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Your Bankruptcy Options If You Owe Income Taxes After Closing Your Business

Most people who close down a failed small business owe income taxes. Chapter 7 and Chapter 13 provide two very different solutions.

 

Here are the two options:

Chapter 7 “Straight Bankruptcy”

File a Chapter 7 case to discharge (permanently write off) all the other debts that you can, and sometimes some or even all of your income taxes. If you cannot discharge all of your taxes, right after your Chapter 7 is completed you (or your attorney or accountant) would arrange for you either to make monthly payments to pay off those remaining taxes or to enter into a settlement with the taxing authority(ies).

Chapter 13 “Adjustment of Debts”

File a Chapter 13 case to discharge all the other debts that you can, and sometimes some or even all the taxes. If you cannot discharge any of your taxes, you then pay the remaining taxes through your Chapter 13 plan, while under continuous protection against the IRS’s or state’s collection efforts.

The Income Tax Factor in Deciding Between Chapter 7 and 13

In real life, especially after a complicated process like closing a business, often many factors come into play in deciding between Chapter 7 and Chapter 13. But focusing here only on the income taxes you owe, the choice could be summarize with this key question: Would the amount of tax that you would still owe after completing a Chapter 7 case (if any) be small enough so that you could reliably make workable arrangements with the IRS/state to pay off or settle that obligation within a reasonable time?

As just mentioned, in a Chapter 7 case you deal with the IRS/state about any remaining taxes after that Chapter 7 case is completed, when the protection against tax collection efforts against you have expired. In contrast Chapter 13 protects you from such tax collection during the three to five years while you are in the Chapter 13 case. 

Being in a Chapter 7 case only makes sense if you don’t need that ongoing protection.

Crucial Information from Your Attorney

To find out whether you need Chapter 13 protection, you need to find out from your attorney the answers to two questions:

1) What tax debts will not be discharged in a Chapter 7 case?

2) What payment or settlement arrangements will you likely be able to make to take care of those remaining taxes?

How reliably your attorney (or anyone else) can predict how a particular taxing authority will allow a tax debt to be paid or settled depends on the circumstances. For example, the IRS has some rather straightforward policies about how long a taxpayer can make monthly payments to pay off income tax obligation in full—and thus how much those monthly payments would have to be—as long as the balance owed is less than a certain amount. In contrast, predicting whether or not the IRS/state will accept a particular “offer-in-compromise” to settle a debt can be much more difficult to predict.  Your attorney (or tax accountant) should tell you the likely success of any proposed game plan.

When in doubt about whether you would be able to pay what the taxing authorities would require after a Chapter 7 case, or in doubt about some other way of resolving the tax debt, you may well be better off under the protections of Chapter 13.

Conclusion

Once you know how much in tax you would still owe after filing a Chapter 7 case, do you have a reasonable and reliable means of paying it off or settling it within a sensible length of time? If so, file a Chapter 7 case. Otherwise, take advantage of the greater protection of Chapter 13.  

 

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A Sample Simple Save-Your-Business Chapter 13 Case

A business Chapter 13 case does not have to be complicated. Here’s how it can work.

 

It’s true that if you own a business that usually means you have a more complicated financial picture than someone punching a time clock or getting a regular salary. So usually if does take more time for an attorney to determine whether and how bankruptcy could help you and your business. But saving a business in the right circumstances can be relatively straightforward and extremely effective.

A good way to demonstrate this is by walking through a realistic Chapter 13 “adjustment of debts” case.

Jeremy’s Story

Jeremy, a single 32-year old, started a handyman business when he lost his job a little more than three years ago. He had ten years steady experience before that in construction and maintenance work. A hard worker and self-starter, he’d been itching to run his own business. He’d slowly accumulated the tools and equipment he needed, and had taken some courses at the local community college in small business management. He had decent credit at the time, owing nothing except his modest mortgage that he had never been late on plus about $2,800 spread out on a number of credit cards. Jeremy had always lived in the same area along with most of his extended family, so he had tons of contacts, and had a great reputation as a responsible guy who could fix anything. He had begun to accumulate some money to get him past the start-up of his business, but then his employer ran into financial problems and he was reluctantly laid off. So Jeremy decided to take the risk of starting his business in spite of having very little working capital. He had $8,500 of credit available on his credit cards if he got desperate.

