Dealing with mounting IRS tax debt can be one of the most stressful financial situations for individuals and businesses. If you’ve fallen behind on tax payments, the IRS has broad powers to collect, including wage garnishments, tax liens, and asset seizures. However, if you find yourself unable to repay the IRS, bankruptcy may offer a viable solution to get out from under overwhelming debt.
In this comprehensive guide, we’ll explore how **bankruptcy** and **IRS debt relief** work together, the types of bankruptcy that may help with tax debt, and what you need to know before using bankruptcy to resolve IRS obligations.
Can Bankruptcy Help with IRS Tax Debt?
Yes, bankruptcy can provide relief from IRS tax debt under certain conditions. However, not all tax debts are eligible for discharge in bankruptcy, and there are specific rules that must be followed to determine which taxes can be wiped out. The type of bankruptcy you file, the age of the tax debt, and your compliance with IRS filing rules all play a role in whether or not bankruptcy will resolve your tax obligations.
Types of Bankruptcy and Their Impact on IRS Debt Relief
Two main types of bankruptcy are used by individuals to manage IRS debt: Chapter 7 bankruptcy and Chapter 13 bankruptcy. Each type offers different approaches to handling tax debt.
Chapter 7 Bankruptcy and IRS Debt Relief
Chapter 7 bankruptcy, also known as liquidation bankruptcy, is designed for individuals who do not have the financial ability to repay their debts. Under this type of bankruptcy, certain eligible debts, including some IRS tax debt, may be discharged or eliminated. However, not all IRS debts can be wiped out through Chapter 7.
Conditions for IRS Debt Discharge in Chapter 7
To have IRS tax debt discharged in Chapter 7, it must meet specific criteria, often referred to as the five rules:
1. The Three-Year Rule: The tax return for the debt must have been due at least three years before the bankruptcy filing. This includes any extensions you may have received.
2. The Two-Year Rule: The tax return must have been filed at least two years before the bankruptcy filing. If you didn’t file the return on time, the two-year clock begins when the return is finally submitted.
3. The 240-Day Rule: The tax assessment, which is the formal recording of the tax debt, must have been made at least 240 days before the bankruptcy filing.
4. No Fraud or Evasion: The debt cannot result from fraudulent activity or tax evasion. If the IRS can prove that you filed a fraudulent tax return or attempted to evade taxes, the debt will not be discharged.
5. Income Taxes Only: Only federal income tax debt is eligible for discharge under Chapter 7. Other types of taxes, such as payroll taxes or penalties, are not dischargeable.
If your IRS debt meets all these criteria, Chapter 7 bankruptcy can wipe it out completely, allowing you to move forward without the burden of tax debt.
Chapter 13 Bankruptcy and IRS Debt Relief
Chapter 13 bankruptcy is often referred to as a reorganization bankruptcy because it allows individuals to keep their property while making affordable payments to creditors over a period of three to five years. Chapter 13 may be a better option if you want to protect valuable assets or if you do not qualify for Chapter 7 due to higher income levels.
In Chapter 13, tax debt is typically categorized into priority and non-priority debts, with different rules for each:
1. Priority Tax Debt: Priority tax debts, such as recent tax obligations, cannot be discharged in bankruptcy. However, Chapter 13 allows you to repay these debts over the course of your repayment plan, usually within three to five years. This can stop collection actions and give you breathing room to repay the IRS without facing garnishments or liens.
2. Non-Priority Tax Debt: Older tax debts that meet the criteria for discharge (the three-year, two-year, and 240-day rules mentioned above) are considered non-priority. These debts can be discharged at the end of your Chapter 13 repayment plan, meaning you will no longer owe them once the plan is complete.
Benefits of Chapter 13 for IRS Tax Debt Relief
– Automatic Stay: Filing for Chapter 13 triggers an automatic stay, which halts all collection activities from the IRS, including wage garnishments, bank levies, and asset seizures.
– Structured Repayment Plan: Chapter 13 allows you to repay tax debt over time based on your income, potentially lowering your monthly payments and preventing aggressive IRS actions.
– Discharge of Non-Priority Debt: At the end of the repayment plan, any qualifying non-priority tax debt can be discharged, freeing you from the obligation to repay it.
