File a Partial-Year Tax Return for All Income Taxes
To avoid owing income taxes April 15 of NEXT year, file a partial-year tax return and pay the tax owed on it through your Chapter 13 case.
The Problem
If you owe income taxes for last year–2012, you could very well also owe at the end of the current year-2013. Naturally, you likely will owe for 2013 if some of the same circumstances that caused you to owe for last year continue to apply to this year so far —such as not having enough taxes withheld from your paycheck or not paying enough in estimated quarterly taxes if you’re self-employed.
You’ve heard that Chapter 13 can be a great tool for taking care of income tax debts, especially those spanning multiple tax years. But you’ve probably also heard that bankruptcy—including Chapter 13—deals only with debts you owe at the time you’re case is filed, NOT future debts. So you are appropriately worried about entering into a court-approved payment plan that you won’t be able to pay as soon as you’re hit with a big tax bill on April 15, 2014. In fact, instead of being relieved that Chapter 13 is taking care of all your tax debts, you may be dreading what will happen a year from now.
Fortunately, there’s a solution for this. In fact, there are probably more than one. But first, let’s make a little more sense of the law that applies here.
The Law—Income Taxes and Chapter 13
A Chapter 13 payment plan is often an excellent package for resolving all your income tax debt problems. This is especially true if you owe taxes for a number of tax years, because it deals favorably with all their possible legal categories: those that can be discharged (written off), those that can’t and have to be paid, and those that are encumbered with a tax lien.
Focusing on those income taxes that can’t be discharged—usually because they are not old enough—they must be paid in full before your Chapter 13 is completed. But paying these in a Chapter 13 case is done with major advantages in flexibility, low payment amount, and protection from the IRS and/or state tax authority, among other advantages. So if you have to pay taxes, it’s not a bad way to do it.
The Solution
So now let’s go back to the problem that you are behind on paying income taxes for the year so far. We know that this won’t be a debt that you can include in your Chapter 13 case because it won’t be a legally recognized debt until the end of the tax year, which for just about everybody is December 31. Presumably you can’t wait until then because of other debt pressures.
One solution—as signaled in the title to this blog—is to turn the fact that you are informally behind on taxes so far this year into a legally recognized debt as of the day you file your Chapter 13 case. You can do this by exercising your right to file a partial-year tax return on that day. Then you CAN include the taxes owed for the year so far among those that are paid in your Chapter 13 case. Indeed, you would be obligated to pay those taxes in full along with any other non-dischargeable income taxes. But remember, they would be paid under the favorable circumstances mentioned above, and discussed in detail in earlier blogs of this current series on taxes.
How about the rest of the current 2013 tax year? Won’t you still owe taxes in April 2014 for the other partial year of 2013? Won’t you just owe less, because the first part of the tax year is now covered in the Chapter 13 case? No, you should owe no taxes next April. Why? Because In your Chapter 13 budget you are required to correct your tax withholding/estimated quarterly payments so that you are staying current on the ongoing taxes. But including the appropriate amount of ongoing taxes should (at least in theory) reduce what you pay your creditors, enabling you to finally keep current on your taxes. Chapter 13 doesn’t just solve all your past income tax debts, it is designed to prevent similar problems from reoccurring, at least as long as you are in your Chapter 13 case.
Caution
Bankruptcy and taxes are a volatile mix, one that no blog or even series of blogs can cover thoroughly enough. There are other potential solutions to this problem, some that might work better than the partial-year tax return potential solution presented here. Some may work better or worse with the IRS vs. with your state tax authority (for the majority of states that have income taxes), or with your local Chapter 13 trustee and/or bankruptcy judges.
So if you believe you may have fallen behind on your current year’s income taxes, be sure you tell your bankruptcy attorney about it. Ask about the partial-year tax return as a possible solution. And then once the game plan is established, make sure that you understand and how it is solving the problem. You deserve to feel the relief of knowing that your Chapter 13 plan is solving ALL of your tax problems, even the most recent one.
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