Dealing with a large IRS debt is difficult. The IRS doesn’t want to “settle” with most people because they don’t qualify under the IRS’ standards. The vast majority of people with tax debt end up in some form of IRS payment plan end up in a payment plan as a second choice. That payment plan is often difficult as well, as the IRS isn’t taking into account all of the budget items in determining how much a person can really afford. In certain circumstances, Chapter 13 Bankruptcy can be a good alternative to an IRS payment plan for a whole host of reasons.
The following is a list of the most common reasons we encounter.
Tax debt can be discharged in a Chapter 13 bankruptcy
Certain tax debts are dischargeable in bankruptcy….even a chapter 13 bankruptcy. So depending on your income and budget situation you may be able to get rid of your tax debt.
Tax penalties are dischargeable in a Chapter 13 Bankruptcy, even if the tax debt is new
Tax debt can be treated as dischargeable in chapter 7 or chapter 13 bankruptcy. This means that if the tax debt is not a trust fund tax like an employment tax or collected sales tax, and it meets certain date requirements, it’s possible to eliminate your entire obligation to the IRS and other taxing agencies. This is true both in a chapter 7 bankruptcy and in a chapter 13 bankruptcy.
But what if the tax debt is an income tax but doesn’t meet certain date requirements? In a chapter 7 bankruptcy, the penalty applied by the IRS to the tax for failure to file the return on time or failure to pay the tax debt on time would survive the bankruptcy. In chapter 13, these penalties are always treated as dischargeable and are paid the same amount that other creditors like credit cards and medical bills might get in the chapter 13 case…which may be a very small amount.
The IRS is forced to play by the U.S. Bankruptcy rules and not by own rules
The IRS has it’s own set of rules when it is dealing with you in relation to the tax debt you owe. These rules make it difficult to settle tax debt and eliminate penalties. Also, the rules provide a lot of leeway to the IRS in making decisions about settlement, collection, and payment plan amounts.
When you file a bankruptcy, the IRS has to follow the Bankruptcy Code not it’s own rules.
In a Chapter 13 case, the repayment terms can be very favorable to you and not the IRS under certain circumstances. The tax debt may be dischargeable debt and your plan may require that the IRS only be paid a fraction of the debt it is owed. Even if the debt isn’t dischargeable and is a “priority” debt that must be paid through the plan in full, interest stops and penalties are treated like unsecured, dischargeable debt making it much easier to pay the debt off.
IRS collection must stop once a chapter 13 bankruptcy is filed
The IRS is in the collection business and it issues levies and liens by the hundreds every day. Many of our clients are being levied or are about to have a Notice of Federal Tax Lien filed when they first visit. The Bankruptcy Code contains a provision that stops all IRS collection on the date the Chapter 13 Bankruptcy case is filed. The case is removed from IRS collection and into the hands of the Federal Bankruptcy Judge. If the IRS continues to collect after the bankruptcy is filed and it’s notified of it, the Judge can sanction the IRS.
The amount you pay the IRS (and sometimes all your creditors) in a chapter 13 plan is often less than the amount of your IRS payment alone
If you have a large IRS debt, aren’t a good candidate for an IRS offer in compromise…(most people aren’t) and have a long time period remaining until the IRS Collection Statute Expiration Date arrives, you may be left with just two options. An IRS payment plan or bankruptcy. The payment plan can be difficult to manage because the IRS can use a budget that is stricter than your actual living expenses in calculating how much you can afford to pay toward the debt. As a result, many people who are in large or full pay payment plans struggle to meet their living expenses.
A Chapter 13 budget can be a friendlier budget than the IRS budget…and because certain tax debts, penalties, and other debts can be treated as dischargeable in Chapter 13, the overall monthly outlay to creditors inside the plan is often much less than you are paying to all your creditors outside the plan.
A chapter 13 deals with all the debts at one time
Most people with tax debt also have other debt issues. A car may be upside down, credit card collectors may be calling, or they may be behind on the mortgage. Chapter 13 is a way to deal with all these debt problems and others with one plan.
A chapter 13 bankruptcy allows you to maintain control of your stuff
Your business, your paycheck, your retirement, your savings…all things the IRS is interested in seizing when you don’t pay your tax debt. A chapter 13 bankruptcy, when set up correctly, protects your assets. It’s not a liquidation case so the trustee isn’t trying to take and sell non-exempt assets like in a chapter 7 case.
Tax liens higher than asset value can be crammed down
At the end of the plan, liens related to dischargeable tax debts that haven’t been paid in full during the plan are eliminated.
The chapter 13 bankruptcy can fall off your credit report more quickly than a tax lien and a chapter 7 bankruptcy
A chapter 13 bankruptcy may be removed from your credit report 2 years after the case discharges. Plan length is typically 5 years. In chapter 7, it’s ten years. A tax lien stays on the report until the lien is released. If you’re in a partial payment plan with the IRS, or the debt is over $25,000.00 and the lien has already been recorded, the lien won’t be released until the debt is paid in full, settled in an offer in compromise, discharged in a Chapter 7 bankruptcy (and liened assets are turned over), or the 10 year statute runs out on collection. (CSED – Learn more about it here)