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Bankruptcy and Past Due Taxes


The IRS audit rate has declined significantly in recent years. But do not let that fact lull you into a false sense of security. The IRS is still the world’s largest collection agency, and it has legal tools which other debt-buyers dream about. So, if you owe back taxes, the government will come after you and it will collect that money. It just might take longer.

Also in recent years, the IRS has introduced some new repayment programs and introduced some new ones. However, most people do not qualify for programs like the offer-in-compromise, even under the expanded guidelines. And, payment plans extend time to pay, but in the meantime, penalties and interest keep piling up.

Bankruptcy is different. Almost everyone qualifies for these government-sponsored debt relief programs. And, bankruptcy does not just give people more time to pay while the IRS keeps charging interest. In many cases, bankruptcy either discharges tax debt or at least suspends penalty and interest accumulation.

Discharging Tax Debt in a Chapter 7

Income tax debt is unsecured debt. So, like most other kinds of unsecured debt, like credit cards and medical bills, it is dischargeable in bankruptcy.

Generally, government-affiliated debt works differently than private debt. FSOs (family support obligations), like alimony and child support, are usually not dischargeable, even though they are unsecured debts. And, student loan debt is only dischargeable in certain circumstances.

There are also very strict rules for tax debt discharge. However, the rules are very objective. To determine if the debt is dischargeable, an attorney basically only needs a calendar. The rules are:

  • Three Years: The tax debt must be at least three years old. Bear in mind that Tax Day is not always April 15. And, the IRS has disputed discharge because the debt was a few days’ shy of three years old.
  • Two Years: Furthermore, the tax returns must have been on file for at least two years. Substitute returns don’t count. The returns must be taxpayer-filed returns.
  • 240 Days: If the IRS has assessed the debt within the last eight months, the debt is not dischargeable. “Assessment” is an internal accounting procedure. Generally, if the taxpayer has not received a letter in the last eight months which includes the total amount due, the debt has probably not been assessed.
  • No Fraud: According to the Supreme Court, bankruptcy is designed to give an honest yet unfortunate debtor a fresh start. If the debtor was dishonest, this principle does not apply. Typically, the fraud must be blatant, like using a fake Social Security number or omitting an income source.

Bankruptcy eliminates the legal obligation to repay the debt, but it does not address the collateral consequences of debt. So, if the IRS filed a tax lien, that lien must be addressed in a separate proceeding, even if the bankruptcy judge discharges the underlying debt.

Retiring Tax Debt in a Chapter 13

Some people do not qualify for tax debt discharge. Other people do not qualify for a favorable IRS tax repayment program. Chapter 13 debt repayment is usually a good option in these situations.

In most cases, bankruptcy’s Automatic Stay does more than stop IRS wage garnishment and other harsh collection efforts. Section 362 of the Bankruptcy Code might also suspend penalties and interest during the protected repayment period. That grace period could save the debtor thousands of dollars.

Chapter 13’s protected repayment period lasts up to five years. As long as the debtor pays off the tax debt within that period, the IRS must normally accept the repayment plan. In other words, the tables are turned. Outside bankruptcy, the IRS calls the shots. But Chapter 13 bankruptcy gives families control over their finances.

Contact Tenacious Lawyers

Bankruptcy usually eliminates tax debt or at least makes it easier to retire. For a free consultation with an experienced Chicago debt lawyer, contact the Bentz Holguin Law Firm, LLC. We routinely handle matters in Illinois and Indiana.



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