The Extraordinary Tools of Bankruptcy: Getting Out of an Unaffordable Installment Plan with the IRS

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If you can’t afford your current IRS monthly payment plan, or are about to break it with a new year of taxes due, bankruptcy can save you.


Getting Backed into the IRS Corner

It’s a very easy dilemma to slip into. If you owed a chunk of income taxes a year or two ago when you sent in your tax returns, you may have been relieved at the time to learn that the IRS (and, if you owe state income taxes, probably your state taxing authority as well) allows taxpayers to pay back taxes through a monthly installment plan with relatively reasonable payment terms.

So back then you set up the payment plan with the IRS (and/or state), paid the modest set-up fee, and then struggled to pay the agreed monthly amount as you continued to be under financial pressures from your other creditors. The only way you could keep up with it was by not having enough withheld from your paycheck or, if you’re self-employed, by not paying enough estimated quarterly taxes. So you may have had a second year in which you owed taxes and couldn’t pay the amount owed when filing the tax return. Again you might have been relieved that the IRS let you roll the new amount into your installment agreement, although likely with an increased monthly payment.

But now again this year for the same reasons you expect once more to owe income taxes. You are worried that you won’t be able to qualify for the monthly installment payment plan. Or will simply be unable to pay the increased amount. You know if you don’t pay on time the IRS/state will take aggressive collection action against you, putting you into a financial tailspin.

Or even if somehow you could add another year of tax debt onto your installment program, you see yourself sliding backwards instead of making progress. The interest and penalties, which seemed relatively modest at first, are now adding significantly to the amount you have to pay. You’re in a classic vicious cycle. You don’t see a way out.

But there ARE potentially two ways out.

Chapter 7 Allows You to Discharge Some Debts, Catch Up on the Rest

Some of your income taxes could be altogether written off—“discharged”—in a Chapter 7 “straight bankruptcy.” Generally, at least 3 years must have passed since the tax return for the tax was due, and also at least 2 years since you filed that tax return with the IRS/state. If all your taxes meet those two conditions (and some other that may or may not apply), then your bankruptcy would discharge those taxes along with all or most of your other debts. That would be the end of your tax problem.

If you could discharge some of your taxes but not all, discharging part of them, along with all or most of your other debts, would make it easier to pay off the remaining taxes. You should be able to start withholding the right amount of taxes out of your paycheck or paying the right amount of your self-employed income towards your quarterly taxes. This would allow you to keep current on your taxes going forward, finally getting you out of your vicious cycle.

Even if all the income taxes you owe are too recent to discharge any of them, discharging all or most of your other debts may do you enough good. If that allows you to withhold/pay enough ongoing income taxes, and to pay off the back taxes in a reasonable time, then at least you’d be making progress and would be tax-free in the foreseeable future.

Chapter 13 Avoids Additional Interest and Penalties, More Flexible Payments

If you can’t discharge all your income taxes through Chapter 7, consider a 3-to-5-year Chapter 13 “adjustment of debts.”

This usually allows you to stop accruing and paying all ongoing interest and penalties on the tax debt. Chapter 13 also gives you tremendous flexibility in paying that portion of the tax that must be paid.

For example, the amount you pay to all your creditors under Chapter 13 is based primarily on your budget, much less so on how much you owe. How much of that goes to the IRS is based not on the limitation of the IRS’s regulations but on your entire financial picture, often allowing you to pay other important creditors—such as a home mortgage arrearage or a vehicle lender—ahead of the IRS.

Throughout the whole Chapter 13 procedure you’re legally protected from the potentially aggressive collection tactics of the IRS/state. That prevents a tax lien from being recorded against you, your home, and other assets, and if one was recorded earlier you have a lot more leverage over the IRS in satisfying that lien and getting it released. Finally, if your circumstances change, you can modify your payment plan to reflect your financial realities instead of being at the mercy of the IRS or state.


Filing bankruptcy allows you to unilaterally break your monthly installment agreement with the IRS and/or state. You can either discharge your tax debts under Chapter 7 and/or pay off the remaining taxes more quickly with a new, more manageable monthly installment agreement. Or if that does not help sufficiently, Chapter 13 provides the other significant advantages listed above. One or the other will likely be able to get you out of your downwards tax spiral.