Most of us are able to breathe a big sigh of relief following tax season. Taxes are paid, refunds are imminent (for the lucky ones), and all the paperwork is filed and finished. It’s all settled… unless you were unable to pay your taxes and are now facing tax debt.
When tax debts that are owed to the IRS are not resolved in a timely manner, debtors can face serious consequences, including property seizure and even jail time. Have you accumulated tax debt and are looking for a way to discharge it? Read on to learn about tax debt and what your options are when it comes to bankruptcy. Additionally, you will want to contact a phoenix chapter 7 bankruptcy lawyer that is familiar with the bankruptcy laws and can advise you on next steps that are based on your own personal circumstances.
Discharging Tax Debt Through Bankruptcy
Discharging tax debt in bankruptcy is not as easy as you may think. In fact, most tax debts cannot be wiped out through bankruptcy. Tax debt will still need to be paid after you exit Chapter 7 bankruptcy, or will need to be repaid in full through a Chapter 13 bankruptcy repayment plan.
Quick Review of Chapter 7 and Chapter 13 Bankruptcy
Chapter 7 (also known an straight bankruptcy) is the most common form of bankruptcy and is available to consumers and businesses.
Under Chapter 7, assets are sold off so that the proceeds can go to paying debt. All proceeds from the sales of those assets are handed over to a trustee, who then pays down any and all creditors. After all creditors have been paid off they are no longer able to collect funds directly from you and your debts are cancelled, meaning you are no longer responsible for them.
You are not able to discharge the following debts under Chapter 7:
- Alimony and child support
- Drunk driving judgments, criminal fines, restitution
- Debts incurred as the result of fraud or intentional wrongdoing
- Back taxes under 3 years old
- Student loans
- Recent purchases made for substantial amounts
- Contracts involving titles or liens such as land or automobiles
Chapter 13 reorganizes debt so that you are able to pay back debts over the next three to five years. This pay-back plan is called a debt repayment schedule. Based on your income, and how much you owe, you’ll repay 10-100% of the debt you owe.
You are not able to discharge the following debts under Chapter 13:
- Alimony and child support
- Drunk driving judgments
- Criminal fines
- Student loans
Tax debt is hard to discharge, but it can be done. Remember, that Chapter 7 might be your best option if you are looking to discharge tax debt.
Able to Discharge a Tax Debt
A debtor might be able to discharge tax debts in Chapter 7 bankruptcy only if all of the following conditions are true:
- The tax debt is for income taxes. Taxes other than income can never be eliminated in bankruptcy.
- The debtor did not commit fraud or willful evasion.
- The debt is at least three years old. The tax return must have been originally due at least three years before the debtor filed for bankruptcy.
- The debtor filed a tax return. A debtor must have filed a tax return for the debt he or she wishes to discharge at least two years before filing for bankruptcy.
- The debtor pass the “240-day rule." The rule says that the income tax debt must have been assessed by the IRS at least 240 days before the debtor filed for bankruptcy petition, or must not have been assessed yet.
Federal Tax Liens
While a debtor may be able to discharge tax debt in a Chapter 7 bankruptcy, this discharge will not wipe out prior recorded tax liens. A tax lien is often imposed on a property as a means of securing the payment of back owed taxes. If the IRS recorded a tax lien on a debtor’s property before he or she filed for bankruptcy, the lien will remain on the property. The tax lien will need to be paid in order to sell the property.
When to Declare Bankruptcy
While bankruptcy might not help you discharge tax debt, it might help in clearing other debt so that you are freed up to pay back owed tax debt. But are you ready?
There are some options that you might want to consider, if you haven’t already yet, and a few questions to ask yourself.
Number one, are you able to reduce your debt or work out a favorable payment plan with your creditors? Many times creditors will work with people that are delinquent on their payments to help negotiate terms so that a debtor can pay their debt. Before you throw bankruptcy into the mix as a potential option, explore alternatives such as credit or financial counseling, negotiating with creditors, credit card consolidation, loan modification, and loan refinancing.
The following indicate a good time for when to seriously consider declaring bankruptcy:
- You’ve been out of work for an extended period of time and you have no unemployment income or savings
- You are delinquent on your taxes
- Your home is nearing foreclosure
- Your wages are being garnished
- You are facing lawsuits for delinquent bills
The decision to declare bankruptcy is different for everyone. There are also a number of pros and cons you should know about and weigh before you decide. Speaking with a professional about your particular situation can help you evaluate your options.
Pros and Cons of Filing Bankruptcy
As with any major decision in your life, there are pros and cons of filing bankruptcy. Below we discuss the advantages and disadvantages of filing for bankruptcy. As always, it’s advised you work with a phoenix chapter 7 bankruptcy lawyer that can help advise you.
One immediate advantage that helps debtors when they file for bankruptcy is the “automatic stay.” This motion alerts creditors that they must stop their efforts to collect money from debtors. This stay is what stops creditors from calling you! Under an automatic stay, creditors are not allowed to call, send collection letters, file lawsuits, garnish wages, or seize assets, except for in specific situations such as the collection of alimony and child support payments.
The biggest “pro” of filing bankruptcy is that a court discharges your debts. That means that certain debts will not need to be repaid. This of course is dependent on the form of bankruptcy you file: either chapter 7 or chapter 13.
One “con” of bankruptcy is that while it will discharge most debt, it does not discharge certain debt, such as mortgages, student loans, taxes, alimony, or child support. While student loan debt has been forgiven in extreme cases, for the most part, it is never discharged in bankruptcy. Additionally, a debtor can lose certain nonexempt property in a bankruptcy filing because a court orders it to be sold.
Bankruptcy will also have an affect on your credit score. While your credit might already be low because of delinquent payments, once a bankruptcy is filed, it’s required by the national credit reporting agencies that it appears on your credit report. A chapter 7 bankruptcy will stay on your credit report for 10 years and a chapter 13 will stay for 7 years.
The impact on your credit can hurt your future ability to qualify for a future loan or credit card. It might also affect your ability to be hired or secure living arrangements. Some employers and future landlords evaluate a persons credit score to determine if they are good candidates.
Working with a Bankruptcy Attorney
Bankruptcy can be an overwhelming process. That’s why we advise that you work with a phoenix chapter 7 bankruptcy lawyer that is familiar with various debt repayment options. Chapter 7 bankruptcy might be the best option if you are looking to discharge tax debt and you also meet the qualifications listed above. If you do not meet the requirements, Chapter 7 or Chapter 13 might still be a good option for you to wipe out other debt so you are able to pay off the tax debt. It will all depend on the specifics of your situation and a phoenix chapter 7 bankruptcy lawyer can help walk you through what options are available for your specific situation. We are committed to helping our clients understand their rights and options under the bankruptcy law and developing the debt relief solution that makes the most sense for each individual. We invite you to call (602) 648-3274 or contact our Arizona office to schedule a free initial consultation.
668 N. 44th St., Ste 320, Phoenix, AZ 85008