Summary:
Bankruptcy can provide debt relief but may not eliminate all tax debts; understanding the process and requirements is crucial.
Different types of bankruptcy, such as Chapter 7 and Chapter 13, offer varying approaches to managing debt, including tax obligations.
While some tax debts can be discharged under certain conditions in bankruptcy, others may require repayment through a structured plan or negotiation with the IRS.
Post-bankruptcy, rebuilding credit becomes essential, and seeking professional guidance, like that offered by CreditAssociates®, can help navigate financial recovery.
CreditAssociates® can provide debt relief counseling and financial management advice to help you avoid bankruptcy or manage your finances effectively.
Bankruptcy is often thought of as a way to eliminate all debt. However, many people are surprised to learn how the process works and how your finances and assets can be affected. Below, we explain how bankruptcy works, how it can be used to distinguish tax debts, and what to do with your remaining taxes.
What are bankruptcy and tax debt?
Bankruptcy is a legal process that provides debt relief for individuals and businesses. When an individual or business files for bankruptcy, they are seeking protection from creditors. The bankruptcy court will then discharge (erase) some or all of the debtor’s dues.
Tax debt is what an individual or business owes to the government if they have failed to pay taxes. It can be in the form of income taxes, property taxes, or other types of taxes. If you don’t pay your taxes, the IRS can take action to collect what is owed, including filing a tax lien or levy, which can result in wage garnishment, seizure of assets, or even jail time.
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How do you declare bankruptcy?
There are multiple types of bankruptcy, but two are used more commonly in individual cases: Chapter 7 and Chapter 13.
Chapter 7
Chapter 7 is known as “liquidation” because the court may order some assets to be sold in order to pay creditors. Student loan and tax debt are typically not forgiven in this scenario, but it is more than likely that unsecured debt (credit cards or medical bills) will be erased. Filers can only be approved for this bankruptcy if the court rules that the filers do not make enough to pay back their creditors.
Chapter 13
Chapter 13 is called “reorganization” and is also known as the “wage earner’s plan.” This type of bankruptcy is for those with a regular income who can pay back some, but not all, of what they owe. It allows the filer to keep their property while they repay their debt over a three- to five-year period. Chapter 13 can only be used if there are unsecured debts less than $419K and secured debt less than $1.25M.
To declare bankruptcy, you will need to file a petition with the bankruptcy court in your district. The petition will list all of your capital and you will also need to take a credit counseling course and pass a means test.
Does bankruptcy clear tax debt?
Not all tax debt can be forgiven through bankruptcy, but if certain requirements are met, it is possible to have federal or state income taxes erased. To have it forgiven under a Chapter 7 bankruptcy, one must:
- Not willfully evade paying taxes or file fraudulent returns
- Have tax debt that is three or more years old
- Have filed a tax return in the past two years
- Have tax debt assessed by the IRS 240 days before filing
If you are considering bankruptcy as an option to clear your tax debt, you should speak with a bankruptcy attorney to discuss your options.
How do I clear tax debt?
If the above does not apply to you, you will most likely have to choose the repayment route. You can file a Chapter 13 and pay them off through the reorganization plan and some older debts might be discharged. The only catch of this plan is the court, and occasionally the IRS, can monitor your spending and budget for some time after.
If filing a Chapter 13 bankruptcy is not an option for you, the IRS may be able to make a similar payment plan with you to pay back what you owe, with no court costs.
After filing for bankruptcy
If you do choose to go through with filing for bankruptcy, you’re probably wondering, what’s next? After deciding what type you’re going to file for, there are a few things you’ll have to do. You will work with a trustee on all of the background work, attend a creditor meeting, attend financial management courses, and begin your repayment plan, if applicable.
Once your bankruptcy is settled, meaning your debts are discharged or you pay them in full through your repayment plan, your most important task will be building your credit score back up. You will be free of that debt but your credit history will be damaged, so getting loans and making big purchases will be slightly harder for some time.
How can CreditAssociates help?
While CreditAssociates cannot file bankruptcy for you, we can try to help before you get to that point. Debt relief is our purpose and we can offer counseling as well as advice in budgeting and managing your finances. Head over to our website to get more information or start a conversation.
Common Questions About Bankruptcy
Can IRS debt be forgiven?
Occasionally and under the right circumstances, the IRS will forgive partial debt amounts. You can apply for an Offer in Compromise to have a partial amount forgiven and pay off what you can or you can wage garnish and pay off your debts directly through your paychecks. It’s best to talk to a professional before deciding on any actions.
What if I owe the IRS and can’t pay?
The first thing you should do is try to come up with a plan to repay your debt. You can set up an installment agreement with the IRS which will allow you to make monthly payments until the owed amount is paid off. If this is not an option for you, other ways to repay your debt are answered above. Speak to a professional if you need more in-depth information or help.