His business started off slowly, partly because he didn’t have the cash to invest in advertising. But he was creative in setting up a website and using social media, and worked very hard building a customer base and a good business reputation. His income crept steadily upwards, but way too slowly. Over the course of the first year Jeremy maxed out his credit cards to keep current on his mortgage, feed himself, and keeps the lights on. But he simply didn’t have enough money to pay any estimated quarterly income taxes to the IRS, falling behind $3,500 to them that year.

Then during the second year of his business, Jeremy managed to keep current on the increased payments on his credit card debts but couldn’t pay them down any. Plus he fell behind another $6,000 in income taxes. Then recently, towards the end of his third year of business, after again failing to pay any estimated quarterly income taxes and falling another $4,500 behind, the IRS required him to start making $400 monthly payments on his $14,000 debt, plus to pay his estimated quarterly payments going forward. As a result he started not being able to keep current on his credit card payments, leading to ratcheted-up interest rates, pushing him over the credit limits and into the vicious cycle of large extra fees piling up. And now he’s missed two payments on his mortgage, putting him $3,000 in arrears.

In spite of all these distractions Jeremy’s business now has reasonably steady income, which continues to increase, slowly but quite consistently. His accumulated debt problems ARE taking a toll on his ability to focus on growing his business. In spite of this he still very much likes his work and being his own boss, and realistically believes he can keep increasing his income, especially as the economy improves. He very much wants to keep his business going.

But his creditors have him in an impossible situation. If he misses a payment, the IRS could levy on his business equipment or even garnish his business customers—requiring them to pay the IRS instead of him and trashing his very hard-won reputation. A couple credit cards creditors are sending their accounts to collection agencies. He not too far behind on his mortgage but still doesn’t see how he could catch up on even just two missed mortgage payments considering his other financial pressures.

The Chapter 13 Solution

If Jeremy met with an experienced business bankruptcy attorney, this is likely what the attorney would tell him that a Chapter 13 case would accomplish:

  • Cancel the $400 monthly payments to the IRS, giving him 5 years to pay that debt, with no additional ongoing interest or penalties during that whole time. This would significantly reduce the amount that he would need to pay each month and overall.
  • Stop all collection efforts by the credit card creditors and any collection agencies. They would only receive any money after Jeremy caught up on the house arrearage and paid off the income taxes, and then only to the extent that Jeremy’s budget would allow.
  • Immediately protect all his business and personal assets—tools and equipment, his business truck and/or personal vehicle, receivables owed by customers for prior work, and his business and personal bank and/or credit union accounts.
  • Enable Jeremy to concentrate on his business by greatly relieving his month-by-month financial burden, as well as save him a lot of money in the long run.
  • At the end of his 3-to-5 year Chapter 13 case, Jeremy will be current on his mortgage, he would owe nothing to the IRS, and he would have paid as much as he could afford on the credit cards, with any remaining amount discharged (legally written off).

 

As a result the business that he loves and in which he has invested so much hope and effort would be thriving and providing him a decent livelihood. 

 

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You Can Write Off Some Income Taxes with a “Straight Bankruptcy”

Chapter 13 can be a great way to deal with tax debts. But you don’t always need it, or its 3-to-5-year payment plan.

 

Chapter 7 vs. 13 for Income Taxes

Thinking that the only way to handle your income tax debts in bankruptcy is through Chapter 13 is a misunderstanding of the law. It’s an angle on the broader error thinking that you can’t write off taxes in a bankruptcy.

Both are understandable mistakes.

