Do you owe back taxes to the IRS? Many Americans do and find it difficult to meet their financial obligations to the federal government, especially when interest and penalties are taken into account.
You’ve no doubt wondered if there’s a way to get rid of your tax liability, and perhaps you’ve thought about bankruptcy as a possible solution. While filing for bankruptcy can help you reorganize your tax liability or even discharge some of it, there’s a lot more to know on this subject.
Take some time below to read more about tax liability and bankruptcy.
What does filing for bankruptcy actually mean?
Before we discuss what happens to tax debt specifically when you file for bankruptcy, let’s first quickly review the basics of bankruptcy.
Bankruptcy is a legal process whereby an individual or business can get relief from some or all of their debts. An individual or business may file in the United States Bankruptcy Court. While representation is always a great option, an individual can represent themselves in bankruptcy court. Hiring a bankruptcy lawyer can serve as your advocate and help you to navigate the complicated process.
Bankruptcy explained further
Before filing for bankruptcy, individuals are required to complete a credit counseling course and obtain a certificate to file alongside their bankruptcy petition.
The court may also appoint a bankruptcy trustee. This is a person appointed to represent the debtor’s estate during a bankruptcy proceeding.
There are several types of bankruptcy proceedings, but the two most common for individuals are Chapter 7 bankruptcy and Chapter 13 bankruptcy.
In a Chapter 7 bankruptcy, also known as a “liquidation” bankruptcy, the court will appoint a trustee to oversee the case. The bankruptcy trustee will then sell off any non-exempt assets of the debtor in order to pay creditors.
In contrast, a Chapter 13 bankruptcy is also known as a “reorganization” bankruptcy. In this type of bankruptcy, the debtor will work with the court to develop a repayment plan to pay back creditors over a three- to five-year period.
Which type of bankruptcy should you file?
Bankruptcy is a powerful debt relief tool that has helped many people, but it is important to decide if it makes sense for your financial situation. If you’re considering bankruptcy as a way to deal with your tax debt, you might be wondering which type of bankruptcy you should file. According to the U.S. bankruptcy code, there are two common options for a bankruptcy filing.
The answer to this question depends on a few different factors, such as your income, the amount of tax debt you owe, and whether you have any non-exempt assets that could be sold off in a Chapter 7 bankruptcy.
You might also want to consider whether you’re currently able to make any payments on your tax debt. If you are, a Chapter 13 bankruptcy filing might be the better option as it would allow you to repay your debt over time.
On the other hand, if you’re not currently able to make any payments on your tax debt, a Chapter 7 bankruptcy filing might be a better option as it could discharge some or all of your tax debt.
It’s important to note that even if you go through the bankruptcy process, you will still be responsible for any taxes that are due for the current year.
What is a bankruptcy discharge?
A bankruptcy discharge is a court order releasing you from liability for certain types of debt. Most types of debts are discharged in bankruptcy, including secured and unsecured debts.
What is tax liability?
Tax liability is any tax money not paid to the federal government. If you don’t pay the full balance of your tax bill on time, you accumulate tax liability. If you don’t pay your tax liability, the IRS can charge penalties and interest on your liability, which creates more tax liability. The IRS can also take enforcement action against you, such as putting a tax lien on your property or issuing a levy against your bank account or wages.
Filing Chapter 7 vs. Chapter 13 to erase debt
Chapter 7 bankruptcy and Chapter 13 bankruptcy can eliminate debt in their own ways. Chapter 7 bankruptcy provides debt relief by liquidating non-exempt property and using the resulting cash to pay creditors. Any remaining debt is discharged. Chapter 13 reorganizes debt into a repayment plan that lasts three to five years, sometimes discharging any remaining debt after the plan is successfully carried out. To be eligible for Chapter 13 Bankruptcy, your debts may not exceed a certain amount set forth in the Bankruptcy Code.
Most tax debts can’t be erased with a Chapter 7 discharge, but they can be included in a Chapter 13 repayment plan as long as they are ultimately paid in full.
What is dischargeable debt?
However, if your tax liability meets certain conditions, you may be able to eliminate it through a Chapter 7 bankruptcy. To do this, your liability must be considered dischargeable. Dischargeable tax liability is one that meets the following conditions:
- The taxes are at least three years old
- You filed a return for the taxes at least two years before filing for bankruptcy
- You didn’t commit tax fraud or willfully evade paying taxes
- The IRS hasn’t already filed a tax lien against you
If your tax liability doesn’t meet all of the above conditions, you can still include it in a Chapter 13 repayment plan.
Consequences of not paying taxes
Not paying your taxes has consequences that go beyond accumulating tax liability. The IRS can take enforcement action against you, such as putting a tax lien on your property or issuing a levy against your bank account or wages.
