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Chapter 7 Bankruptcy Helps You SETTLE Your Income Tax Debt

Even if a straight bankruptcy would leave you owing some or all of your income taxes, it may position you well to settle those taxes with an Offer in Compromise.


The last blog was about using Chapter 7 to discharge all or most of your debts other than taxes, so that afterwards you could afford to pay off the taxes through monthly payments to the IRS and/or the state. Or if you needed more payment flexibility, the usual alternative would be a Chapter 13 payment plan.

But there’s another possibility.

What if Neither Chapter 7 + Tax Payment Plan, Nor a Chapter 13 Will Work?

You may need a bankruptcy no matter what, to deal with debts other than taxes. But a Chapter 7 case may leave you owing too much income tax to be able to afford the minimum monthly payments that the IRS or the state would require. And a Chapter 13, as helpful as it can be for dealing with tough tax problems, may not be helpful enough. Chapter 13 requires payment in full of all “priority” debts—which includes non-dischargeable taxes—during the life of the case. That means a maximum of 5 years. You may just not have enough money available to pay into a Chapter 13 plan to do that.

So your best option may be to file a bankruptcy and then try to settle with the IRS and/or the state for less than you owe them.

Chapter 7 + Tax Settlement

A tax settlement would often be done in conjunction with and after a Chapter 7 bankruptcy filing, for three reasons: 

1. If you owe a bunch of taxes, you are extremely likely to also owe lots of other debts, which need to be dealt with through bankruptcy.

2. Some of your older tax debts may be dischargeable. Trimming that debt away with a Chapter 7 bankruptcy would reduce the amount of remaining tax debt to be settled.

3. With an IRS Offer in Compromise or similar state procedure, you would need to show that you are pretty much focusing all your available financial resources on the settlement. It usually helps to get rid of your other debts to be able to do that.

Clean Your Slate of Other Debts So You Can Settle Your Taxes

You may owe too much in nondischargeable taxes to be able to make either the minimum permitted tax installment payments after the Chapter 7 case, or the necessary Chapter 13 plan payments. Then you may not have much choice except to attempt a tax settlement after completing a Chapter 7 case. (You generally cannot attempt an Offer in Compromise while in a Chapter 13 case.)

But even if you don’t seem to have much choice, before filing your Chapter 7 case you should still have a good idea what the IRS/state might accept once you make the offer a few months later. The basic settlement standard with the IRS is, as stated on its website, that “the amount offered represents the most we can expect to collect within a reasonable period of time.” Determining what that means in your situation, and so whether a particular settlement offer will fly, are delicate judgment calls, which is why you need to work with an experienced professional. Talk with your bankruptcy attorney about whether he or she regularly negotiates IRS Offers in Compromise and/or tax settlements with the state. If not, get a referral to a tax attorney or accountant who does. 

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