You may not think of bankruptcy as a solution to your tax problems. But do look into it before the tax collector starts grabbing at you.
Bankruptcy Can Be a Surprisingly Good Way to Cure Tax Problems
For many reasons bankruptcy may not come to mind as an effective way to solve income tax problems.
For one, a misconception persists that tax debts can’t be legally written off (“discharged”) through bankruptcy. Untrue. Past due income taxes CAN often be discharged, easier than you might think. For most people it’s a matter of meeting a couple of conditions that mostly just involve the passage of time.
Second, even if you have heard that older taxes can be discharged, you may have more recent tax debts and so just figure that you can’t be helped. The truth is that bankruptcy CAN hugely help, even with taxes that can’t be discharged.
Third, tax law is notoriously complicated, as is bankruptcy. Put them together and no wonder it gets confusing. But in fact in most people’s situations a competent attorney can chart out a sensible game plan, turning an impossible-seeming mess into a manageable way forward.
Finally, tax and bankruptcy are two of the scariest, ego-threatening, emotion-filled areas of life to deal with. They are fertile ground for feeling negative and hopeless. But when approached objectively and with good legal counsel, in fact there is usually plenty of reason for optimism.
So instead of trying to hide from the tax collectors by not filing tax returns or by living in constant dread of what they are about to do to you, open yourself to the likelihood that either Chapter 7 “straight bankruptcy” or Chapter 13 “adjustment of debts” may be the very best way for you to permanently resolve your tax debt headaches.
Timing Is Crucial
It is so important to recognize as soon as possible that bankruptcy could be helpful, because so much about all this is a matter of timing. First, because of all the time-based rules, the sooner a wise game plan is formulated for you the sooner you can put that game plan into effect, and can feel empowered with the good decisions you’re making. Second, timing is important because bankruptcy can stop bad things from happening. Let’s focus the rest of this blog post on this second aspect.
Preventing Tax Levies on Paychecks and Bank Accounts
The most obvious bad things that a bankruptcy would prevent are the IRS and/or your state tax collection agency seizing your wages or salary, or the money in your checking or savings accounts.
As you’ve probably heard, a bankruptcy filing immediately stops garnishments of paychecks and bank accounts. That’s the power of the “automatic stay,” the federal law that prevents your creditors from pursuing you and your assets the moment your bankruptcy case is filed. What you might not realize is that for most purposes the taxing authorities are treated just like any other creditors for purposes of the “automatic stay.” So as soon as your Chapter 7 or Chapter 13 bankruptcy case is filed, it is illegal for the IRS/state to grab (“levy on”) the money in your paycheck or financial accounts.
Preventing the Unnecessary Losses
The odds are that if a tax collector is about to garnish your wages and/or bank accounts for a back income tax debt, a bankruptcy could permanently discharge that tax. So not only could you avoid the sudden financial shock of such a “levy” on your money, most likely the money that would be collected from you there would be money down the proverbial drain, money that you do not need to pay. That’s because by the time the IRS/state would normally be getting to that point in their collection procedures, that tax would likely be old enough to qualify for discharge.
Instead of waiting to be motivated by a tax garnishment to go see an attorney, it makes much more sense to prevent that garnishment from happening in the first place
The Better Way
The tax being garnished for may not meet the conditions for being discharged, but even then a garnishment is about the worst way to pay that tax. Here are two much better ways.
First, you could discharge all or most of your other debts—and maybe some older income taxes—in a Chapter 7 case. Then, if that has freed up some room in your budget, you could arrange to make reasonable monthly payments directly to the IRS/state thereafter. Or, if you have no money whatsoever for payments, an “Offer in Compromise” with the IRS (or a similar settlement procedure with the state) may be possible.
Second, you could pay the remaining tax more flexibly through a Chapter 13 case, with payments based on a realistic budget, usually paying no accruing interest and penalties. In a Chapter 13 plan the tax is often paid along with or only after other more urgent debts, all the while receiving constant “automatic stay” protection preventing any collection activity by the tax collectors throughout the 3 to 5 years of that process.