Chapter 7 Helps with Income Tax Debt Even Without Writing off Any of It
Oct. 10, 2016
Are your income taxes are too new to be written off with a Chapter 7 bankruptcy? Nevertheless sometimes Chapter 7 is still your best option.
The last blog post was about the conditions an income tax debt must meet to be discharged (legally written-off). What if none of the income taxes you owe, or most of them, can’t be discharged?
A Chapter 7 bankruptcy may still set you up so you can deal with those taxes effectively. You may not need the extra expense and time of a three-to-five-year Chapter 13 case.
Discharge Your Other Debts So You Can PAY Your Taxes
Ask yourself this one crucial question: if you filed a Chapter 7 case and discharged all or most of your non-tax debts, would that leave you with enough monthly cash flow to enable you to reliably make large enough monthly payments to the IRS/state on whatever tax debt(s) the Chapter 7 would not discharge, so that those taxes would be paid off SAFELY and in a REASONABLE TIME?
“Safely” refers to the reality that you would be dealing directly with the tax authorities after the Chapter 7 case. And you (and maybe your lawyer) would be doing so without bankruptcy protection once your Chapter 7 was completed.
That’s not a problem if you arrange to pay a monthly tax installment payment that you can confidently afford. The expectation is that you will be able to once you discharge of your other debts through your Chapter 7 case. But you also have to be able to maintain those tax payments until the tax is paid off.
A Chapter 7 is a good idea if you don’t need a Chapter 13’s continuous protection from creditors throughout the payment process. That protection is especially valuable if your circumstances change in the future. The Chapter 13 procedures are likely more flexible than that of the IRS or the state.
“Reasonable time” refers to the reality of ongoing interest and penalties assessed by the IRS and state agencies. These will almost always continue to accrue throughout the time you are making installment payments. The taxing authorities are sometimes relatively flexible about stretching out the payments (and sometimes they’re not). But you need to look at how much the ongoing interest and penalties will add to the amount you must pay before you’re done.
How to Know Whether You Will Be Able to Pay Non-Discharged Tax Debt
How can you tell in advance that you will be able to afford to pay taxes that you can’t discharge? How can you tell if you’ll be able to do so safely and within a reasonable time?
First, it means calculating how much a Chapter 7 case would help your monthly cash flow and your longer term financial stability by discharging your other debts.
Second, you need to know what the IRS and/or state tax authority will likely accept as monthly payments, given the amount of your remaining tax debt. From there the estimated additional interest and penalties can be roughly calculated.
Your bankruptcy lawyer will help you with these projections and calculations. Then he or she will counsel you with the decision about whether you are a good candidate for cleaning your slate with Chapter 7 and then paying your remaining tax debt directly.
Discharge Your Other Debts So You Can SETTLE Your Taxes
A similar analysis comes into play for using Chapter 7 to position yourself to settle your taxes instead of just paying them through monthly installments. The IRS may allow a taxpayer to settle a tax debt through an Offer in Compromise, and most state agencies have similar procedures.
This choice—between filing a Chapter 7 case and then attempting to settle the remaining taxes vs. just filing a Chapter 13 case to handle the taxes—is likely more difficult to make than the installment payment choice above. That’s because tax settlements 1) take much longer to approve, and 2) are less predictable. The tax authorities tend to have relatively clear monthly payment parameters, but tend to use more discretion with settlement.
Some bankruptcy lawyers regularly handle Offers in Compromise and state tax settlements, others do not. If not, your lawyer will be able to refer you to a lawyer or accountant who does.
Regardless, the same basic analysis applies here as with installment payments. Find out how much a Chapter 7 bankruptcy would help clear away your other debt. Determine how that would position you to make a settlement offer for the remaining taxes. Then assuming some sort of settlement would likely be approved, would it be feasible and reasonable compared to what would happen in a Chapter 13 case?
To oversimplify, file a Chapter 7 case instead of a Chapter 13 if the taxes you’re left with can very likely be handled with a safe and reasonable installment payment plan, or with a settlement. Otherwise file a Chapter 13 case for more protection and flexibility.