Are you about to file for bankruptcy and are afraid that the IRS is still going to come after you to collect tax debts? What can you do about this? Wondering if there are extensions, pardons or anything you can do to get some time to get back on your feet?
Filing Chapter 7 versus Chapter 13
In the United States, there are 2 main kinds of personal bankruptcy you can file for – Chapter 7 and Chapter 13. Chapter 7 is a liquidation bankruptcy that allows the filer to walk away from general unsecured debts (like credit cards or medical bills) entirely. It is usually used in cases where debts are so high or income is so low that recovering is nearly impossible.
Chapter 13 is a reorganization bankruptcy that allows a filer with regular income the option to draft a recovery plan to repay all or part of their debt usually over a 3-5 year period.
What Does Filing for Chapter 7 Mean?
While filing for Chapter 7 bankruptcy may sound like the most logical solution, it’s not that easy. One can become easily disqualified from filing for Chapter 7 bankruptcy if you make over a certain percentage of disposable income (free income after basic needs met). In most cases, a trustee is appointed to administer your case. A trustee has the responsibility of reviewing your bankruptcy papers and supporting documents but is also in charge of selling your nonexempt property to pay back your creditors. Depending on your state’s exemption laws, you may be allowed to keep a certain amount of your assets – if you can’t mark it as exempt, your trustee can liquidate it and distribute the proceeds to your creditors.
Does Filing for Bankruptcy Qualify You to Discharge a Tax Debt?
Most tax debts can’t be wiped out when filing for bankruptcy. You’ll most likely continue to owe money to the IRS at the end of your Chapter 7 bankruptcy case or you may have to repay your debts in full upon completing your Chapter 13 repayment plan.
If you are eligible to file for Chapter 7 bankruptcy, you may be able to discharge tax debts. You must meet ALL of the following conditions to discharge federal income tax debt under Chapter 7 bankruptcy:
- The discharge is for income taxes: Payroll taxes and fraud penalties aren’t eligible for discharge)
- The debtor filed a legitimate tax return: Debtor filed a tax return for the relevant tax years at least 2 years before filing for bankruptcy
- The tax liability is at least 3 years old: The tax debt is from a tax return originally due at least 3 years before bankruptcy was filed
- The debtor is eligible under the 240-day rule: The IRS assessed the tax debt at least 240 days before the debtor filed for bankruptcy. One can often request that the IRS suspend debt collection activity during negotiation and request for an extended applicable date.
- The debtor did not commit willful tax evasion: Things like changing your Social Security number, your name, the spelling of your name, repeated failure to pay taxes, filing a blank or incomplete tax return, or withdrawing cash from a bank account and attempting to conceal it are considered evasive actions.
- The debtor did not commit tax fraud: The return contains no information that may have been intended to defraud the IRS.
Federal Tax Liens and Filing for Bankruptcy
The IRS will likely place a federal tax lien on a Chapter 7 filers property prior to the bankruptcy case that will remain if the discharge of tax debt occurs. Therefore, it’s necessary to clear the title by paying off the lien before selling the property.
Other Considerations for IRS Debt
If you are unable to discharge tax debt under Chapter 7, you may be able to consider other arrangements with the IRS. Entering an installment agreement with the IRS or compromising on a settlement of the tax debt for a lesser amount may be possible.
Speak to an Enrolled IRS Agent to check if you qualify for Tax Debt Discharge.