Tax Season: Pay Your Income Taxes by Discharging Your Other Debts

With interest rates low, it doesn’t cost all that much to pay back taxes in monthly installments. File bankruptcy so you can afford to.

 

Our last blog post was about the 4 conditions that must be met to discharge—permanently write off—income tax debts. Those conditions mostly just involve waiting long enough before filing bankruptcy. But what if you can’t wait it out, usually because you have other debts that are pressuring you?

A Broader View of Bankruptcy As a Problem-Solver

The immediate question you may understandably have when you think about whether bankruptcy will work for you is whether it will discharge your debts. If you learn that a Chapter 7 “straight bankruptcy” won’t give you a completely clean slate, you may well figure it’s not a good solution for you. Specifically, if you learn that some or all of your income tax debt can’t be discharged because it’s too recent, you may see no point to filing bankruptcy.

But often the best solutions to serious problems involve more than one step. In your particular situation, it may be best to file a Chapter 7 bankruptcy to discharge the debts you can discharge, thus enabling you to make payments on the debt or two that you can’t discharge.

To see how this can work, forget about taxes for a moment, and consider a person who owes tens of thousands of dollars of medical bills, and a vehicle loan. He or she absolutely needs the vehicle to be able to get to work, but can’t make the vehicle payments and keep up on its insurance and maintenance because of getting his or her paycheck garnished for the unpaid medical bills. When that person files a Chapter 7 case, that would stop the garnishment and discharge all the medical bills so that he or she could afford to pay for the vehicle and its expenses. In this way, bankruptcy enables a person to prioritize among debts and focus on the one or ones that are—for whatever reason—the most important.

Back to taxes. If you owe a bunch of income taxes, that is likely one of your biggest worries. Even if you can’t discharge these income taxes—or at least not all of them—in a similar way as with the vehicle loan in the above example, if bankruptcy got rid of all or most of your other debts thereby enabling you to pay the taxes in reasonable monthly payments, that could effectively resolve your tax worries.

Here are two distinct ways this could work.

If You Can’t Discharge ANY of Your Income Tax Debts

If you find out that you cannot discharge any of the income taxes you owe, but that you can discharge all or most of your other debts, the question is whether discharging those debts would help you enough with the taxes. Would filing a Chapter 7 case enable you to pay off the taxes in a reasonable way through an installment payment plan directly with the IRS and/or state taxing authority?

The IRS in particular (and probably your state taxing authority as well, if you owe state income taxes) allows taxpayers to pay back taxes through a monthly installment plan with relatively reasonable payment terms. You do have to pay a set-up fee (with the IRS), plus ongoing penalties and interest, which can certainly add up if the amount you owe is high. But the IRS interest rate has been quite low during the last few years—3 percent annual rate. And there may be room for adjusting the monthly payment if your circumstances change. You can likely set up the payment plan quite easily (by yourself or the help of a tax professional), online or with a (surprisingly friendly!) phone call, in many situations without even providing financial information or a detailed application form.

So paying back taxes directly in a monthly payment plan started AFTER your Chapter 7 case is completed can be decent way to go. Talk with your bankruptcy attorney about this option.

If You Can Discharge SOME BUT NOT ALL of Your Income Tax Debts

You may owe taxes for a number of tax years, so that one or more (older) ones meet the conditions for discharge but one or more (newer) ones do not and so can’t be discharged. This kind of situation often calls for the power and flexibility of a Chapter 13 “adjustment of debts,” since that can often deal well with both kinds of taxes.

But that may not be necessary. Taxes that can be discharged are functionally no different than the medical bills in the above example. The key question is the same one as in the above situation: would discharging the debts that can be discharged—including those taxes that can be—help you enough with the remaining taxes? Would filing a Chapter 7 case discharge enough debts—including tax debts—to enable you to enter into a reasonable installment payment plan directly with the IRS and/or state taxing authority?

Again, this is a question to talk about with your bankruptcy attorney. However, you can get a good idea in the meantime by penciling out your after-bankruptcy budget to estimate how much you could afford to reliably pay monthly towards the surviving taxes. 

 

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