It is true that some taxes cannot be discharged (legally written off) in bankruptcy. But some can be.

And it is true that Chapter 13 can be the best way to solve many income tax problems. But that does not necessarily mean it is the best for you. Chapter 7 might be instead.

When Chapter 13 Is Better

Chapter 13 tends to be the better option if you owe a string of income tax debts, and especially if some are relatively recent ones. That’s because in these situations Chapter 13 solves two huge problems in one package.

First, if you owe recent income taxes which cannot be discharged, you get lots of advantages under Chapter 13, including paying less by avoiding most penalties and interest. That can be a huge savings, especially if you can afford only relatively small payments. Indeed the amount you pay each month is based on what you can afford to pay. You can often even hold off on paying anything towards the back taxes while you first pay even more important debts—such as back child support, or home mortgage arrearage.

Second, if you have older back taxes, under Chapter 13 you pay these only to the extent that you can afford to do so after first paying your more recent taxes. Then whatever of these older taxes are not paid during your case are discharged at the end of it.

When Chapter 7 is Better

But you don’t need the Chapter 13 package if all or most of your income tax debts are dischargeable. In that situation, the generally much simpler Chapter 7 could be enough.

So, what makes an income tax debt dischargeable under Chapter 7?

The Conditions for Discharging Income Taxes

Some of the conditions for determining which taxes can be discharged are quite straightforward, but some are more complicated. It’s not as simple as applying a simple formula to any particular tax debt to see if it is dischargeable. Figuring out whether a particular tax debt will be discharged requires the careful judgment of an experienced attorney.

The conditions for discharging income taxes are listed here, and then will be explained in the next blog. As listed, they may well not make perfect sense, so make sure you see the next blog post.

To discharge an income tax debt in a Chapter 7 case, it must meet these conditions:

1) 3 years since tax return due: The tax return for the pertinent tax must have been due more than three years before you file your Chapter 7 case. Also, if you requested any extensions for filing the applicable tax returns, add that extra time to this three-year period.

2) 2 years since tax return actually filed: Regardless when the tax return was due, you must have filed at least two years before your bankruptcy is filed in court.

3) 240 days since “assessment”: The taxing authority must have assessed the tax more than 240 days before the bankruptcy filing.

4) Fraudulent tax returns and tax evasion: You cannot file a “fraudulent return” or “willfully attempt in any manner to evade or defeat such tax.”

These four conditions need clarification, which will be provided in the next blog post.

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Dramatic Examples of How Bankruptcy Can Be a Good Idea Even if It Can’t Write Off Every Debt

Here’s how bankruptcy actually works, and works well, even when a significant debt or two can’t be written off.

The last blog gave six reasons why it’s worth looking into bankruptcy even if you know that you can’t discharge (write off) one or more of your most important debts. Today here are concrete examples how the first three of those could work for you.

The first two reasons we’ll cover together. First, sometime debts which you might think can’t be discharged actually can be, and second, some debts that can’t be discharged now may be able to be in the near future.

Let’s say you currently owe $10,000 in federal income tax for the 2008 tax year. You filed that tax return on October 15, 2009 after getting an extension. You’ve been making monthly payments to the IRS on a payment plan, but because of that you did not make adequate tax withholdings or quarterly estimated payments for 2011. You know that once you file your 2011 tax returns (by October 15, 2012, because you got an extension) you’re going to be in trouble because you will owe a lot for that year as well. You know the IRS will cancel the payment plan for 2008 because of your failure to keep current on your ongoing tax obligations. You’re pedaling as fast as you can, but October 15 is less than two months away and you don’t know what to do. You are quite certain that the $10,000 tax debt cannot be discharged in bankruptcy.