Which IRS Debts Cannot Be Discharged in Bankruptcy?
While bankruptcy can provide significant relief from IRS debt, not all tax debts are eligible for discharge. The following types of IRS debts typically cannot be discharged in either Chapter 7 or Chapter 13 bankruptcy:
1. Recent Tax Debt: Taxes owed for the most recent tax year are generally considered priority debt and cannot be discharged.
2. Payroll Taxes: Any taxes you owe as an employer, including Social Security and Medicare taxes withheld from employee wages, are non-dischargeable.
3. Trust Fund Taxes: Trust fund taxes, which are withheld by an employer from an employee’s wages (such as income taxes), cannot be discharged in bankruptcy.
4. Tax Penalties for Fraud or Evasion: If the IRS can prove that your tax debt resulted from fraudulent activity or deliberate tax evasion, the debt will not be discharged.
5. Property Taxes: Local and state property taxes typically cannot be discharged in bankruptcy.
It’s important to consult with a bankruptcy attorney to fully understand which debts are dischargeable and which debts will remain after bankruptcy.
The Role of the IRS in Bankruptcy
When you file for bankruptcy with outstanding IRS tax debt, the IRS becomes a creditor in your bankruptcy case. However, the IRS is bound by bankruptcy laws, and certain protections automatically go into effect when you file, such as the **automatic stay**.
Automatic Stay Protection
As soon as you file for bankruptcy, an automatic stay goes into effect. This legal provision stops all collection activities from the IRS, including:
– Wage garnishments
– Bank levies
– Tax liens
– Property seizures
The automatic stay gives you breathing room while your bankruptcy case is processed, preventing the IRS from taking any further collection actions until the court makes a ruling.
IRS Tax Liens in Bankruptcy
If the IRS has already placed a tax lien on your property before you file for bankruptcy, the lien may remain in place even after the debt is discharged. In this case, while the IRS can no longer pursue you for payment, they may still have a claim on your property. If you want to sell the property, the lien would need to be satisfied before the sale.
Alternative IRS Debt Relief Options
Bankruptcy isn’t the only option for resolving IRS tax debt. Depending on your financial situation, there may be alternative debt relief programs available, such as:
1. Offer in Compromise (OIC)
An Offer in Compromise allows you to settle your tax debt for less than the full amount owed. The IRS will consider your ability to pay, income, expenses, and asset equity before accepting an offer. This option is available outside of bankruptcy and can help you avoid filing altogether.
2. Installment Agreements
If you cannot pay your full tax debt upfront, the IRS offers **installment agreements**, allowing you to make monthly payments over time. This option does not require bankruptcy, but it may not offer the same level of protection as a Chapter 13 repayment plan.
3. Currently Not Collectible Status
If you’re facing financial hardship, you may qualify for **Currently Not Collectible** status, where the IRS temporarily halts collection actions against you. This status doesn’t eliminate your debt but provides temporary relief until your financial situation improves.
Should You File for Bankruptcy to Resolve IRS Debt?
Deciding whether or not to file for bankruptcy is a personal decision that depends on your overall financial situation. If your tax debt meets the discharge criteria and you’re struggling to repay other debts as well, bankruptcy may be a viable solution. However, it’s important to weigh the long-term consequences of bankruptcy, such as its impact on your credit score, against the benefits of tax debt relief.
Factors to Consider:
– Amount of Tax Debt: If tax debt is a significant portion of your overall financial burden, bankruptcy may provide meaningful relief.
– Eligibility for Discharge: Review whether your tax debt meets the qualifications for discharge under Chapter 7 or Chapter 13.
– Alternative Relief Options: Consider whether non-bankruptcy options, like an Offer in Compromise or installment agreement, could resolve your debt without the need for bankruptcy.
Navigating the complex relationship between bankruptcy and IRS debt relief can be challenging, but for many individuals, it offers a fresh start. By understanding the rules and eligibility criteria for discharging tax debt in bankruptcy, you can make informed decisions about how best to resolve your IRS obligations.
Whether you pursue Chapter 7 bankruptcy, Chapter 13 bankruptcy, or an alternative tax debt relief option, working with a knowledgeable bankruptcy attorney is essential. They can help guide you through the process, protect your rights, and provide a clear path to financial freedom.
