Bankruptcy and IRS Tax Obligations
The Internal Revenue Service (IRS) is the most brutal of all collection agencies with powerful tools and the ability to impose staggering financial penalties unavailable to other creditors. Many parties facing tax deficiencies along with penalties and interest attempt to negotiate an offer in compromise or other resolution of their outstanding tax obligation with no success. These strategies often fail with the debtor exposed to wage garnishments, bank levies, liens on real property and other harsh collection tactics by the federal taxing agency.
A fair number of people who are unable to pay their federal income tax and cannot resolve the matter presume they are out of options because unpaid federal income taxes cannot be discharged in bankruptcy. Despite this common assumption, federal income arrearages can be discharged along with the accompanying penalties and interest rates under certain circumstances. While the decision to pursue a Chapter 7 or Chapter 13 when dealing with outstanding income tax obligations will depend on the unique circumstances of a debtor’s situation, we have provided an overview of how the bankruptcy process can alleviate pressure from the IRS.
Requirements to Discharge Federal Income Taxes
While federal income taxes can be discharged, the following criteria must be met to qualify for such a bankruptcy discharge:
- The unpaid taxes must be liabilities based on a tax return that was filed a minimum of two year prior to filing the bankruptcy.
- The debtor must have filed a bona fide tax return (i.e. not fraudulent) for the tax year in question.
- The IRS cannot have assessed the liability within 240 days of the date that the bankruptcy has been filed. (The waiting period may be extended to the degree that the IRS has suspended collection efforts while negotiating an Offer in Compromise or a prior bankruptcy filing).
- The tax return covering the unpaid taxes must have been due a minimum of three year prior to the bankruptcy filing.
Although a debtor’s entire income tax obligation can be discharged in a Chapter 7 bankruptcy if these requirements are satisfied, the discharge may provide only limited relief. The discharge will not remove a tax lien that the IRS has already obtained on your family home or other real estate. This means that the bankruptcy discharge will extinguish personal liability so that the IRS cannot use a wage attachment or levy against the funds in your bank account to obtain payment of the taxes, penalties, assessments and interest owed to the IRS. However, the lien on your real property will mean that the IRS obligation must be satisfied if you sell the property before you receive any remaining proceeds or use proceeds to purchase a new property.
Options When Discharge Criteria Not Met
While debtors may prefer to have their tax obligation extinguished by a bankruptcy discharge, there are still benefits that may be obtained from filing bankruptcy even if the taxpayer cannot satisfy the criteria for a discharge. The oppressive enforcement tools available to the IRS can make it necessary to obtain some form of relief so that you can provide for the basic financial needs of your family. A Chapter 13 bankruptcy may allow you to repay your federal tax arrearages over a three or five year payment period. While you will not be able to obtain a discharge of the tax obligation, the Chapter 13 can help ease the financial strain of dealing with the IRS in the following ways:
- Arrearages paid over 36 or 60 months giving you more time to pay
- IRS collection tools like wage garnishments and bank levies abated during plan
- Protection from other creditors while stretching out those payments over the term of the plan
- Potential discharge of some unsecured obligations at the end of the repayment plan
While the precise benefits that a person with outstanding obligations owed to the IRS will experience depends on the taxpayers unique circumstances, bankruptcy may protect debtors from harsh collection strategies and even eliminate one’s income tax deficiency. A Florida bankruptcy law firm can provide legal advice regarding your unique situation.