Filing for Chapter 7 bankruptcy or Chapter 13 bankruptcy helps many individuals get on top of insurmountable debts. In addition to enjoying benefits like the automatic stay, which freezes collection actions, filers are typically permitted to discharge unsecured debts following the successful completion of the bankruptcy.
Not all types of debt can be discharged, however, and it is important to evaluate whether bankruptcy makes sense for your financial situation with a legal professional. You may be wondering if it is ever possible to discharge tax debt, or money owed to the Internal Revenue Service (IRS), the government agency responsible for managing the country’s federal tax system. Discharging tax debt is not as simple or open and shut as discharging unsecured debt, but there are certain conditions in which you are permitted to discharge money owed to the IRS.
Below, we will discuss the consequences of ignoring tax debt and how bankruptcy can be potentially be used to combat it. We will also discuss the conditions in which tax debt can be discharged and alternative ways bankruptcy can address the problem.
Why Addressing Tax Debt Is Important
Ideally, you should never ignore any type of debt. Debts tend to grow over time due to a combination of late fee penalties and interest. Should a balance become high enough, creditors will likely begin to hound you for payment. If the debt persists, they may even file a lawsuit against you in an effort to collect.
Owing money to a government agency like IRS can lead to even more severe and immediate consequences. Accumulating tax debt can also be startlingly common. The United States tax code constantly changes with new administrations and legislations, making filing for taxes each year a stressful and confusing endeavor for many Americans. It can be extremely easy to make mistakes in reporting income or making deductions, resulting in your owing money you did not initially realize or plan for.
The IRS, as a federal government agency, has more powers in collecting payment on an outstanding tax bill, including the doling out of significant punitive measures to debtors. This includes tools not available to other types of creditors or collection agents.
At first, a tax bill will typically operate like other debts. There will be a deadline in which you are expected to pay. If you do not meet it, you can expect to hear from IRS agents, either through letters in the mail or phone calls. These communications will explain what you owe and what could happen if you do not promptly repay.
If you begin to receive these letters or calls, you should consider contacting to a qualified legal professional to assess your options. The longer you wait to address tax debt, the worse the problem will get. IRS subjects overdue payments to interest and late fees, just like many other types of debts. If you continue to fail to make payments or communicate with IRS agents, you may face steeper measures.
The IRS may consider the following actions if you fail to pay tax debts:
- Charge you with tax evasion, a felony crime
- Force you to forfeit any previous tax refunds
- Revoke your United States passport
- Garnish your wages, which does not require a court’s approval
- Seize your property to repay the debt
- Issue a federal lien on your property
If you know you are likely to owe a significant amount of money to the government come tax season, it can be tempting to avoid filing your tax return altogether. This is a huge mistake and will prevent you from any mode of tax debt relief: You must always file your taxes, on-time. In addition to having no option to discharge any tax debt through bankruptcy, you will face more severe penalties for late or nonexistent tax return filings.
How Bankruptcy Can Enable You To Discharge Certain Tax Debts
A successful Chapter 7 bankruptcy or Chapter 13 bankruptcy can enable filers to discharge their unsecured debts. This generally includes credit card debt, medical bills, unpaid utility bills, and personal loans – but not taxes, which are typically considered a “secured” loan. However, there are still conditions in which tax debt can be potentially discharged upon completion of a bankruptcy filing.
It should be noted upfront that discharging money owed to the IRS is not easy, and many types of tax debt will not qualify. You should discuss your financial situation in detail with an experienced bankruptcy attorney to determine if your tax debt might be eligible for discharging before filing for bankruptcy. Even if your IRS debt does not qualify, there are other ways bankruptcy can still help you.
To start, you will need to determine if you are eligible for either Chapter 7 bankruptcy or Chapter 13 bankruptcy. The criteria to discharge certain tax debts is basically identical across both types of bankruptcy, meaning your ability to discharge is not dependent on the type you file for.
In Chapter 7 bankruptcy, your nonexempt assets will be subject to the liquidation process, in which they are sold to help repay a portion of your debts. You will be permitted to exempt certain assets using the Pennsylvania or federal exemption schedule, safeguarding some or even all of your property from liquidation. An experienced lawyer can help strategize on how best to minimize impact on your estate during this process.
