a handle on your tax debts, especially on those taxes that cannot be simply discharged under Chapter 7.

If you owe an income tax debt that does not meet the conditions for discharge, then paying those taxes through a Chapter 13 plan can be much 1) cheaper, 2) easier and 3) safer than dealing directly with the IRS or state tax authority. That’s especially true if that tax debt is relatively large and again also if you owe for multiple tax years.

1) Cheaper: It can cost you less to pay taxes that can’t be discharged because usually no more interest and penalties are added after the case is filed. Often you don’t have to pay even the previously accrued penalties, or only a small percent of them. Especially if the amount of tax is large, avoiding the related interest and penalties can help greatly.

2) Easier: Paying the tax through Chapter 13 is usually much easier than dealing directly with the IRS or state because the payment terms tend to be more reasonable and flexible. The payment amount is based on what you can actually afford to pay, instead of what the IRS or state’s rules and regulations would dictate. You can often delay paying on the tax during your Chapter 13 case while paying other even more urgent debts, such as to save your vehicle or home. And if your circumstances change, you can usually amend your Chapter 13 plan to reflect the actual changes in your income and expenses.

3) Safer: Chapter 13 is a much safer way to pay such taxes because you have a constant blanket of protection against the taxing authorities and their potential efforts to take collection action against you personally or your assets. While you are following your Chapter 13 plan, the tax authorities cannot record tax liens on your home and other assets, cannot garnish your paychecks or bank accounts, and cannot seize your vehicle or any other possessions through tax levies. This protection is especially valuable when your circumstances change and you need your payments to be adjusted. Chapter 13 shields you from constant worry about the IRS and/or state hitting you with some aggressive collection action if you can’t keep up on the payments they require.