Taxes and bankruptcy: which types can be discharged, how liens work, dealing with taxes without filing bankruptcy, keeping your tax refund after filing bankruptcy, non-bankruptcy options and property taxes (or Ad Valorem taxes).

Ways to beat delinquent federal income taxes

There are basically ten options for dealing with delinquent taxes:

1. Pay the past due taxes. Most people don’t realistically have this option because they don’t have the money. It is an obvious option.

2. Do a voluntary installment agreement. As far as federal income taxes, there is now a new, streamlined installment plan that you can do on-line if your past due taxes are less than $25,000. The installment agreement is limited to a maximum of five years. If you qualify and can afford to pay off your taxes in five years, your installment agreement will be automatically approved. This is considered streamlined because you don’t have to submit a financial statement to the IRS to be approved. Importantly, you are not bound by IRS guidelines in determining the amount of the payment. Because the process is straightforward, your attorney or tax professional can limit the amount of time spent which obviously will be a savings to you.

3. Dispute or litigate the tax liability.

4. Negotiate an offer in compromise.

5. Have the taxes placed in non-collectible status. This is where you request that the IRS place the account in non-collectible status because you simply cannot afford to pay your taxes and live under the IRS standards (which are pretty frugal). So, if you have no equity in any assets and no excess income, you can request and the IRS may grant non-collectible status. This doesn’t discharge your taxes though. So, I some point in time (before the statute of limitations runs), if you begin to earn wages or acquire assets, the IRS may require that you pay. This will give you, at least, a temporary reprieve if you are really down and out. This is a straightforward process.

6. File bankruptcy to discharge those taxes that are dischargeable. If any are nondischargeable, you may be able to pay back the taxes you owe in a Chapter 13 bankruptcy, or you may be able to discharge a substantial portion of the taxes in a Chapter 7, and then use one of the other tools described above to settle your tax liability.

7. Do nothing and wait out the statute of limitations. Once the statute of limitations runs, the IRS lien is automatically removed. This is not helpful if you are facing a levy or garnishment. But depending on your circumstances and how long it is until the statute of limitations is exhausted, this may be the best course of action for some.

8. Seek innocent spouse status.

9. Request a due process hearing.

10. Demand collection appeals.

Discharging Taxes in Bankruptcy

Bankruptcy can stop tax enforcement action, such as bank account levies, seizures and wage garnishments. The automatic stay applies even against governmental entities that are trying to collect.

While not all taxes are dischargeable, bankruptcy can be a tool for establishing a reasonable payment plan where you can pay back taxes without fear of your accounts being levied or wages being garnished. For example, a Chapter 13 can be used to pay back taxes over five years in an orderly manner (along with other bills).

Will a bankruptcy stop a wage garnishment or levy by the IRS?

The IRS is subject to the automatic stay just like any other creditor. One the bankruptcy case is filed, the IRS has a special department that can be called to immediately stop levies and liens. Depending on the type of tax (income versus trust taxes, etc.), you may be able to use bankruptcy to totally cancel out all or some of the taxes; or you may need to reorganize the taxes and force the IRS to permit payments over time. If  you have the type and age of taxes that can be helped by bankruptcy, bankruptcy is an extremely powerful tool.

What taxes can be discharged in bankruptcy?

Certain taxes, such as payroll taxes or trust taxes, are not dischargeable. Federal income taxes may be dischargeable depending on a number of factors. Generally, in order for taxes to be dischargeable:

1. The tax return must have been due more than three years from the filing of the bankruptcy petition. This includes extensions, so if you had an extension of the due date to October 15, as many people do, the due date would be October, rather than April.

2. The tax return must have been filed more than two years before the bankruptcy was filed. Sometimes, if you don’t file a tax return, the IRS files one for you. This may not count as a tax return filed.

3. The tax must have been assessed more than 240 days before the petition was filed.

While a tax may be dischargeable if the IRS has filed a valid lien, the tax may be dischargable if it meets 1 – 3 above, but the IRS may still have a lien against your real and personal property. If the IRS has a lien, you may use a Chapter 13 bankruptcy to pay secured amount, or you may use a Chapter 7 to discharge the taxes as to your personal liability, but you will have to still address the IRS lien.

Are interest and penalties dischargeable?

As a general rule, if the tax is dischargeable, so are the penalties and interest. One advantage of using bankruptcy to resolve tax issues is that with respect to taxes secured by a lien, penalty and interest stops accruing once you file. Unsecured priority taxes (taxes that are not secured by a lien; and don’t meet 1-3 above) no longer accrue penalties, but interest continues to run at the rate of interest in effect at the time the petition was filed.