You’d be right about that… but only for the moment. Because under these facts that 2008 tax debt could very likely be discharged through either a Chapter 7 or 13 bankruptcy case filed AFTER October 15, 2012. (Whether you’d file a Chapter 7 or 13 would depend on other factors, including how big your 2011 and anticipated 2012 tax debts will be.) Instead of being in a seemingly impossible situation, you would avoid paying all or most of that $10,000—plus lots of additional interest and penalties that you would have been required to pay. Instead you would be more than $10,000 ahead on paying off the 2011 and 2012 taxes!

Now here’s an example to go with the third reason to consider bankruptcy: even if you can’t discharge a debt, bankruptcy can permanently solve an aggressive collection problem.  

Change the facts above to make that $10,000 debt one owed for the 2009 tax year instead of 2008. Since that tax return was also filed with an extension to October 15, 2010, that $10,000 would not be dischargeable until after October 15, 2013. But in this example you’ve already defaulted on your monthly payment agreement. So you are appropriately expecting the IRS to file a tax lien on all of your personal property and on your home, and to start levying on (garnishing) your financial accounts, and on your paycheck if you’re employed or on your customers/clients if you’re self-employed.

With all that the IRS can do to you, you can’t wait until October of next year to discharge that $10,000. But if you filed a Chapter 13 case now the IRS would not be able to take any of the above aggressive collection actions against you. You would have to pay the $10,000 (and any taxes owed for 2010 and 2011) but you would have as long as 5 years to do so. And most importantly, throughout that time you’d be protected from any future IRS collection action on any of those taxes, as long as you complied with the Chapter 13 rules.

As for the 2012 tax year, you would likely be given the opportunity to pay extra withholdings or estimated payments during the rest of this year, which you would be able to afford because of temporarily paying that much less  into your Chapter 13 plan.

So instead of being hopelessly behind and deathly scared about everything the IRS is about to do to you, within a few days you could be on a financially sensible path to being caught up with the IRS. And then within three to five years you’d be tax debt free, AND debt free.

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Three Big Ways Bankruptcy Helps with Income Taxes

Bankruptcy CAN 1) legally write off some income taxes; 2) stop IRS wage garnishments, bank account levies, and tax liens; and 3) enable a faster payoff of the taxes you must pay, by avoiding most ongoing interest and penalties.

In the last two blogs I explained what happens to tax refunds in Chapter 7 and 13. But what if instead you owe income taxes? The treatment of tax debts in bankruptcy is a complicated subject, but here today I’m covering the most basic and important powers of bankruptcy over taxes.

1) The ability to “discharge” (write-off) income taxes:

I’m not going into the detailed rules here, but let me clear up any possible confusion: income taxes can be discharged if they meet some very specific conditions. Among those conditions:

  • the age of the particular tax
  • whether and when the tax return was filed
  • whether there was any effort to enter into an “offer in compromise”
  • whether there is evidence of tax evasion

Generally the older the tax, the more likely it will be discharged, although some of the conditions are not time-based.  If you owe more than one year of income taxes, then each year of tax debt is analyzed separately. In fact portions of each tax year’s debt—tax, interest, and penalties—are treated differently in many situations. To be clear, taxes can be discharged under either Chapter 7 or Chapter 13. So determining which of these two options is better requires carefully comparing how each treats your tax debts, as well as all your other debts.

2) The “automatic stay” applies to the IRS, and to the state and local taxing authorities:

Changes in the law tend to cause confusion, to get blown out of proportion. The last major overhaul of the bankruptcy laws by Congress in 2005 allowed the IRS and other tax agencies to do certain very limited things in spite of the taxpayer having filed a bankruptcy. These limited exceptions to the automatic stay include:

  • conducting (or continuing) a tax audit (but not taking any action outside the bankruptcy court to collect the tax resulting from the audit)
  • issuing a notice of deficiency
  • assessing the taxes
  • issuing a “notice and demand” (although again without taking any collection action)

Otherwise, just like all other creditors, the IRS and its state and local cousins cannot pursue collection of any liabilities while your bankruptcy case is pending, except in the unusual event that the bankruptcy court gives special permission to do so.

