Here’s how bankruptcy can help if you were already on the financial edge and just found out you owe (more) income taxes.
If you didn’t have much other debt but you found out you owed the IRS for last year’s income taxes, you probably wouldn’t need to think about filing bankruptcy. In straightforward situations the IRS can actually be reasonable to work with in setting up a monthly payment plan to catch up on a single year’s tax shortfall. Yes, you’d pay some penalties and interest. But if you really could pay off the tax liability through reasonable monthly payments over the course of a year or so, that might not be so bad.
But if you owe for more than one year of taxes, or have a lot of other debts, you may well not be able to reliably pay a monthly installment for these taxes. Or if you just filed your 2014 tax return because you got an extension and now here you are a couple months from the end of 2015 afraid you’ll also owe for this year, then it looks like you’re getting into a vicious tax-debt cycle.
So you owe it to yourself to check out Chapter 7 “straight bankruptcy” and Chapter 13 “adjustment of debts” as possible ways out of this vicious cycle.
Today we’ll look briefly at how Chapter 7 helps, and then next time at Chapter 13.
Chapter 7 and Income Taxes
You may have other reasons for choosing to file a Chapter 7 case instead of a Chapter 13 one. But as far as income taxes the rule of thumb is quite simple, especially if the only taxes you owe are from the last year or two:
File a Chapter 7 case if that will enable you to get caught up on your unpaid taxes through reasonable monthly payments that you can reliably make over a reasonable period of time. Another way of putting this, file a Chapter 7 if you don’t need the extended protections and other benefits provided by Chapter 13. (Again, more about those protections and benefits next time.)
“Discharge” of Income Taxes
Both Chapter 7 and 13 can legally write off (“discharge”) an income tax if it meets certain conditions. The bankruptcy filing must be at least three years after the date the tax return for that tax was due to be filed. (That initial due date is extended if you got an extension that year.)
So for example, as of right now you could discharge 2011 income taxes, but not later ones. That’s because 2011 taxes were due either April 16, 2012 (April 15 was a Sunday), or October 15, 2012 if you got an extension. So you could discharge a 2011 tax debt starting three years later, after April 16, 2015 or after October 15, 2015, repectively.
In addition, you must have actually filed the tax return more than two years before filing the Chapter 7 case, regardless when that tax return was due.
You’d have to meet some additional conditions as well, but those are ones that most people have no trouble meeting.
Questions to Ask
So if you have tax debts that meet the above timing conditions, they will be discharged in a Chapter 7 case. If you have more recent tax debts they will not be discharged under Chapter 7.
Even if some or all of your income tax debts would NOT be discharged under a Chapter 7 case, it may still be better than filing under Chapter 13. That’s if you get enough benefit from discharging all or most of your other debts that you can pay any remaining income taxes over time. So consider these two sets of questions:
1) How much will filing Chapter 7 improve your monthly cash flow? In other words, how much will you be able to pay to the IRS realistically on a monthly basis? Be sure to consider not just what it takes to catch up on the back taxes, but also for any other necessary adjustments to the current withholdings or estimated quarterly payments so that you don’t slide back into owing next year.
2) How much do you owe in back taxes? Will the amount that you can realistically afford to pay each month allow you to get current in a reasonable time so that you’re not incurring an unreasonable amount in additional penalties and interest?
If you’re not confident that Chapter 7 will help you enough, Chapter 13 gives you a number of additional tools. Look at our next blog to see whether those Chapter 13 tools are worthwhile for you.