While it might be hard to get rid of income tax debt by filing for bankruptcy, filing for bankruptcy may help you deal with your tax problems. This can be accomplished by freeing up money to pay your tax debt by helping eliminate or reduce your other debts. Or, if your tax debt is old enough, bankruptcy can even help eliminate or reduce how much you have to pay back on your taxes.
Often the reason someone owes taxes is because of things they have done to keep up on other bills like:
- Decreasing the taxes withheld from their paycheck
- Cashing in a TSP or 401k
- Settling a debt and ending up with phantom income
I often find my Southern Maryland bankruptcy clients in this exact situation. They owe more taxes because of the actions they took to help reduce other debts. (See my post Large Tax Bills Are A Sign You May Need To File For Bankruptcy)
Getting Out of Income Taxes
There are a number of things that prevent people from being able to discharge their tax debt. First, the tax debt needs to be more than three years old. That is 3 years from when they were filed. For example: your 2018 taxes are due to be filed and paid in April 2019. While your 2018 taxes are the ones causing the trouble, they are not considered 3 years old until 2022.
In addition, to the tax debt being at least 3 years old there are numerous reasons why one may not be able to eliminate their tax debt. Here is list of some common issues that prevent people from being able to discharge their tax debt:
- Failing to file tax returns
- Failing to file a required amended return after an audit
- Having filed a late return or amended return in the last 2 years
- A tax assessment in the last 240 days
- Tax debt other than income taxes (such as sales tax)
- Fraud or willful evasion
- Having a tax lien
Paying Down Your Income Tax Debt
Even if you can’t discharge your income tax debt filing for bankruptcy can help you get your tax debt under control. The two most common forms of bankruptcy are a Chapter 13 Adjustment of Debts and a Chapter 7 Liquidation bankruptcy. Think of the Chapter 13 as a payment plan and the Chapter 7 as the straight bankruptcy. (See my post What are the different types of bankruptcy for more about Chapter 7, Chapter 13 and the other types of bankruptcy).
A Chapter 7 can help you get your tax debt under control because it is the only remaining debt. Typically, a payment plan with the IRS or the Comptroller of Maryland can be established after a bankruptcy. If you file a Chapter 7 and eliminate your other debt you might be surprised at the payment plan these agencies are willing to offer.
In a Chapter 13 you come up with a payment plan to take care of all your debts. This plan lasts from 3 to 5 years. This payment plan the tax debt that can’t get discharged gets paid first. At the end of the plan you have cleared up your income tax problem and your other debts. You may even find that when the IRS and the State file their claims some of your debt is old enough to be treated as unsecured. This type of debt gets treated just like your credit card debt. In many cases you don’t have to pay this type of debt in full and the balance is discharged.
Tax debt is never an easy thing to deal with. However not dealing with it is even worse. Even if the IRS hasn’t started sending you letters, knowing you have a tax debt is going to hangover your head and keep you awake at night. And if you stop filing returns, by the time they do start sending threatening letters your problem will be even harder to solve. If you end up with some tax debt don’t wait. Come in for a free bankruptcy consult and see what your options are and if filing for bankruptcy can help with your tax problems.