November 11, 2020
If your debts have gotten out of control, then you’re more than likely considering filing for bankruptcy. So, what are the best actionable next steps to take? There are three main types of bankruptcy that you may qualify for, all of which can help you either get out of debt entirely or make your debts more manageable. While that easily works for common debts like those created by credit cards and other purchases, will it work for tax debt? What if you owe the IRS a lot of money? While some tax debts may be dischargeable through a bankruptcy, most are not, leaving you with a large bill owed to the IRS.
Debt Collection
When you owe money to the IRS, they will do everything that they can to collect that debt. If you ignore the debt long enough or owe a large sum of money, the IRS will file a tax lien on your property. But first, you’ll receive a number of notices which allow you time to reach out to them in order to set up a payment plan or file for bankruptcy before they will actually seize your property and sell it at auction in order to recoup the money. However, this will happen if the debt is ignored long enough. The IRS wants you to pay what you owe and will go to great lengths, if necessary, in order to collect the money that you owe them.
Filing for Bankruptcy
Depending on your overall financial situation, you may have to file for bankruptcy in order for your tax debts and other debts to be cleared up. There are three main types of bankruptcies available to you, all of which both businesses and individuals can qualify for, depending on their income, debts, and other qualifiers.
- Chapter 7 – In a Chapter 7 bankruptcy, all of your debts are cleared, except, possibly for your tax debt. A Chapter 7 case is also known as a liquidation because it essentially liquidates any assets that you have to pay off some or part of your debts before wiping the slate completely clean. With that said, in some cases, your tax debts will not be included in the bankruptcy and may stay in place. On a positive note, this type of bankruptcy does free you of all your other debts, so you can then put money towards paying the IRS.
- Chapter 11 – A chapter 11 bankruptcy is often called a reorganization. Businesses often file in this category, although some individuals may as well, if the amount of their income is too high to qualify for a chapter 13 bankruptcy. In this type of bankruptcy, your debts will be reorganized and your payments lowered. Some debtors may discharge your debt entirely, but in most cases, they will settle with you and your attorney, allowing you to pay a smaller amount. You’ll then pay off your debts over time, rather than get rid of them all at once. What about tax debts? Well, they may be dischargeable as well, but it depends on the circumstances.
- Chapter 13 – A Chapter 13 bankruptcy is a lot like a chapter 11. However, different people qualify for this form of bankruptcy. Sole proprietors, those who are self-employed, and wage earners are the only ones who qualify. Specific income requirements must be met. A chapter 13 bankruptcy works a lot like a chapter 11, where a repayment plan is set up and the debtor agrees to it, then the debts are discharged, but smaller amounts are owed. Again, the IRS may allow your tax debts to be a part of the bankruptcy, but it depends on the circumstances. Either way, as with the other options, you’ll have more money available to pay off those tax debts once your debts are discharged or payment plans are in place.
Qualifications to Possibly Discharging Tax Debts
In order to even attempt to include your tax debts in your bankruptcy case, you first must meet a number of specific conditions. You must be up to date with your tax return filings, meaning that the last four years must be filed correctly and on time. In addition, while your bankruptcy is pending, you must make all of your tax payments on time, and stay up to date with your tax return filings. Plus, if you have any current tax payment that may come due while your case is going through the court system, you must also pay them in full. While your tax debts may or may not be dischargeable in bankruptcy court, they definitely will not be included in your bankruptcy case should you fail to meet any of these requirements.
What if Bankruptcy Did Not Discharge Your Tax Debt?
When this happens, you’re left facing plenty of interest and other penalties built up over time, which makes your debt to the IRS even larger than it was before. Can those interest fees and penalty amounts be waived?
The true answer is rather complicated. The interest amounts that have been accrued on penalties may be waived, if and only if those penalty amounts themselves are waived. However, interest accrued on your balance owed will still be in place. It is against the law to waive all of the interest.
Penalties themselves may be waived under specific circumstances. For instance, if you can prove that you have reasonable cause for the penalty, qualify under the first-time exemptions, or qualify for a statutory exception, then waived penalties may be possible. However, the only penalties that can be waived include filing a tax return late or making a late tax payment, not depositing required tax amounts on time and other penalties that the IRS deems appropriate. Many of these are entirely up to the IRS and subjective based on the amount of proof and quality of the argument that you can provide.
Alternatives to Bankruptcy for Unpaid Taxes
Although filing for bankruptcy may clear up your tax debts, depending on the type of bankruptcy that you qualify for, there are several alterative options that may help. These include:
- An IRS Payment Plan – Anyone can contact the IRS and set up a payment plan using one of the required forms. However, this is best done by a tax professional who has plenty of experience working with the government. With a payment plan, you will have to pay off the debt in a certain number of years by making automatic monthly payments. You will have to pay the interest charges, and interest will continue to accrue on the existing balance until the debt is paid in full. If the IRS has placed a tax lien on your property, it won’t be removed until you pay off the debt.
- An Offer in Compromise – With an offer in compromise, you and the IRS reach an agreement to pay off a smaller portion of the tax debt in full in one lump sum. It’s a win-win for both sides. The IRS is happy, because your debt is cleared, and you are as well, because you receive a small discount in exchange for making that payment.
Debt Settlement Companies
Many debt settlement companies claim that they can help you with your tax debts and other amounts owed. But all too often, people trust them, hand over their information, and then end up in a world of trouble. The end result? They end up having to file for bankruptcy because they were misled. While there are some debt settlement companies out there that manage to help those who are up to their ears in debt, there are more that will cause further damage to your credit.
The problem is that it’s too hard to tell which ones are legitimate and can actually negotiate your debts down and which ones will charge you large fees and then leave you financially struggling. On top of this, the IRS does not work with debt settlement companies. If you want to settle your tax debt with them, you will have to contact them yourself or work with an experience tax professional to speak to them on your behalf. Do not trust the debt settlement companies to help you in these cases. They can (and most likely will) only make things worse.
If you have questions about filing for bankruptcy, contact us. The tax advisors at the Enterprise Consultants Group can answer your questions, discuss your rights, and provide actionable options. Please contact us online or at (800) 575-9284 today to schedule a free and confidential consultation to see how we can help you.
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