3. As for taxes that cannot be discharged, Chapter 13 usually provides a way to avoid most ongoing interest and penalties, reducing the total amount of taxes to pay:

Back taxes often take a long time to pay off because interest and penalties keep accruing while you are making the payments. Especially if your payments are relatively small, the additional interest and penalties can greatly increase the total you end up paying. But in a Chapter 13 case, the penalties stop accruing as soon as soon as your case is filed. Even the earlier penalties are treated like normal debt and so are often paid little or not at all. And interest does not get added unless that tax debt is covered by a recorded tax lien.  In combination these benefits can save lots of money. This lack or reduction in accruing interest and penalties also allows you to pay other important debts before paying the taxes—such as vehicles or home mortgage arrears. This allows you to better protect those valuable possessions by paying their debts faster.

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Chapter 13 Conquers Both Older and Newer Income Taxes

If you owe a number of years of income tax debt, Chapter 13 allows you to favor those taxes that have to be favored, while dumping the taxes that can be dumped.

In my last blog I gave an example showing how Chapter 13 can be an extremely good way to handle income tax debts particularly when you owe multiple years of taxes. In that hypothetical case, without a bankruptcy a couple would have had to pay about $30,000 to the IRS for back taxes, plus about another $45,000 in medical bills and credit cards, a total of $75,000. And paying this huge sum of money on their income would have taken them many, many years of pressure and uncertainty. In huge contrast, in a Chapter 13 case this same couple would only need to pay about $17,500, less than 1/4th the amount. And they would be allowed to do so through pre-arranged affordable monthly payments, for three years, all the while not having to worry about aggressive actions by any of their creditors, including the IRS.

How does Chapter 13 pull this off?

1) Tax debts that are old enough are lumped in with the lowest priority “general unsecured” creditors—like medical bills and credit cards—and so in many cases do not need to be paid anything unless there is enough “disposable income” to do so. This means that often those taxes are paid either nothing—as in the example—or  only a few pennies on the dollar.

2) The more recent “priority” taxes DO have to be paid in full in a Chapter 13 case, along with interest accrued until the filing of the case, but a) penalties—which can be a large part of the debt—are treated like “general unsecured” debts rather than “priority” ones, and 2) usually interest or penalties stop when the Chapter 13 is filed. These can significantly reduce the amount of tax that has to be paid.

3) “Priority” taxes are paid in a Chapter 13 case before and instead of “general unsecured” debts. This often means that having these taxes to pay simply reduces the amount of money which would otherwise have gone to those “general unsecured” creditors. So sometimes, amazingly, having tax debt does not increase the amount paid in a Chapter 13 case. In our example, the couple paid about $500 per month for three years, which is the same amount they would have paid even if they did not owe a dime to the IRS! They met their obligations under Chapter 13 by paying the IRS instead of their other creditors.

4) The bankruptcy law that stops creditors from trying to collect their debts while a bankruptcy case is active—the “automatic stay”—is just as binding on the IRS as on any other creditor. The IRS can continue to do some very limited and sensible things like demand the filing of a tax return or conduct an audit, but it can’t use the aggressive collection tools that the law otherwise grants to it. Gaining relief from collection pressure from the IRS AND all the rest of the creditors is one of the biggest benefits of Chapter 13.

I confess that I put this example together in a way that would showcase the advantages of Chapter 13 in dealing with income tax debts. If the facts were different, the advantages could easily be less. If, for instance, more of the taxes were “priority” debts that had to be paid, the debtors would have to pay more, either through larger monthly payments or for a longer period of time. There are definitely situations where it is a close call choosing between Chapter 7 or Chapter 13, or possibly even not filing bankruptcy at all but doing an offer in compromise with the IRS. To decide what is best for you, you need the independent advice of an experienced bankruptcy attorney, who is ethically and legally bound to look out for your best interests. Regardless whether your tax debts and other circumstances point strongly in one direction or it’s a closer call, you need a professional qualified both to help you make an informed decision and then to execute on it.  

