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October Tax Season: Why Should You Think about Bankruptcy If You’re Already Paying Your Overdue Income Taxes through an Installment Agreement?

If you can afford your monthly installment agreement with the IRS/state, it may be an appealing solution. But often not the best one.


If you previously fell behind on your income taxes, you may have entered into a monthly installment agreement with the IRS and/or your state income tax authority. This may feel like an appealing resolution, if it does indeed fix your tax problems and your financial problems overall. But here are four questions you should ask in considering whether such a tax payment plan is the best way to go. (We focus here on the IRS’s installment agreement, but most states have similar payment programs.)

1) Should you pay older income taxes that you could avoid paying altogether?

The IRS payment program generally requires you to pay all your income taxes, all penalties, all interest. Instead, under Chapter 7 “straight bankruptcy” you can “discharge” (permanently write off) older taxes, as long as they meet some conditions that may be easy for you to meet. If so, you would likely not need to pay anything on those older taxes. If you have broader financial problems—trouble paying other debts or important expenses, falling further behind instead of getting ahead—then instead of struggling to pay the IRS/state in an installment plan that pays taxes you do not have to pay, look into filing a Chapter 7 case.

Your circumstances may be more appropriate for filing a Chapter 13 “adjustment of debts,” either because of your tax situation or because of other debts. Chapter 13 provides a very good way to deal with younger debts that can’t get discharged in a Chapter 7 case. And it does well with special debts like back payments on your home mortgage and vehicle loan, and child and spousal support obligations. Under Chapter 13 the older taxes that would usually be paid nothing under Chapter 7 are often also be paid little or nothing. At most those older taxes would be paid only as much as you can afford, no matter how much you owe on those taxes.

2) Can you afford to pay the accrued penalties, and the ongoing interest and penalties?

The IRS is quite generous with the length of time you are allowed to stretch out your payments under its installment payment plan. But you must pay all accrued and ongoing tax penalties and interest. So the longer you extend the payments—in order to keep the monthly payments manageably low—the more you’ll pay in interest and penalties. And so it will take you that much longer to finish paying the old taxes.

If you file a Chapter 7 case, as to those income taxes that cannot be discharged (usually because they are too recent) you will usually need to pay all interest and penalties. That includes both the interest and penalties accrued before filing the case and the ongoing ones until the tax debt is paid off. But in most cases the difference would be that you would pay off that tax debt much faster. That’s because you would be paying it after discharging most of your other debts, possibly including some of your older income taxes. You’d be able to focus your financial energies on paying off the remaining taxes, so that would happen faster, and so less interest and penalties would accrue and be paid.

If you file a Chapter 13 case, you usually pay little or nothing on the prior accrued penalties. And no further tax penalties are added from the moment your case is filed. Plus no interest is added going forward as long as no tax lien has been recorded against you. Instead you pay the fixed tax-plus-prior-interest amount, and are given three to five interest-and-penalties years to pay it, with payment amounts based on your budget.

3) What if your circumstances changed that you couldn’t pay the IRS the established monthly amount?

In an IRS installment agreement if your financial circumstances changed so that you had to reduce your payment amount, you would be subject to the IRS’s discretion about whether and how much the payments could be reduced.

In contrast, if the tax was dischargeable under Chapter 7 you would no longer owe the tax at all so you wouldn’t have to worry about future financial changes. And if you discharged some taxes and had to pay some, you’d have more flexibility because you’d have less tax to pay. Or by the time the financial change happens, you may even have already paid off the tax debt because of having less to pay.

Under Chapter 13 how much you pay to all your creditors, including to the IRS/state, are based on your budget. If your financial circumstances change, your Chapter 13 plan can usually be amended to accommodate it. And very important, throughout the 3-to-five-year case the IRS/state cannot take any collection action against you, unless it asks for and gets prior permission from the bankruptcy judge. You don’t’ have to fear the power of the IRS/state.

4) Are you making progress with your taxes and debts overall, or falling further behind?

If you have a stable financial life in which the tax payment plan is helping you make steady progress towards paying off your back taxes and becoming debt-free, then that payment plan is serving a good purpose.

But otherwise a tax installment payment plan can be an enticing trap. This is particularly true if you arrive at a new annual income tax return due date owing taxes for that year and needing to add more tax debt to your payment plan. The IRS now lets you fall as much as $50,000 behind on your taxes, and gives you 72 months to pay it. This could result in a vicious cycle in which you are constantly struggling to pay the taxes of the previous  two or three years, with its constantly accruing penalties and interest, making you unable to pay enough taxes for the current tax year, never allowing you to get ahead.

Even if your situation is not as bad as that, you may be struggling to maintain your tax installment payments because of other debt obligations. If so it makes sense to look into how either a Chapter 7 or Chapter 13 could help you stop the bleeding and enable you to move in a productive and sustainable direction.

You should particularly get legal advice about the bankruptcy options if you entered into the tax payment plan without getting that advice beforehand. And that’s true whether you entered into the payment plan recently and wonder if it was a wise step, or you did so quite a while ago and feel yourself sliding backwards.


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