If you owe more than 1 year of income taxes, some may be dischargeable and some may not. What happens if you owe both kinds?
If you owe more than a single tax year of income taxes, the first thing that you and your attorney will determine is whether any or all of those taxes can be “discharged.” That means permanently, legally, written off.
If all of your taxes can’t be discharged, usually because they are too new to meet the required conditions, then look at our last blog post a couple days ago about what to do in that situation.
If all of your taxes can be discharged, usually because they are old enough to meet those conditions, then look at our blog post a couple days earlier about that.
But if you owe some taxes that are older and some that are newer, some that can be discharged and some that can’t, read on.
The Tax Discharge Conditions
What do we mean by “older” and “newer”? What ARE the conditions that an income tax debt needs to meet to be able to simply discharge that tax in bankruptcy?
In the vast majority of the time there are just two relatively straightforward time-based conditions to meet. Occasionally, in more complicated tax situations other conditions come into play. For example, if you’ve already made an offer to the IRS or state to compromise, or settle, the tax debt, or if the tax is involved in a formal dispute, involving tax court or an administrative appeal, then other timing rules can come into play. But these are quite rare, so we aren’t going to get into those.
The two usual conditions for discharging a tax debt that do apply to most situations are:
more than 3 years must have passed between the due date for the tax return of the tax debt in question and the filing date of the bankruptcy case; and
more than 2 years must have passed between the date that pertinent tax return was actually submitted to the IRS/state and the filing date of the bankruptcy case.
Let’s say you owe the IRS $5,000 for the 2011 tax year and $4,000 for the 2012 tax year, and you either electronically filed or mailed in both tax returns on April 15, 2013.
As of now, November of 2015 (or later), as to the $5,000 due for the 2011 tax year you’ve met the 3-years-since-due condition because its tax return was due in April 2012 (or October 2012 if an extension was requested), which is MORE than 3 years ago. For that 2011 tax you’ve also met the 2-years-since-filed condition because the tax return was delivered April 2013, which is MORE than 2 years ago. So that $5,000 tax debt can be discharged under either Chapter 7 or 13.
As to the $4,000 due for the 2012 tax year, you haven’t met the 3-years-since-due condition because its tax return was due in April 2013 (or October 2013 if an extension was requested), which is LESS than 3 years ago. You HAVE met the 2-years-since-filed condition because the tax return was delivered April 2013, which is MORE than 2 years ago. But BOTH conditions must be met before a tax can be discharged. So the 2013 $4,000 tax debt cannot be discharged under either Chapter 7 or 13.
Mixed Income Taxes under Chapter 7
If you owe both income taxes that would be discharged and some that would not, Chapter 7 “straight bankruptcy” may effectively solve your problem better than a Chapter 13 “adjustment of debts.”
If, after discharging all the debts that Chapter 7 would discharge (including tax debt) you could afford to pay off the tax debt that would not be discharged, then Chapter 7 would make sense. By “afford to pay off” we don’t mean in a lump sum payment but rather within the (likely monthly) payment terms that the IRS and/or the state would allow.
In the above $5,000/$4,000 tax debt example, a Chapter 7 case would result in the discharge of the 2011 IRS debt of $5,000, and do so within a matter of about 4 months. But it would leave the 2012 tax of $4,000 still owing. If the Chapter 7 case discharges enough other debts so that you could afford to consistently pay a relatively modest monthly payment directly to the IRS, that would likely be the way to go (assuming there weren’t other unrelated reasons to do a Chapter 13 case).
When Chapter 7 Doesn’t Work
Sometimes a Chapter 7 case does not gain you that much cash flow, particularly if you have other debts that you either can’t or don’t want to discharge and therefore must pay. You may owe back child support which you want to catch up on quickly. You may have a vehicle loan that you must pay to keep the vehicle or a home mortgage arrearage that you must catch up on to avoid a foreclosure. With the pressure of these other obligations continuing after the Chapter 7 was completed you may well not have enough income to make any consistent payment arrangements with the IRS or state.
Even without the pressure of other special continuing debts, you may simply owe too much tax to be able to afford to pay what the IRS and/or the state requires. Or you may not qualify for a payment plan because you owe too much taxes or some other reason.
Mixed Income Taxes under Chapter 13
In these situations a Chapter 13 case may well be better for you than a Chapter 7 one.
In a Chapter 13 payment plan all your creditors are dealt with in one package. This plan is proposed by you and your attorney, and after a limited opportunity for creditors to object, the plan is approved by the bankruptcy judge. Then all your creditors, including the IRS and state, have to comply with it. If you have other important debts that have to or you want to pay, and doing so fits within the rules, then the IRS and state have to wait their turn in line. And they can’t take any collection action whatsoever on the taxes owed throughout the life of the plan as long as you follow the rules as well.
The taxes that can’t be discharged must be paid within the 3-to-5-year plan, but usually without any additionally accruing interest and penalties. The taxes that can be discharged are treated like your other “general unsecured” debts, and are paid only if and to the extent that you have extra money after paying more important debts. The dischargeable taxes usually do not increase what you have to pay.
At the end of the Chapter 13 case you will have paid all the taxes (and any other debts) that you had to pay because they couldn’t be discharged. Your dischargeable taxes and all other dischargeable debts are forever written off. So you are tax debt free and (except perhaps for a mortgage) are debt free altogether.