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Chapter 13 Tames Your Income Tax Monster

A “straight” Chapter 7 can write off some income taxes. But if you owe recent taxes, or multiple years of taxes, Chapter 13 is usually a much better way to go. It often provides tremendous advantages over both Chapter 7 and dealing with the IRS on your own.

I’ll illustrate this with an example, and then explain it in my next blog.

Let’s say a husband and wife owe $35,000 in a combination of medical bills and credit cards, requiring monthly payments of $800. After the husband lost his long-time job back in 2006, he followed his dream of starting a business, which was starting to make progress when it got hammered in the Great Recession. He closed it in 2010 and found a reliable job a number of months later, although one where he earns 30% less than he did at the one lost years earlier. His business had generated some income, but barely enough for the couple to meet their bare essentials. So there was no money to pay the quarterly estimated taxes, and they had no money to pay the amount due when they filed their joint tax returns for 2006, 2007, 2008, 2009 and 2010. They expect to come out even for the 2011 tax year because of tax withholdings from their wages. To try to simplify the facts, assume they owe the IRS $4,000 in taxes, $750 in penalties, and $250 in interest for each of those five years. So their total IRS debt for those years is $25,000—including $20,000 in the original taxes, $3,750 in penalties, and $1,250 in interest. The wife has had consistent employment throughout this time, with pay raises only enough to keep up with inflation. They filed each of the tax returns in mid-April when they were due, and have been making modest payments when they have been able to, but those have not even been keeping up with the penalties and interest. Assume they have no secured debts—no mortgage or vehicle loans. They can realistically afford to pay about $500 a month to all of their creditors, not enough to pay their regular creditors much less the IRS.

Outside of bankruptcy, the IRS would likely require payment in full of the entire tax obligation, with interest and sometimes penalties continuing to accrue until everything was paid in full. Their payments would be imposed without regard to the other debts they owe. And if the couple failed to make their payments, the IRS would likely try to collect through garnishments and tax liens. Depending how long repayment would take, the couple could easily end up paying $30,000 or more with additional interest and penalties. This would be in addition to their $35,000 medical and credit card debts, which could easily increase to $45,000 or more, especially if these other debts went to collections or lawsuits. That’s likely because the couple would be paying all available money to the IRS. So likely the couple would eventually end up paying at least $75,000 to their creditors.  

In a Chapter 13 case, the 2006 and 2007 taxes, interest and penalties would very likely be paid nothing and discharged at the end of the case. So would the penalties for 2008, 2009, and 2010. That takes care of $11,500 of the $25,000 present tax debt. The remaining $13,500 of taxes and interest for 2008, 2009, and 2010 would have to be paid as a “priority” debt, although without any additional interest or penalties once the Chapter 13 case is filed. Adding in some “administrative expenses” (the Chapter 13 trustee and our attorney fees), and assuming that their income qualified them for a three-year Chapter 13 plan, this couple would likely be allowed to pay about $500 per month to ALL of their creditors—credit cards and medical, AND the IRS. Then after three years, they’d be done. The “priority” portion of the IRS debt would have been paid in full, but the older IRS debt and all the penalties would be discharged likely without any payment. So would the credit card and medical debts. After the three years, the couple would have paid a total of around $17,500 (including the “administrative expenses”), instead of about $75,000 without the Chapter 13. They’d be done instead of barely starting to pay their mountain of debt. And they would have not spent the last three years worrying about IRS garnishments and tax liens, lawsuits and harassing phone calls, and the constant lack of money for necessities.

As I said, in my next blog I’ll explain how all this works.

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Four Hoops to Jump Through to Write Off Income Taxes in Bankruptcy

The conditions you have to meet to write off an income tax debt actually make sense. And understanding those conditions is a lot easier if you understand the sense behind them.

In my last blog I introduced the four conditions for discharging taxes in a Chapter 7 “straight bankruptcy,” and said I’d explain them in this blog today.