If you don’t pay your taxes and the IRS takes enforcement action, it can be difficult to get out of liability and back on track.
What are the conditions for discharging tax liability?
So, here’s the big question: When can you discharge tax liability? If you need to wipe out tax liability with bankruptcy, it can only be done under a few circumstances. Those conditions include whether the type of tax is dischargeable and whether you qualify for Chapter 7 bankruptcy.
Here are those conditions in greater detail:
- Your tax liability is from income tax. Only income tax is dischargeable, all other types of tax liability – including penalties – can’t be eliminated through personal bankruptcy.
- You didn’t commit tax fraud or willfully evade your tax liability.
- Your tax liability is at least three years old.
- You’ve filed a tax return for the tax liability you wish to wipe out.
- The IRS assessed your income tax liability at least 240 days before you filed for bankruptcy or have yet to do so.
What is a tax lien?
Tax liens are legal claims the IRS places against the assets of those who fail to pay their tax liability. If the liability isn’t paid, eventually the assets – which can include real estate – can be seized.
A tax lien is placed on your property when you don’t pay your taxes. The IRS files a public notice, called a Notice of Federal Tax Lien, informing creditors that the IRS has a legal right to your property. Once the lien is filed, you have 20 days to pay your liability in full or work out an alternative arrangement with the IRS. If you don’t take action, the IRS can begin to collect on the debt by seizing your assets.
Can I discharge a tax lien?
Federal tax liens are not dischargeable through bankruptcy. Your obligation to pay off a tax lien continues after your bankruptcy case concludes. However, if you file for Chapter 13 bankruptcy, you can include the lien in your repayment plan and pay it off over time.
What happens if I file for bankruptcy & my taxes can’t be erased?
If you can’t discharge your tax liability through bankruptcy, then you will continue to owe back taxes to the IRS. Fortunately, the IRS writes off tax liability once 10 years have passed since the liability was originally created.
While you can’t discharge tax liability through bankruptcy, the statute of limitations may offer some relief. The statute of limitations is the amount of time you have to file a lawsuit or take legal action. The statute of limitations for tax liability is 10 years from the date the taxes were assessed. This means that after 10 years, the IRS can no longer take legal action to collect the liability.
While the statute of limitations may offer some relief, it’s important to note that your obligation to pay taxes doesn’t go away. The IRS can still garnish your wages or seize your assets if you don’t repay liabilities.
When is the best time to file for bankruptcy (before or after taxes)?
There are risks and advantages when it comes to filing for bankruptcy before or after filing your income tax return. These risks and advantages ultimately come down to your unique situation, so it’s a good idea to consult with a tax attorney who can help you learn more about your options.
If you’re considering bankruptcy, the best time to file might be after you’ve filed your taxes. This is because a tax liability’s dischargeability is determined by the date of assessment, which is usually the date your return is due or the date it was actually filed, whichever is later. So, if you wait to file bankruptcy until after your taxes are filed, there’s a chance the tax liability will be dischargeable.
Are you filing bankruptcy before filing taxes?
If you file bankruptcy before you file your taxes, on the other hand, the assessment date is the date of your bankruptcy filing. This means that if you want to try to discharge your tax liability through bankruptcy, it’s better to wait until after you’ve filed your taxes.
Filing for bankruptcy may not be the best option if you owe a lot of money in taxes. This is because tax liability can’t be discharged through bankruptcy, and you may end up owing even more money if the IRS places a tax lien on your property.
Will filing stop creditor harassment?
Yes. When you file for bankruptcy, the court will put an automatic stay on collection actions against you. An “automatic stay” is a court order that prevents creditors from contacting you or taking legal action against you in an attempt to collect payment on your liability. The automatic stay remains in effect throughout the duration of your bankruptcy case. Creditors who attempt to contact you or take legal action against you after they’ve received this notice can be held in contempt of court.
Unsecured debt VS secured debt
The automatic stay only applies to unsecured debt, such as credit card debt and debt from medical bills. It does not apply to secured debt, such as mortgages and car loans. It also doesn’t apply to taxes or student loans.
I have more questions. Who can I call for help?
Speaking to an experienced attorney. is critical for complex tax cases. It is important to have someone who understands Federal and State Bankruptcy laws to advise you on your case. If you owe money to the IRS, you may be eligible for an offer in compromise, allowing you to settle with the agency for an amount less than you owe. Having an experienced bankruptcy attorney can help with the negotiation process.
If you have more questions about how to deal with your tax liability during bankruptcy, bankruptcy filings, or learn more about your options, reach out to our tax attorney at Damiens Law Firm for assistance. We understand that having any kind of liability can be overwhelming, so we especially appreciate the burden people feel when they owe a debt to the IRS. Having someone on your side with an in-depth knowledge of how to navigate bankruptcy is best for protection and reassurance.