Breaking an IRS/state income tax payment plan usually has very bad consequences. But filing bankruptcy lets you escape a tax payment plan.
Tax Installment Agreement You Can’t Afford
It’s a common problem. You owed income taxes a year or two ago when you sent in your tax returns. Money was very tight so you couldn’t just pay it off. You found out that the IRS let you pay that unpaid tax through a monthly installment plan. If you also owed state income taxes, you likely found out that your state taxing authority lets you do this, too.
So you set up the payment plan with the IRS and/or state. But your financial situation only got tighter because now you had a new monthly obligation you absolutely had to pay. So now you are struggling to pay the monthly tax payment along with your living expenses and other debts. You wish there was a way to escape, to get out of your IRS/state monthly tax payment and other debts.
Tax Installment Agreement You Are About to Break
If you were desperate to have the money to pay the monthly tax payment (along with your other obligations), you may have arranged to withhold less from your paycheck during the current year. Or if you’re self-employed you may not have paid enough estimated quarterly taxes.
If so, you’ll likely owe income taxes again when your next tax returns are due. Assuming you couldn’t then immediately pay this new tax owed, you would be in default of your current payment plan with the IRS/state.
At that point the IRS/state could terminate the monthly payment agreement. It could then take aggressive collection action against you, something you really want to avoid.
Or instead the IRS/state might let you roll the new tax owed into your current installment agreement. But that would likely result in an increased monthly payment. This only aggravates your problem of having more debt than you can handle.
Even if you could afford to pay an increased monthly tax installment payment, you’d be going backwards instead of making progress. The tax interest and penalties would add significantly to the amount you have to pay. You’re in vicious cycle and don’t see a way out of it.
Two Ways Out
Chapter 7 Discharge of Tax Debts
Which Chapter is better depends on many factors, but especially on whether your older income tax debts are “dischargeable.” This means whether the taxes can be legally, permanently written off in bankruptcy.
Some income taxes CAN be discharged. Basically, certain amounts of time must pass since the time the tax return for the tax was legally required to be submitted, and since the tax return was actually submitted. If you meet those conditions (and some other possibly relevant ones), the tax debt is dischargeable just like any ordinary debt.
When Chapter 7 Makes Sense
If ALL the income tax debt in your present monthly payment plan is dischargeable, Chapter 7 likely makes sense. You’d not have to pay anything anymore on that monthly payment plan. If you anticipate owing new taxes with your next tax return(s), you could likely enter into a fresh monthly payment plan for these taxes. You wouldn’t end up breaching your present payment plan because you would no longer owe anything on it.
If SOME of the income tax debt in your present monthly payment plan is dischargeable, Chapter 7 may also make sense. You would no longer have to pay that part of your taxes, which would presumably reduce your monthly tax payments. If that reduced amount is one that you could afford—especially after discharging all or most of your other debts—Chapter 7 would help enough to justify using this tool.
When Chapter 7 Isn’t Good Enough
If you can’t discharge all your income taxes, or enough, through Chapter 7, consider Chapter 13 “adjustment of debts.” We’ll explain in our blog post next week. Your Louisville bankruptcy lawyer can also advise you on the best choice for you.