When a person is weighed down by debt, they believe they cannot pay; they often turn to bankruptcy as an option to get them out of debt. Most people, when filing for bankruptcy, do it either under Chapter 7 or Chapter 13. Through these options, some debts cannot be discharged, but options on how to pay for them may be availed. Government taxes are some of those debts that cannot be dismissed under bankruptcy. However, filing for bankruptcy will still help with your taxes by offering IRS payment plans or getting an offer in compromise. These, among others, are options that can help you find some relief with your IRS tax debt. If you are thinking of filing for bankruptcy, it is essential to talk to a bankruptcy attorney who will assist you to understand the various requirements and obligations for when you file. San Diego Bankruptcy Attorney is a well-experienced law firm to help you through the process and advise on your tax obligations when you are bankrupt.
When Declared Bankrupt, Can IRS Collect Tax Debts?
If you have old income tax debts that you are unable to pay, a bankruptcy option can discharge them as long as they meet the qualification guidelines. Bankruptcy can also assist you in paying recent taxes at a more reasonable rate than IRS would.
When one files for bankruptcy, an automatic injunction known as the automatic stay comes into effect. This stay works to stop all creditors from collecting their debts until the bankruptcy case is concluded. These creditors also include the IRS, who will be barred from any activity of collecting the debt. These may include sending you letters reminding you to pay, garnishing your accounts or wages, or even filing of liens on your assets.
As long as the bankruptcy case is going on, every creditor is prohibited from seeking payment from you. However, once the bankruptcy case is concluded, debtors whose debt was not discharged are free to pursue you for collection. This will include the IRS if the tax debt you owe has not been discharged. However, it is crucial to understand that not all tax liabilities get wiped out, as we will discuss below.
IRS Debt and Automatic Stay
As stated, immediately upon filing for bankruptcy, an auto-stay order is issued that stops creditors from collecting what you owe them. This order states that a creditor will not bill, garnish, call or sue you for the debt, including the IRS. The IRS will not issue any notices for the tax lien, attach your bank accounts or income or attempt to clear your tax refund.
When the bankruptcy discharge is affected, or the case is dismissed, the auto-stay will expire. However, if you were expecting a tax refund from the IRS, this will also be held until the stay expires. The IRS will hold from refunding you so that they can collect their debt from some of the refunds.
Limitations of the Auto-Stay
In case you had filed a bankruptcy case the previous year and withdrew it voluntarily, a new bankruptcy case will give you an auto-stay of thirty days. A limit is put by the court so that a debtor will not file multiple bankruptcies aimed at keeping their creditors from pursuing their payment. If you had filed for bankruptcy in the previous year, through your lawyer, you could request an extension of the stay.
If a person had filed for at least two bankruptcies the year before and withdrew them, the auto-stay order will not protect them against debtors. This means that the IRS will still come after you for the debt you owe them or tax lien. However, through your bankruptcy lawyer, if you are able to convince the court the previous filings were done in good faith, the court can grant your stay.
On the other hand, a creditor can request a stay relief. This, if granted, will mean that they can pursue their payment from you regardless of the stay order. This is common with secured debts such as mortgage or vehicles. If the IRS can convince the court that you committed tax fraud, they too can get a relief of the stay and pursue you for payment.
Tax Liabilities that can be Discharged
As earlier mentioned, bankruptcy can dismiss some but not all tax debt. Before one is forgiven from paying taxes, they must meet the criteria discussed below:
- The tax debts are on gross receipts or wages like income or business income
- That the taxes were owed three years or more prior to filing for bankruptcy. This is together with the valid extensions given
- The last time you filed for tax returns was two years or more before filing for bankruptcy. If you failed to file tax returns or filed them late, or the IRS filed an alternative on your behalf, some courts will not permit discharging of those taxes.
- You entered your tax as tax liability on your books, not less than 240 days prior to seeking bankruptcy. This period can be extended if you previously had previously filed for bankruptcy or had an offer in compromise.
- For the tax debt in question, you did not fraudulently and willingly evaded your obligation of paying taxes.
When one meets all the elements above, it is possible to have their tax debt discharged. However, if the aspects discussed are not met, it is unlikely your tax obligations will be dismissed when declared bankrupt.
Aside from the above conditions, the petitioner for bankruptcy must show that they filed their taxes with the IRS for the last four years. This is typically a condition before bankruptcy is granted. A petitioner must also present their latest tax returns copy in court and to any creditor that requests for it.
When Tax Debt is not Discharged, What Happens?