In Chapter 13 bankruptcy, you forgo liquidation and instead repay some of your debt through a court-ordered repayment plan. A bankruptcy court will assess your ability to pay based on your disposable income, ultimately setting a single, monthly payment that you will be required to pay for a period of 3 to 5 years.
In both types of consumer bankruptcy, you will be protected from most collection actions from the IRS until your filing is completed. Consequently, the mere act of filing for bankruptcy can help provide immediate relief if you are facing imminent punitive measures from the agency.
Once you have completed your bankruptcy filing, you will generally be given permission to discharge unsecured debts. Again, tax debts are usually excluded from this process, but there are specific circumstances where you may discharge IRS debt.
Conditions for Discharging Tax Debt
Your tax debt must meet the following conditions for it to be deemed dischargeable:
- Your debt must be the result of unpaid income taxes – Only income taxes can be discharged through bankruptcy. All other fees, penalties, or other types of taxes do not qualify.
- You must have filed tax returns – If you did not file your tax returns on-time or at all, you will not be able to discharge the debt associated with that return.
- Your tax debt must be a minimum of 3 years old – You will not be able to discharge newer tax debt. The debt must have aged at least 3 years before you file for bankruptcy.
- You must not have evaded paying taxes or committed any other type of tax fraud – If you have ever attempted to avoid paying your taxes or defraud the IRS, you will be ineligible for any sort of tax debt relief, including discharging otherwise qualifying debts.
- You must meet the 240-day rule – The IRS must have assessed your taxes at least 240 days before you can attempt to discharge them. You also may be able to discharge your taxes if the IRS has not assessed your taxes at all.
If your tax debt meets all of the above requirements, there is a strong chance it is dischargeable at the conclusion of a Chapter 7 bankruptcy or Chapter 13 bankruptcy. Again, it is strongly recommended you speak to a qualified legal representative to ensure your tax will debt qualify.
Options to Consider If Your Tax Debt Does Not Qualify
There are scenarios where you might be facing a large amount of tax debt that does not meet one or more of the requirements for discharging. Luckily, there are other forms of relief you can pursue, including through bankruptcy, though they may be less direct.
It is worth mentioning the IRS’s own relief program, the Offer in Compromise (OIC). This program assesses your current disposable income, similar to a Chapter 13 bankruptcy, and determines how much you can reasonably repay. Sometimes the IRS requests a lump payment, while other times it sets a monthly payment plan. Either way, you will end up repaying less than you originally owed.
While the OIC program can be useful to some individuals facing a great deal of tax debt, especially debt that would not qualify for dischargement through bankruptcy, there are still several caveats to consider. In order to qualify for OIC, you cannot be in the process of filing for bankruptcy or file while you are benefitting from the program. The IRS wants to collect as much payment as possible, so while they may appear to be offering you a reasonable deal through OIC, you might stand to save even more with filing for bankruptcy. Always consult with an attorney before committing to OIC, as doing so will preclude you from bankruptcy relief.
It is worth considering how bankruptcy might be able to help you, even if your tax debt is not eligible for dischargement. If you are unable to pay money owed to the IRS, chances are you owe money to other sources, as well. Herein lies the beauty of bankruptcy: You may be able to discharge other types of debt, giving you the financial flexibility to catch up on debts you cannot discharge, like tax debt.
For example, say your debt stems from a combination of medical bills, unpaid credit card statements, and money owed to the IRS. You qualify for Chapter 13 bankruptcy and file, setting you up for a 5-year, court-mandated repayment plan defined by your current disposable income. This gives you 5 years to find other means of generating additional funds to manage your remaining debt. At the conclusion of the bankruptcy, your medical and credit card debts are discharged – leaving only your tax debt, which you have spent the last several years preparing to pay.
Let Us Help Determine How Bankruptcy Can Help You Manage Tax Debt
For over a decade, our team at Dethlefs Pykosh & Murphy have helped clients throughout Pennsylvania build new financial futures through bankruptcy. We understand how stressful owing money to the IRS can be, and we are determined to help you identify legal solutions for getting on top of your debt. Our bankruptcy lawyers can evaluate whether your tax debt may be dischargeable through bankruptcy, and if not, identify other strategies that can help you overcome overwhelming debt.
The sooner you act to address IRS debt, the better. Call (717) 975-9446 or contact us online to schedule a free consultation.