How to Handle Tax Debt

TAXES, TAXES, TAXES!!  Few words in the English language provoke more fear and loathing.  As Benjamin Franklin said in 1789:  “‘In this world nothing can be said to be certain, except death and taxes.”  What was so certainly true back 228 years ago in Mr. Franklin’s time remains no less true today.  So, what do you do if you’re caught up in a spiderweb of tax debt?  Well, you have a few different options…

First off, of course, is that you can just pay the taxes.  Believe or not, the IRS is actually pretty reasonable to deal with in setting up a payment plan.  Oftentimes, they’ll agree to waive late fees and will set a very low interest rate (think 3% per year) if you agree to a payment plan AND stick to it.  If you are a habitual ower of tax debt, though, the IRS might not be so nice.  You could try an Offer in Compromise on your taxes.  This is typically done when you have a lot of tax debt.  The IRS charges a $186 filing fee for you to file an offer.  There are a lot of forms to complete as well – you’d probably want to hire an accountant or a tax lawyer to complete and file the Offer in Compromise.  But, if you’ve had a significant reduction in your income, making it impossible to pay the tax debt, then an Offer in Compromise might be a good option to further research.

Another option is to file bankruptcy to deal with tax debt.  Consumers file 2 types of bankruptcies – Chapter 7 and Chapter 13.  They deal with taxes basically the same with one important difference.  Both types of bankruptcy will “discharge” or wipe out old income tax debt – generally taxes owed on returns filed more than 3 years ago.  But be warned – there are A LOT of exceptions to that general “3 year old and older” rule.  Those taxes that cannot be discharged due to one of those exceptions and for newer taxes, then Chapter 7 won’t do anything for them.  After your Chapter 7 case is finished, you then must work out a payment plan with the IRS to deal with the tax debt that survives a Chapter 7 case.  However, if much of your tax debt is older, it makes a lot of sense to go ahead and file a Chapter 7 case to discharge as much of it as possible – then set up a payment plan with the IRS to take care of the surviving tax debt.  A recent Chapter 7 case may very well make it easier to deal with the IRS in setting up a payment plan because they know you truly are facing some tough financial issues rather than just “faking” it.

Chapter 13 bankruptcy basically does the same thing as a Chapter 7 case, plus it allows you to pay off that surviving tax debt through making payments to the Court’s trustee, who then pays the IRS.  The advantages to this payment arrangement is that it is documented through the Court trustee, there are no additional penalties or interest accruing, you don’t have to deal with the IRS as your lawyer takes care of that, you can stretch the payments over a long time period – up to 5 years, plus you can discharge other debts such as credit cards and medical bills at the same time.  And, this is all done at a relatively low cost.  Chapter 13 even allows you to pay your bankruptcy attorney’s fees through the trustee over that same 5 years.  Consequently, Chapter 13 bankruptcy is a very, very popular option for dealing with tax debt, and we have many clients who have filed for just tax reasons.  Throw in the additional advantage of getting rid of other debts and Chapter 13 is a great way to get yourself back on solid financial footing.