This is made easier by the fact that there is a single principle behind all four of these conditions: bankruptcy law believes that taxpayers who pretty much follow the tax laws should be able to write off their tax debts just like the rest of their other debts, after first giving the IRS (or other tax authority) a sensible amount of time to collect the taxes.

How long is this sensible amount of time? How much of an opportunity do the tax authorities have to collect before you can discharge the tax debt? Each of the four conditions measures this amount of time differently, based on 1) when the tax return for the particular income tax was due, 2) when the tax return was actually filed, 3) when the tax was “assessed,” and 4) whether the tax return that was filed was honest and therefore reflected the right amount of tax debt when it was filed. You must meet all four of these conditions, all four of these measures of time.

Taking them one at a time:

1) Three years since tax return due: Every income tax debt has a fixed point in time when its return had to be filed. That date is extended by a certain number of months if you asked for an extension, but it’s still a fixed point in time, one that can be easily ascertained. So this first condition gives the tax authorities three years to collect, three years from a fixed point not affected by your actions (the timing of filing the return) or their actions (audits, legal disputes).

2) Two years since tax return actually filed: In contrast, this is a time period triggered by your own action. Notice above when I stated the overall principle at work here, I said you must “pretty much” follow the tax law. Thus you can file a tax return late and still be able to discharge the debt if at least two years has passed since you filed the return.

3) 240 days since assessment: Assessment is the tax authority’s formal determination of your tax liability, usually by its review and acceptance of your tax return. Normally an income tax is assessed within a few weeks that it is received, so the 240 days since assessment usually passes way before the above three-year or two-year time periods. But the law has to account for the less common situations when assessment is delayed. So, when a tax is subject to a lengthy audit or litigation, or an “offer-in-compromise” (a taxpayer’s formal offer to settle), and the three-year and two-year periods have passed, the tax authority still has 240 days after assessment to chase that tax debt.

4) Fraudulent tax returns and tax evasion: This last condition essentially says that none of the above time periods are triggered at all if you are intentionally dishonest on your tax return or try to avoid paying the tax in some other way. If you are cheating on your taxes then the tax authority has no opportunity to collect the debt, so you cannot discharge the debt, no matter how old the tax is.

If your tax debt can jump through these four hoops, you should be able to discharge that tax in a Chapter 7 bankruptcy.

But what if you owe taxes which do not meet these four conditions? What if some of your taxes do but others do not? Or what if the IRS has recorded a tax lien? Or if a lot of the taxes came from operating a business, or are not income taxes but some other kind? I’ll tell you about these situations in my next blogs.

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Writing Off Income Taxes with a “Straight Bankruptcy”

You don’t always need to file a Chapter 13 case—with its 3-to-5-year payment plan–to deal with income tax debts. Thinking that you do is a myth, alongside the broader myth that “you can’t write off taxes in a bankruptcy.” Both have a kernel of truth, which is why they persist. It’s true: some taxes cannot be discharged (legally written off) in bankruptcy. But some can. And it’s true: Chapter 13 is often an excellent way to solve tax problems. But that does not necessarily mean it is the best for you. Instead Chapter 7 might be.

Chapter 13 tends to be the better tool if you owe a string of income tax debts including relatively recent ones. Why? Because in this situation Chapter 13 gives you the best of both worlds. First, if you owe recent income taxes which cannot be discharged, you get lots of advantages under Chapter 13, including paying less by avoiding most penalties and interest. That can be a huge savings, especially if you can afford only relatively small payments. Second, if you have older back taxes, these are also wrapped into the Chapter 13 plan, often without you paying any more into your plan, then they are discharged at the end of your case.

But you DON’T NEED the best of both worlds if all or most of your income tax debts are dischargeable. Then Chapter 7, the straightforward “straight” bankruptcy is enough.

So, WHAT ARE the conditions for a specific income tax debt to be discharged in Chapter 7? How are you going to know if Chapter 7 will discharge all or most of your taxes so that it is the right option for you?

