How Bankruptcy Handles . . . Both Newer and Older Income Taxes at the Same Time, Those that Can Be “Discharged” and Those That Can’t

If you’re behind on income taxes, covering more than one tax year, which is better: Chapter 7 or Chapter 13?

 

If you owe income taxes, you may well owe for more than one tax year. If you do, bankruptcy could treat each of your different tax debts differently. One or more years of your taxes may be handled better in a Chapter 7 “straight bankruptcy” case while the rest may be better in a Chapter 13 “adjustment of debt” case. If so, how do you choose between those two?

Today we’ll start with Chapter 7.

“Discharge” Some Taxes, But Then Need to Figure out What to Do With the Rest

When we started this series on income taxes more than a month ago, in our very first blog post we laid out the conditions under which taxes could be simply written off, legally and permanently, through a Chapter 7 bankruptcy. Those conditions mostly turn on the age of the tax at issue—the older the tax and the longer it’s been since you filed the pertinent tax return the more likely the tax would be discharged under Chapter 7. That’s the reason for the reference in today’s blog title to “older” taxes. (See our first blog post in this series for the actual conditions for a tax to be discharged.) 

If all the income tax debts that you owe qualify for discharge, then a Chapter 7 bankruptcy will get rid of all your tax debts. Unless there would be some unrelated very good reason to file a Chapter 13 case instead, you’d just file a Chapter 7 case and your tax problems would be solved.

But if you have some taxes that qualify for discharge and others—usually newer ones—that don’t, you’ve got to figure out what you’d do with the taxes that survive a Chapter 7 filing. If you have a manageable way of dealing with the surviving taxes, then Chapter 7 may still be sensible. Otherwise, you may need the added ammunition of a Chapter 13 case.

“Discharge” Some Taxes, and Pay the Rest in an Installment Plan

Figure out a reasonable amount of money that you would be able to afford to pay each month towards the income taxes that your Chapter 7 bankruptcy will not be discharging. Do this by putting together a budget of your life after bankruptcy, after no longer having to pay the debts that are being discharged. A listing of your income and expenses is a standard part of the bankruptcy paperwork, so you’ll be doing something similar to this anyway. Your bankruptcy attorney can help you with projecting this into the after-bankruptcy future.

Then see if the amount that you will be able to afford to pay each month to the IRS or state towards that surviving tax debt is 1) enough to satisfy the IRS/state, and 2) will pay off that remaining tax within a reasonable time and under terms that you can live with during that period of time.  If so, Chapter 7 would be a sensible option for dealing with your taxes

“Discharge” Some Taxes, Settle the Rest

The taxes surviving Chapter 7 bankruptcy do not necessarily have to be paid. You may be able to enter into an “Offer in Compromise” with the IRS and/or into a similar settlement plan with your state taxing authority. These usually involve a detailed look at your finances, resulting in a conclusion by the IRS/state that whatever amount you are offering is more than they would get otherwise within a reasonable time. Again, you are already presenting a similar detailed picture of your finances as part of your Chapter 7 case, so making a settlement offer won’t take that much more effort.

This option is particularly sensible if your capacity to pay anything towards the surviving taxes is very limited even after your Chapter 7 case is over. But you will likely need to offer some lump sum in settlement, so it helps to have a generous friend or family member who can help in this way. It may not take much, but you usually can’t come to the settlement table with nothing.

Talk with either an accountant or attorney specifically experienced in these kinds of settlements. Experience really counts in effectively settling these.

“Discharge Some Taxes, the Rest in Uncollectable Status

If you can’t afford to pay anything monthly towards the surviving tax debt, and have absolutely nothing to offer in settlement, the IRS/state could put into a temporary uncollectible status by. This route is especially worth considering if you truly do not have the means to file a Chapter 13 case to pay anything at all each month towards any your debts, and because of medical or other long-term circumstances you don’t expect to be able to into the future.

Talk in detail with your bankruptcy attorney or tax professional about the risks and benefits of this option. Be sure you understand what it takes to get put into uncollectible status by the IRS/state, what would change your tax debt back into collectable status, and how long before the tax debt becomes totally uncollectible according to tax law so you no longer have to worry about it

 

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