If you owe income taxes and the IRS is about to seize your assets, bankruptcy can help in significant and surprising ways.
Here are 15 ways that filing either a Chapter 7 “straight bankruptcy” or a Chapter 13 “adjustment of debts” payment plan could fix your serious income tax problem.
1. Both Chapter 7 and 13 stop the IRS’ collection activities against you, including levies on your paycheck, bank account, and vehicles, as well as tax liens on your home and other assets.
2. Both Chapter 7 and 13 can completely discharge (legally write off) some income taxes.
3. A Chapter 7 case would likely discharge all or most of your non-tax debts, more likely giving you the financial means to enter into a manageable installment payment plan afterwards with the IRS, to pay off whichever taxes were not discharged in that bankruptcy case.
4. If you have an “asset” Chapter 7 case—the relatively unusual kind in which the bankruptcy trustee claims one or more of your assets to sell and distribute to creditors—non-dischargeable tax debts will generally be paid in that distribution ahead of other dischargeable debts, either paying off or at least paying down those tax debts.
5. Even if you cannot discharge a tax debt right now, you likely could by filing bankruptcy at some point in the future. There are strategies for buying time until that time.
6. Chapter 13 allows you to pay off income taxes that can’t be discharged through payments based not on the IRS’ demands but rather on your own realistic budget.
7. If you have other conventional debt—credit cards, medical bills and such—along with back income taxes that can’t be discharged, Chapter 13 generally allows you to favor the tax debt ahead of these other creditors. So you would be allowed to pay the taxes in full before anything would trickle down to those conventional debts.
8. Once the Chapter 13 case is filed, that generally stops any further interest and penalties from being added to the nondischargeable tax debts, which reduces the amount that you need to pay.
9. During the time that payments are being distributed to creditors through the Chapter 13 case, the IRS has to wait its turn in line, often waiting behind debts that are even more important to you, such as back payments on your home mortgage, your child or spousal support arrearage, or even vehicle payments.
10. Even if you only have tax debts that would otherwise be discharged in Chapter 7, but you need to file Chapter 13 to deal with other debts that are important to you—such as on your home and vehicle and support arrearage—these other obligations can legitimately reduce how much you pay on your tax debts. Sometimes you pay nothing on the taxes. So Chapter 13 can be the best of all worlds: protection from all your creditors including the IRS while you take care of other debts, along with paying little or nothing on your tax debts.
11. If you have multiple years of income tax debts—some of which are dischargeable and some not—in most Chapter 13 cases your plan can arrange to pay the taxes that would not be discharged in full before paying a dime to the rest of the taxes. You may even avoid paying anything on those dischargeable taxes before they are discharged forever at the completion of your case.
12. Throughout all this time during a Chapter 13 case—three to five years—the IRS cannot take any collection action against you or any of your assets, unless it gets specific court permission, which would usually only happen if you failed to comply with your own plan commitments.
13. Even if the IRS recorded a tax lien against your home before your Chapter 13 case was filed, the IRS would be prevented from executing on that lien until you had the opportunity to pay off the debt behind that lien, and get a release of that lien.
14. If you are behind in estimated or withheld income taxes during the current tax year, you can file a partial-year tax return, and pay the taxes for that partial tax year through your Chapter 13 plan—with no additional interest and penalties. Then you can put together your budget from that point forward with appropriate estimated tax payments or withholdings so you have no tax owing from that remaining part of the tax year.
15. When your Chapter 13 case is successfully completed you will be tax-free and debt-free.