Some of the conditions for discharge of taxes are quite straightforward. Some are more complicated. And as you’ll see, some are even purposely vague. So unfortunately it’s not as simple as plugging a particular tax debt into a clear formula to see if it is dischargeable. Determining whether a particular tax debt will be discharged requires the careful judgment of an experienced attorney.

I’ll just list these conditions for discharging income taxes here, and then explain them in my next blog. Don’t be surprised if they sound confusing in this list. It’s true: anything having to do with taxes tends to be complicated!

To discharge an income tax debt in a Chapter 7 bankruptcy case, it must meet these conditions:

1) Three years since tax return due: The applicable tax return must have been due more than three years before you file your Chapter 7 case. And if you requested any extensions for filing the applicable tax returns, you have to add that extra time to this three-year period.

2) Two years since tax return actually filed: Regardless when the tax return was due, you must have filed at least two years before your bankruptcy is filed in court.

3) 240 days since assessment: The taxing authority must have assessed the tax more than 240 days before the bankruptcy filing.

4) Fraudulent tax returns and tax evasion: You cannot have filed a “fraudulent return” or “willfully attempted in any manner to evade or defeat such tax.”

You can see that these are begging for some clarification. For that please come back to read my next blog. Or else call to set up a consultation with me. If you have substantial tax debts, you should definitely get some thorough personal advice. Know your options so you can make an informed choice, about bankruptcy and otherwise.

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Taxes and Bankruptcy–Debunking a Hardy Myth

No wonder people think “bankruptcy can’t help me with my tax debt.” Even attorneys sometimes perpetuate the myth.

A few days ago I saw a video of a bankruptcy attorney being interviewed in what amounted to be an infomercial. He was asked by the interviewer whether there were some debts that can’t be “touched” in a bankruptcy:

Attorney: “Absolutely. Things like child support, alimony, uh, tax debts, student loans. Those generally aren’t dischargeable.”

Interviewer:  “So the government’s gonna help you eliminate some of the debt in a bankruptcy. But not the debt to them.”

Attorney: “Not theirs, of course!”

Lumping tax debts in with child support and alimony—which indeed cannot be legally written off, or discharged—is just plain wrong. For him to say that tax debts “generally aren’t dischargeable” while including it with other debts that are never dischargeable, or in the case of student loans very rarely dischargeable, is at best very confusing.

And no question, the merger of taxes and bankruptcy can be confusing, because each of these are rather complicated areas of law. Misinformation doesn’t help.

In my next few blogs, you’ll get some solid answers about what taxes can be discharged and what can’t. The fact is that bankruptcy can discharge taxes of many types and in many situations. Sometimes ALL of a taxpayer’s taxes can be discharged, or most of them. But there ARE significant limitations, which I will explain carefully.

But right now maybe the most important thing to understand is that even as to the particular taxes that may not be discharged, a bankruptcy still usually provides huge advantages in dealing with those taxes. So besides the possibility that you will be able to discharge some or all of your taxes, bankruptcy can also:

1. Keep the taxing authorities from garnishing your wages and bank accounts, and “levying on” (seizing) your personal and business assets.

2. Stop them from gaining greater leverage against you, through tax liens and piling on greater penalties and interest.

3. Avoid forcing you to pay them monthly payments based on totally unreasonable policies (such as giving no consideration to most of your other legal obligations), all the while penalties and interest continue to accrue.

Overall, bankruptcy gives you leverage against the IRS, or state or local taxing authority that you cannot get any other way. It gives you a lot more control over a very powerful class of creditors. And your tax problems are resolved as part of your whole financial package, so you don’t find yourself working hard to deal with your taxes while worrying about being blindsided by other creditors.

I’ll explain all this in my next blogs. Call me in the meantime if you can’t wait, or you know you shouldn’t wait. There is no kind of debt that needs more careful personal attention and advice than tax debts.

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