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Dealing With Tax Debt In and Out Of Bankruptcy

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In a Nutshell

While bankruptcy isn’t always the best solution, discharging an old tax debt through Chapter 7 bankruptcy or paying it off through a Chapter 13 bankruptcy is possible.

Written by Attorney Andrea Wimmer.  
Updated December 4, 2020


If you owe federal taxes to the Internal Revenue Service (IRS) you’re not alone. In 2019 alone, more than 23 million tax returns showed a balance due to the government.[1][2]If you’re confused because you’ve heard that you can’t erase tax debts through bankruptcy, that’s pretty normal, too. Ultimately, even though there are limitations on what kind of tax debt can be discharged in bankruptcy, it’s not impossible. 

Plus, once a bankruptcy case is filed, collections of all debts - including tax debts for the most part - has to stop. This automatic stay remains in effect until the bankruptcy discharge has been entered. 

Dealing With Tax Debt

If you owe past-due taxes, you’ll want to solve that problem sooner rather than later. The IRS is one of those creditors that won’t just “forget about it” and charge off the balance you owe. Rather, they’ll add interest to your balance, steadily increasing the amount you owe. The IRS also charges penalties for things like not filing your tax return, not paying your balance due when filing your return, or bouncing a check, to name a few.

Most states follow similar rules with respect to charging interest and penalties. Your best bet for learning more about how your state handles tax debts is to check the website for your state’s taxing authority, often called the “Department of Revenue.” The IRS provides a link to all state government websites for your convenience. 

When Can Bankruptcy Deal With Unpaid Taxes?

Filing bankruptcy can help with some but not all types of tax debt. Most consumers have income tax debt, which can be discharged in bankruptcy if certain conditions are met: 

  • Your tax debt has to be at least three years old.

  • 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 determined by the IRS more than 240 days before your bankruptcy was filed.

You can’t use bankruptcy to deal with your unpaid taxes if you willfully evaded paying your taxes or engaged in fraud. Having filed your return late can also render some or all of your tax debt non-dischargeable even if all other requirements are met. 

Kinds Of Tax Debt Not Eligible For Bankruptcy

Certain kinds of unpaid taxes can’t be discharged through bankruptcy. If you’re a small business owner and owe payroll taxes or trust fund taxes your best bet is to speak to a bankruptcy attorney as well as a tax professional. 

If the IRS has a tax lien on your property, your tax debt is considered a secured debt. Since the IRS is not subject to exemptions, this can cause issues in a bankruptcy case. Again, your best bet in this situation is to talk to a knowledgeable bankruptcy attorney about it. 

In short, it’s important to figure out what kind of tax debt you have and - if you’re hoping to erase it in bankruptcy - how old it is. If your tax debt can’t be dealt with in a Chapter 7 bankruptcy (yet) you do have other options.  

Dealing With Unpaid Taxes: Alternatives To Bankruptcy

If bankruptcy is not an option for you, you do have some alternatives. Depending on how much you owe, it may make sense to agree to a payment plan with the IRS or to do an “Offer in Compromise.” 

IRS Payment Plans

A payment plan is an agreement you make with the IRS to pay your taxes over an extended period of time, rather than as a one time lump sum payment. You can apply online to see if you can repay your taxes through a payment plan. If you think you can pay your taxes in the new timeframe, this may be the best way to deal with your tax debt and avoid the IRS collection process.

Depending on how much time you need, you may even be able to avoid the set up fee for a payment plan. Any payment plan with a duration less than 120 days (so about 4 months) can be set up for free. If your tax debt is too high to make manageable payments in that short amount of time, you can set up a longer payment plan. The set up costs for anything over 120 days start at $31. 

Offer in Compromise

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 a detailed 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. For example, you’re not eligible for this option if you are currently in an open bankruptcy proceeding. Luckily, the IRS has a tool to check if you’re eligible for an Offer in Compromise.

If the IRS accepts your offer, you’ll pay your tax debt in a combination of lump sum and periodic payments. If it doesn’t and you’re 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.

Let’s Summarize…

Owing money to the IRS can be stressful and scary, but you can take charge of how you want to handle it. Just remember that the idea that bankruptcy can’t help with any tax debts is a myth. While bankruptcy isn’t always the best solution, discharging an old tax debt through Chapter 7 bankruptcy or paying it off through a Chapter 13 bankruptcy is possible. And if bankruptcy isn’t the right choice for you, you have other options. You’re already taking the most important first step by learning all about it, so keep doing what you’re doing! 


Sources:

  1. MarketWatch. (2019, June). More Americans owed the IRS money after Trump’s sweeping tax reform. TaxWatch. Retrieved December 4, 2020, from https://www.marketwatch.com/story/after-trumps-sweeping-tax-reform-more-americans-owed-the-irs-money-2019-06-21
  2. Taxpayer Advocate Service. (n.d.). Fiscal Year 2020 Objectives Report to Congress . Volume 1. Retrieved December 2, 2020, from https://taxpayeradvocate.irs.gov/Media/Default/Documents/2020-JRC/JRC20_Volume1_2019Review.pdf

Written By:

Attorney Andrea Wimmer

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Andrea practiced exclusively as a bankruptcy attorney in consumer Chapter 7 and Chapter 13 cases for more than 10 years before joining Upsolve, first as a contributing writer and editor and ultimately joining the team as Managing Editor. While in private practice, Andrea handled... read more about Attorney Andrea Wimmer

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