There are four types of debt for which the federal government will withhold your tax refund or send it to one of your creditors. These debts include past-due federal taxes, state income taxes, child support payments and amounts you owe to other federal or state agencies, such as federal student loans or medical debt for state hospitals that you haven’t paid. If you have these types of unpaid debts the U.S. Treasury can hold back all or part of your income tax refund to help pay the amount that you owe. The practice is known as an offset, and it certainly leads to upset, so try not to let it happen to you.
Yes, the “automatic stay,” the federal law that stops all creditors from chasing you the moment your case is filed, applies to the IRS and the state for most purposes just like any other creditor. There are some minor reasonable exceptions—the tax authorities can continue to require you to file a tax return, can “assess” the taxes and tell you how much you owe, and can do an audit to help determine the amount of tax you owe.But otherwise, from when your case is filed to its completion you do not have to worry about tax garnishment, levies on your possessions, tax lien recordings, or phone calls or visits from the IRS or the state.
If you file during tax season, we will generally be able to protect the tax refund through your available exemptions. However, if you have high valued assets that don’t leave extra exemptions available, there are a couple of strategies to take. First, you could file for bankruptcy after receiving and spending your tax refund. If you choose to do this, be sure to use your refund on necessities (living expenses such as your mortgage, medical expenses, clothing, or food) and not to purchase new assets. Second, you could use your income tax refund to pay your attorney for the fees and costs of your case.
Both Chapter 7 and Chapter 13 can “discharge”—legally and permanently write off—certain personal income taxes, ones that meet certain conditions. The main conditions relate to how long ago the tax return for the tax was due to be filed with the IRS or state tax authority, and how long ago that tax return was actually filed.So if you owe income taxes, and all the taxes you owe are old enough and meet all the conditions, you can discharge and walk away from your entire tax debt. Or if you owe for more than one tax year and some of your taxes meet the conditions and others do not, you can discharge some but will owe the rest. Or if none of your taxes meet the necessary conditions, you cannot discharge any of your taxes. But even then, either Chapter 7 or Chapter 13 would likely give you crucial advantages worth looking into.
If you owe income taxes and the IRS is chasing you, a Chapter 7 will definitely do one thing: it will immediately stop the IRS in its tracks. An ongoing garnishment of wages or seizure of assets will be stopped. A threatened tax lien recording against your home will be stopped. The threatening letters and phone calls will stop. But for tax debt, this may only be short-lived. You will still have to pay back the IRS debt, but filing for a Chapter 7 would buy you some time and would get rid of most of your other debts.
Sometimes filing Chapter 7 does make sense even if it leaves you with taxes owing. Although Chapter 13 gives you major advantages with such tax debts, under the right circumstances the simpler Chapter 7 is better.First, if the remaining tax debt is not huge, and you are discharging a lot of other debts, you may well be able to enter into monthly payment arrangements with the IRS and/or the state to pay off the taxes with reasonable payments over a reasonable period of time. Second, even if the remaining tax debt IS huge, your overall financial circumstances may be appropriate to settle the tax with an “offer in compromise” to the IRS and/or a similar settlement with the state.
Chapter 13 can give you much more flexibility on the timing and amount of the payments made on the taxes that can’t be discharged. It also provides full protection from all of your creditors for the entire duration of your case. Additionally, if your circumstances change and you need to make changes to your payment plan, you are not at the mercy of the tax authorities.Another key benefit to filing Chapter 13 is that you will not need to pay any interest and penalties on those taxes from the time your Chapter 13 case is filed to its successful completion three to five years later. You often pay less on the tax penalties that accrued up to the date of filing the case. The recording of a tax lien against your home and other possessions are prevented during that period. And if a tax lien had been recorded before your Chapter 13 was filed, usually the lien can be satisfied and released after the taxes have been paid.
One of the biggest benefits to filing bankruptcy as opposed to using your IRS payment plan is that all or part of the interest and penalties may be eliminated from your payment plan. You may also be able to eliminate certain years that you are paying for based on how long those debts have been outstanding.Second, unless your current monthly tax payments are part of a carefully thought out, long-term financial plan, one that includes your current year’s and future tax obligations, you could easily keep getting further behind when the next tax year rolls around. When you get behind on even more years, those interest and penalties will keep increasing and your monthly installment payment could go up. If the interest and penalties on the taxes keep accruing, the financial pressure from your non-tax debts keep may also increase, bringing you to a point that is no longer sustainable.
Generally it’s better to file your tax returns sooner rather than later because the clock starts running to discharge (legally write off) an income tax only when the return for that tax is filed. But if you currently have one or more years of unfiled tax returns, and know that you owe taxes on the unfiled year(s) (and maybe for an earlier year or two), you should see an experienced attorney as soon as possible.