What You Need to Know About Bankruptcy and Taxes

If you owe money in unpaid federal taxes and owe money to the Internal Revenue Service (IRS) you are not alone. As many as 3.8 million Americans may have unpaid taxes with the IRS. Unpaid taxes are a unique kind of debt that you may be able to deal with through bankruptcy.

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If you have unpaid taxes you may be able to deal with them through bankruptcy. When you file for bankruptcy an immediate stay is put on all collections for your tax debt meaning that collections will stop until your bankruptcy case is resolved.

There are certain restrictions on what kinds of taxes can be dealt with through bankruptcy.

In this article:

  • What happens if you have unpaid federal taxes?
  • When can bankruptcy deal with unpaid taxes?
  • What options do you have to deal with unpaid taxes?

Dealing with tax debt

If you have substantial tax debt you will likely want to solve that problem sooner rather than later. You may owe interest on your unpaid taxes that if left unpaid could increase how much you owe. Until you pay down the entire balance of your unpaid taxes, interest will continue to accrue.

Similarly, the IRS may charge you penalties for having unpaid taxes. Penalties may be issued for failing to file your taxes or failing to pay the full amount of taxes that you owe.

You should consider all your options for dealing with unpaid taxes including bankruptcy to help deal with your debt situation and avoid unnecessary interest and penalties.

If you owe money in state taxes you may also be able to use bankruptcy to deal with your unpaid taxes. Similar rules apply to dealing with state taxes through bankruptcy as dealing with federal taxes. You should check your local rules to see if there are any differences in how bankruptcy may work for any state taxes you owe.

When can bankruptcy deal with unpaid taxes?

Chapter 7 bankruptcy can only deal with your tax debt if you meet certain conditions.

Bankruptcy can only eliminate your tax debt for unpaid income taxes. Payroll taxes, for instance, cannot be dealt with by bankruptcy.

You cannot use bankruptcy to deal with your unpaid taxes if you willfully evaded paying your taxes or engaged in fraud.

Your tax debt has to be at least three years old in order for you to be able to get rid of it through bankruptcy.

You must have filed a tax return for the debt you wish to get rid of at least two years before filing for bankruptcy.

Finally, the income tax debt must have been evaluated by the IRS at least 240 days before you file for bankruptcy.

Kinds of tax debt not eligible for bankruptcy

Certain kinds of unpaid taxes cannot be discharged through bankruptcy. Generally, only income taxes can be dealt with by using bankruptcy. If you have these kinds of tax debt then the IRS can resume collections after your bankruptcy is finished.

If you have tax liens they cannot be dealt with by Chapter 7 bankruptcy. Even if you file for bankruptcy, tax liens will stay attached to your property. That means you will have to pay them when you sell your property.

If you have unpaid property taxes within one year of filing for bankruptcy you may still have to pay them. However, you may be able to deal with property taxes more than one year old through bankruptcy.

You cannot recover taxes that are collected by third parties via bankruptcy. Taxes for things taken automatically out of your paycheck such as social security cannot be recovered through bankruptcy.

It is important to figure out what kind of tax debt you have if you are considering bankruptcy as an option to make sure if bankruptcy is the best solution for your unpaid tax debt. If you have unpaid taxes that cannot be dealt with by bankruptcy or want to consider alternatives you still have options.

Alternatives to bankruptcy for unpaid taxes

In addition to bankruptcy, there are other options you can try for dealing with your tax debt. You may be able to set up a payment plan with the IRS or set up an “offer in compromise.” You should figure out if these options, or bankruptcy, is right for you.

In some situations, you can hire an attorney to help you pursue these options or you may be able to do it yourself.

Payment plans with the IRS

As an alternative to bankruptcy, you may be able to set up a payment plan with the IRS for your unpaid taxes.

A payment plan is an agreement you make with the IRS to pay your taxes over an extended timeframe. If you think you can pay your taxes in the new timeframe you might want to consider a payment plan. You can apply online to see if you can repay your taxes through a payment plan.

There are a few different kinds of payment plans you can set up with the IRS to pay your taxes. The simplest option is to pay your entire existing tax debt all at once without any setup cost. Doing so will mean no more future penalties or interest on the taxes you owe.

You may also be eligible for a short term payment plan over a timeframe of less than 120 days. Doing so involves no setup costs, but you may be on the hook for some penalties or fees until you pay off all of your taxes.

Finally, you might be eligible for a long term payment plan over a time frame greater than 120 days. A long term payment plan involves some setup costs, and you may be on the hook for some penalties or interest until you pay off all your taxes.

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Offer in compromise with the IRS

An “offer in compromise” is a deal you can make with the IRS to settle your tax debt for less than the full amount. The IRS has an expansive guide on how this option works. Generally speaking, the IRS will consider your income, assets, ability to pay, and your expenses when determining a potential settlement.

Think of an “offer in compromise” as a negotiated settlement with the IRS where you agree on how much you will pay the IRS in taxes. However, there are a few restrictions on when you may be eligible to pursue this option.

You are not eligible for this option if you are currently in an open bankruptcy proceeding. Luckily, the IRS has a tool to see if you may be eligible for this option.

If the IRS accepts your offer you will pay your owed taxes in a combination of lump sum and periodic payments.

If you are unhappy with your results in trying to secure an offer in compromise for your unpaid taxes, you may be able to appeal the IRS’s decision.

Are you ready to use bankruptcy to deal with your unpaid taxes?

If you are unsure whether you have tax debt that can be dealt with through bankruptcy Upsolve can help. As you go through the process of preparing your Chapter 7 bankruptcy forms.

We do not expect you to understand bankruptcy law because you are not a bankruptcy attorney. Therefore, we have developed a process that helps you determine the category for your debts. You complete the bankruptcy forms, but you have someone to turn to if you have questions.

If you need a fresh start, click here to start Upsolve's free bankruptcy process. Join the millions of other Americans who have discharged their debt through Chapter 7. You will be glad you did.

If you still are not convinced, watch videos of our past users who worked with Upsolve to file for Chapter 7 bankruptcy relief. Together, we were able to help them eliminate their debts while protecting their property and income. They are now on the road to a brighter financial future.

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They got a fresh start to recover and rebuild after a financial crisis. You deserve the same chance. Start your journey on the road to financial well-being today by contacting our office to begin your Chapter 7 bankruptcy filing.

Upsolve is a 501(c)(3) legal aid nonprofit that started in 2016. Our mission is to help low-income Americans in financial distress get a fresh start through Chapter 7 bankruptcy at no cost. We do this by combining the power of technology with pro bono attorneys. Spun out of Harvard Law School, our team includes lawyers, engineers, and judges. We have mission-driven funders that include the U.S. government, former Google CEO Eric Schmidt, and private charities.

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