New Year Resolution #4: Fix Your Income Tax Debts, Once and For All

Chapter 7 and Chapter 13 can conquer your taxes, each in its own way. What could improve your life in 2015 more than getting rid of that worry?!

If you have been behind on your income taxes for a while, you know the stress that causes.

If you’ve filed your tax returns but can’t pay what you owe, you’re afraid what the IRS and/or state will do to you and to your assets in order to collect on what you owe. If you have been afraid to file the tax returns because you don’t have the money to pay what you owe, you know you are violating the law by not filing the tax returns, causing additional worry.

And even if you’ve filed the returns and have set up a monthly payment plan, you worry about being able to keep up on the payments and what will happen if you don’t. Or you worry about what happens if you end up owing again the next year, before paying off the current year.

Yes, income tax debt can be a vicious cycle.

Chapter 7 “straight bankruptcy” and Chapter 13 “adjustment of debts” can both get you out of that vicious cycle, depending on your situation.

In a Chapter 7 case:

• If your wages or bank accounts are about to be garnished by the IRS and/or state, filing a Chapter 7 case will immediately stop that from happening, sometimes only temporarily, sometimes permanently, depending on the age and other aspects of the income tax owed.
• If the IRS/state is about to record a tax lien against your home, your business assets, or your personal property, a Chapter 7 filing also immediately stops that recording, again either temporarily or permanently, depending on the tax. Under the right circumstances, this could enable you to discharge (legally write-off) a tax so that you do not have to pay anything on it, instead of having to satisfy the tax lien by paying all or part of that tax in spite of your bankruptcy filing.
• If the income tax you owe meets certain conditions, mostly having to do with the age of the tax, you can discharge that tax, no different than discharging a medical bill or credit card debt. Most of the time, you can discharge a tax if its tax return was due more than 3 years ago and the return was in fact submitted more than 2 years ago.
• Even if you owe an income tax which does not meet the conditions for discharge, filing Chapter 7 may:
  • Enable you to afford to enter into a reasonable monthly payment plan to pay off that remaining tax, after having discharged all or most of your other debts.
  • Enable you to settle the remaining tax for much less than you owe if you truly cannot afford to pay anything more on it even after discharging your other debts.
• If you have an “asset” Chapter 7 case—the relatively unusual situation in which you own something that is not protected (not “exempt”) so that the bankruptcy trustee can liquidate it to pay your creditors out of the proceeds—then an income tax that can’t be discharged will usually be paid in full before just about any other creditors receive anything. In the right circumstances you can pay all or part of your tax debt this way, through assets that you may well not mind surrendering.
• Even if you are in a formal payment plan with the IRS/state, it may well be worth considering the benefits of bankruptcy, to find out which of the advantages outlined above may apply to you.

In a Chapter 13 case:

• If your wages or bank accounts are about to be garnished by the IRS and/or state, filing a Chapter 13 case will not only immediately stop that from happening, it will do so permanently, no matter the age and other aspects of the income tax owed.
• If the IRS/state is about to record a tax lien against your home, your business assets, or your personal property, a Chapter 13 filing not only immediately stop that recording, it will do so permanently, no matter the age and other aspects of the tax.
• These (and virtually all kinds of collection actions) are permanently stopped through Chapter 13 for all income taxes (not just temporarily for some taxes as in Chapter 7) for a simple reason—under Chapter 13 you will either discharge the tax at issue or will pay it off before the case is completed. So either way there will be no more tax to collect once the 3-to-5-year case is successfully completed.
• Under Chapter 13 the protection from collection (the “automatic stay”) lasts not just 3 or 4 months as in a Chapter 7 case, but rather throughout the 3-to-5 years that the payment plan takes to complete. This is particularly important as to the more recent taxes that can’t be discharged, and as to tax liens, because this protection takes away much of the leverage that the IRS/state would otherwise have over you.
• Income taxes that can’t be discharged must be paid in a Chapter 13 plan, but usually without any additional interest or penalties, and under extremely flexible payments. The payment terms are based on what you can afford to pay, and also usually allows you to pay certain other more time-critical creditors ahead of the taxes, such as child support and home mortgage or vehicle loan arrears.  
• Income taxes that can be discharged (because they meet the 2-year/3-year conditions stated above) are treated in a Chapter 13 payment plan just like other “general unsecured” debts, like medical bills and credit card balances. That means that they are paid only if and to the extent you can afford to do so within the period of time that you are paying into the plan. The “general unsecured” debts are often paid little or nothing, especially when you have other secured or “priority” debts (such as more recent income taxes) that must be paid in full before the “general unsecured” debts are paid anything.
• If you have a recorded tax lien at the time your case is filed, Chapter 13 provides a very favorable way to value and get a release of that tax lien. If the lien attaches to nothing (such as your home that has no equity), then your Chapter 13 plan will treat that tax as an unsecured one, essentially as if there was no recorded lien, and then the lien will be released. If the lien attaches to something you own that does have some value, then your plan will specify the amount of that value, will pay it accordingly (assuming no objection by the IRS/state as to the amount), and  at the end of your case the paid-off lien will be released. If there is an objection, it is usually efficiently resolved, and the plan adjusted as needed.
• At the completion of a Chapter 13 case, you would usually be tax-free, and (except for a home mortgage and/or other long-term obligations) altogether debt-free.

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