There is no doubt that people dread paying income taxes, but they also understand that financial contributions are necessary to support public safety, order, and basic institutions and infrastructures. However, difficult times and unfortunate events can make it challenging to pay in full, on time as the Internal Revenue Service (IRS) expects. Even when you know that the penalties can be severe and interest adds up, you might avoid paying due to financial dire straits.
Carrying around tax debt is stressful, especially since the government is not typically a generous, favorable creditor. Plus, if you did not pay income taxes because of economic difficulties, you might also be having trouble paying other bills and debts. Any amounts you could apply will probably go toward interest and fees, so it is frustrating that your balance never goes down. Under the circumstances, you might be considering bankruptcy as a way to get out from under the burden of debt.
Many people assume that tax debts can never be eliminated through bankruptcy, but this is a misconception. It is possible, yet very challenging to clear back due taxes. You improve your opportunity for favorable treatment when you work with an Arizona bankruptcy attorney who will develop a strategy for dealing with taxes. Plus, you can read on for general information on whether bankruptcy will wipe out tax debts.
Overview of US Bankruptcy Laws
It is important to get a grasp of how bankruptcy laws work to better understand how they apply to tax debts. For individual filers, there are two common types under the US Bankruptcy Code:
- Chapter 7: With this process, you will discharge qualifying debt and be debt-free at the conclusion of the case. Chapter 7 is also referred to as liquidation bankruptcy because the bankruptcy trustee could sell your assets to pay creditors. Items designated as exempt by law cannot be liquidated. This type of bankruptcy is available to those who fall under an income threshold, and expenses may be subtracted from this amount.
- Chapter 13: Some people will not qualify for Chapter 7 because of income, and others may not want to subject assets to liquidation. Chapter 13 is open to more individuals, and your assets will not be sold to satisfy creditors. The process is a debt repayment plan, in which your debts are reorganized and possibly reduced. You pay creditors back the lower amount over a 3 to 5-year period. Bankruptcy laws create priorities for certain types of debt.
Discharge Tax Debts Under Chapter 7
If you qualify, Chapter 7 is an effective way to eliminate your tax debts. In addition to the criteria above, you must also be eligible because of the nature of your tax debts. The requirements are:
- Your tax debts must be related to income taxes, as opposed to payroll, employment, or others. Keep in mind that income taxes are not just from wages and earning interest also counts. Your back taxes must also be actual taxes. You cannot discharge the penalties the IRS assesses for fraud, even though they officially represent an amount due to the government.
- There must not be any fraud connected to your income tax filings, such as evading income taxes or providing a false Social Security number.
- Tax debts must be at least 3 years old to qualify for discharge under Chapter 7. The date is measured by when they originally became due.
- Within the last 2 years before filing for bankruptcy, you filed a return for the income tax associated with the debt.
- You are eligible under the IRS 240-day rule, which requires that the IRS assessed the tax debt within this timeframe.
Chapter 13 and Paying Taxes
The point of Chapter 13 is debt reorganization and repayment instead of discharge. However, you can manage tax debt through the process in a way that could deliver advantages. The reason is that Chapter 13 uses your income to determine how much you will pay, and some creditors will simply not get paid because of priorities. Dischargeable tax debts older than 3 years might be forgiven in the debt repayment plan.
The IRS must obey the plan approved by the Chapter 13 bankruptcy trustee, so collection efforts will stop. You also will not accrue interest on back taxes. However, while you might be able to discharge tax debts more than 3 years old, keep in mind your current tax matters. You must file income tax returns when due, and it is necessary to either pay taxes or get an extension. Still, you could be all caught up with the IRS when the case concludes, as long as you:
- Stay current with your Chapter 13 plan to repay back taxes;
- Remain in compliance regarding taxes less than 3 years old; and,
- Continue to manage taxes that accrue during the 3 to 5 year time period.
Bankruptcy Impact on Tax Liens in Arizona
An important note relates to the distinction between tax debts and tax liens. When a taxpayer accumulates back taxes, the IRS will eventually move forward to place an encumbrance on the person’s assets. This burden is a tax lien, and it can only be removed if you satisfy your back tax liability. If you can work out a settlement agreement regarding the tax debt, the IRS may also consent to remove the tax lien.
However, a tax lien cannot be discharged via Chapter 7 bankruptcy. The most you can do through the process is eliminate your personal obligation to pay the tax, but the lien will remain intact on the subject property. Your situation is different if you file Chapter 13 debt repayment since a tax lien can be part of your repayment plan.
Working out a tax lien via Chapter 13 makes sense to protect the property that is attached. If you do nothing, the IRS may eventually seize your assets and sell them to satisfy the lien.
Effects on Nondischargeable Tax Debt
Even when your taxes do not qualify to be wiped out, there are still advantages to bankruptcy when you are carrying tax debt. With Chapter 7, you discharge other debts, such as high-interest credit cards, medical bills, and others. You have more free income to pay your tax debt down or approach the IRS for a settlement.
If you cannot discharge back taxes through Chapter 13, you are still lowering monthly payments on other debts. You benefit in the same way because you could pay down a tax debt by consent agreement. In addition, there is a benefit that is not available through Chapter 7 bankruptcy. When you use a credit card to pay nondischargeable tax debt, that obligation could be discharged after working through debt repayment.
Benefits of Bankruptcy for Tax Debts in Arizona
Getting your tax debts wiped out through bankruptcy is clearly the best possible outcome, but you, your tax debts, or both, may not qualify for a full discharge. While this aspect might seem disappointing, there are still benefits to filing Chapter 7 or Chapter 13. They may affect you directly or indirectly, and the advantages are even better when you do get your tax debts discharged. Consider a few important points:
- When you file for bankruptcy, your creditors must cease all collection efforts because of the automatic stay under the US Bankruptcy Code. This includes creditors you owe for a mortgage, car loan, credit card, or line of credit, but it also includes the IRS.
- Qualifying debts are eliminated with Chapter 7 bankruptcy, leaving you debt-free when the case is over.
- You can pay down your debts at a pace you can afford with Chapter 13. Some, including tax debts, might be discharged entirely.
- While you cannot discharge a tax lien through Chapter 7 bankruptcy, you could pay it off through your debt repayment plan in a Chapter 13 case.
- With both Chapter 7 and Chapter 13, you are required to participate in credit counseling. These educational sessions provide you with useful information and effective tools to prevent problems with debt in the future.
- It may take some time after your case concludes, but you will eventually get better interest rates because your credit record is clear.
How an Arizona Bankruptcy Attorney Can Help
Any bankruptcy case presents challenges, and tax debts are one of many factors that could complicate your case. You are not required by law to retain legal counsel, but you gain an advantage when you have help. It is possible to leverage back taxes in a productive way with the right strategy. Your lawyer will always seek the best possible outcome by tax debt discharge or other options to minimize your liability. Depending on your case, you may require assistance with:
- Researching eligibility to wipe out tax debts;
- Gathering all tax records and related documentation for proving income tax liability;
- Reviewing your financial details to determine whether Chapter 7 bankruptcy discharge or Chapter 13 bankruptcy repayment is suitable;
- Preparing all forms to file bankruptcy, including documents to support a tax debt discharge; and,
- Assisting with court appearances and other tasks as necessary to protect your rights.
Reach Out to an Arizona Bankruptcy Lawyer to Learn More
Tax debts are an added layer of complexity when filing for Chapter 7 or Chapter 13 bankruptcy, but you still have the right to try and have them legally wiped out. For more information on the process, please contact DebtBusters to set up a consultation with a member of our team. You can reach our Scottsdale, AZ offices by calling (866) 223-4395 or going online.
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