What effect does a tax lien have on payment of taxes through bankruptcy?

Taxes that normally would be dischargeable must be paid the extent that they are secured by equity in property, regardless of whether the property is exempt or not. What this means is that once the automatic stay protection of the Bankruptcy Court ends, the IRS can still collect taxes that are secured by a properly filed tax lien. If the IRS has a valid lien, you must pay the amount of equity in the secured property through a chapter 13 bankruptcy or perhaps an offer in compromise or installment agreement with a chapter 7 bankruptcy.

How long does the IRS have to collect taxes?

As a general rule, the IRS has ten years from the date the tax was assessed to collect taxes. If the IRS files a lien, the lien automatically expires at the end of the ten year period. Keep in mind, though, that certain action stops the counting of the ten years. Examples of this are 1) pending bankruptcy (adds time period when bankruptcy is pending plus six months);  2) submission of offer in compromise (adds time period offer in compromise is pending plus thirty days); 3) various appeals.

Can I file bankruptcy without having filed my tax return?

Yes, you can file bankruptcy without having filed your tax returns, but you will need to make sure you have them filed by the Meeting of Creditors (typically 20-50 days after the petition is filed). Under the Bankruptcy Reform Act of 2005, the debtor is required to have filed the last four years of tax returns in order to receive a discharge.

Will I lose my tax refund if I file a Chapter 13 or Chapter 7 bankruptcy?

If you file around the first of the year when you have a refund due to you, but you have not received it, you must have available exemptions to protect the tax refund in a Chapter 7. In a Chapter 13, you must be counting the tax refund as income necessary for your support in your budget.

Normally, with planning, you will not lose your tax refund. Generally, it is not a good idea to overwithhold, even if you receive earned income credit. The best thing to do is to learn to budget and actually withhold close to what you will be paying in taxes. If you are entitled to an earned income credit, you adjust your withholding to receive your earned income credit throughout the year as well.

You may lose your refund, however, if you owe a domestic support obligation or if you owe the IRS for taxes that were incurred before the petition was filed.

What are Nonbankruptcy Options for dealing with federal tax debt?

Depending on the particulars of your tax situation, bankruptcy may not be the best option for addressing your tax debt. If the tax is large and is also dischargeable, bankruptcy can be a great option for simply wiping out the tax debt. However, if the tax debt is relatively small, not dischargeable and/or you don’t have other debt where bankruptcy provides relief, you may prefer non-bankruptcy options. Before taking any action, you should consult a qualified bankruptcy attorney who will advise you what your options are both in and out of bankruptcy. Listed below are a few non-bankruptcy options:

Streamlined Installment Agreement

You may enter into a streamlined installment agreement if:
1) Your tax debt is under $25,000;
2) You can make a payment large enough to fully pay the account off in 5 years;
3) You have filed all tax returns.

The advantage of a streamlined installment agreement is you don’t have to provide financial statements or other information showing that you are not able to fully pay off the tax. Whether a tax lien is entered is left to the discretion of the IRS. You may enter into this agreement in person, by telephone, by correspondence or online. For more information, go to http://www.irs.gov/irm/part5/irm_05-014-005.html.

Guaranteed Installment Agreement

You may enter into a guaranteed installment agreement if:
1) Your tax debt is under $10,000 (excluding penalty and interest)
2) You can pay off the debt in 3 years;
3) You have filed all your tax returns and agree to continue to file and pay all tax returns during the time the guaranteed installment agreement is pending;
4) You have not entered into an installment agreement in the last 5 years.

If you meet the guidelines of the guaranteed installment agreement, the IRS is required to allow you to enter into the guaranteed installment agreement. Like the streamlined agreement, you do not have to provide financial statements or otherwise provide proof that you can’t pay the tax all at once. For more information, go to http://www.irs.gov/irm/part5/irm_05-014-005.html. You may enter into this agreement in person, by telephone, by correspondence or online.

Offers in Compromise

An offer in compromise is where you make an offer to settle your tax liability for a percentage of what is owed. Generally, this is done by a lump sum payment, but payments on an offer in compromise may be paid out over time in some cases.

Taxpayer Advocate Service
This is a free service available to taxpayers who have issues that they have tried to resolve unsucessfully with the IRS. You can contact the tax advocate by calling 1-877-777-4778, or visit their website at www.irs.gov/advocate. This is an “independent agency” within the IRS. They have at least one advocate in each state. If you have a complex tax situation, or if you may have criminal issues related to your taxes, it may be best to seek the assistance of a private attorney.

Property (Ad Valorem) Taxes

We’ve updated the information on property taxes (Ad Valorem taxes). Go to the new page on dealing with property taxes (Ad Valorem).