Depending on the bankruptcy option you filed for, either Chapter 7 or Chapter 13, debts on income tax get treated differently.
If you had filed for chapter 7 bankruptcy, the case might not have a significant effect if the debt is not discharged, aside from the stay. After the court issues a discharge on your debts, the case is closed by the clerk. However, if the appointed trustee is required to collect and sell nonexempt assets belonging to the debtor, the case may remain open. If IRS debt was not discharged in the case, then you will be expected to make payments because they will be free to collect from you.
Chapter 13 bankruptcy offers a debtor the chance to pay off their debts or liabilities in installments. If your IRS debt did not qualify to be discharged, you can propose a repayment plan to the IRS as you would for other debts. However, the repayment plan cannot exceed five years. This will enable you to clear your unsecured IRS liability and turn your non-dischargeable debt, to a paid one.
IRS Tax Liens
Sometimes, the IRS can file a tax lien against your property. When this happens, your case will get complicated. Your tax debt will automatically be turned to a secured obligation meaning you must pay for it irrespective of the bankruptcy chapter you file. This affects even old taxes that may have qualified to be discharged.
Ordinarily, bankruptcy is filed to release someone from overwhelming debts and give them an opportunity for a new beginning in their finances. Unfortunately, one cannot discharge a tax lien by filing for bankruptcy, meaning they must be paid in full even when one is declared bankrupt.
Understanding Tax Lien
A tax lien can be defined as a claim or security interest placed against a particular asset or property. For instance, if you have a mortgage, it is known as a lien on the home. If you fail to pay your mortgage, the lender can liquidate the home that is subjected to lien and get their money back.
A tax lien is similar to a mortgage. But, it is meant to secure your obligations to the IRS and not to the lender. A tax lien is normally imposed on an individual that fails to make timely payments for their taxes. However, this does not mean that because you owe the IRS taxes, you will automatically be subjected to a tax lien.
To impose a tax lien, the IRS will issue a notice to have a tax lien on an asset or property you own. This notice is usually filed at the local county where the said property is or where you reside. Once the notification is filed, the IRS attains a lien on all your assets or property. The lien takes its effect from the date it is filed and can continue to ten years after the IRS assesses the taxes owed.
Tax Lien and Chapter 7 Bankruptcy
When you petition for bankruptcy, what happens to the tax lien is based on when the bankruptcy was filed.
As earlier discussed, when you apply for bankruptcy, you will automatically get an order for a stay. This means that all creditors are barred from collecting any debts from you until the bankruptcy case concludes. This stay also protects you against tax lien by the IRS. Equally, the IRS will not file a notice for tax lien against your assets post your bankruptcy case, but only before you file for bankruptcy.
If the IRS filed for tax lien against your assets before you filed for bankruptcy, the court could not discharge the debt, meaning you will have to pay for it.
Tax Lien Payments through Bankruptcy
The bankruptcy process allows for the payment of tax lien in full or part. After filing for Chapter 7 bankruptcy, a trustee is identified that is responsible for liquidating your assets under the bankruptcy estate. The money raised through the process is meant to pay your creditors what you owe them. The IRS is among the creditors that are entitled to be paid from the proceeds of the bankruptcy estate.
For instance, you have a home valued at $400,000 and owe the mortgage lender $120,000 and in tax lien $80,000. Perhaps you are also entitled to a home exemption of $120,000. When the appointed trustee sells the home, he or she will have to pay the mortgage lender, tax lien, and for the home exemption. The money that remains from the sale proceeds will go into paying other creditors that you may have.
When the Bankruptcy Process Does Not Pay Tax Lien
Aside from what has been discussed above, under ordinary circumstances, tax liens don’t get paid when a person has filed for Chapter 7 bankruptcy. This is because most bankruptcy cases under chapter 7 have no assets. This means that creditors stand to lose because the person applying for bankruptcy has no sufficient assets to attach that can be liquidated and benefit the creditors. If the assets attached are liquidated, they may not be enough to pay all the debts meaning to pay some and leave others would be unfair. For this reason, the trustee will not liquidate the property.
For instance, your house is valued at $250,000, and you have a mortgage of $200,000, a tax lien of $30,000, and a homestead exemption of $100,000. In such a case, the trustee will not liquidate the property because the proceeds will not be adequate to pay all the creditors.
This means the debts will remain in place, and the tax lien will not be lifted from your property until it is paid in full. To get it lifted, however, you can liquidate the asset and pay off your debt or have a repayment plan for the IRS that will enable you to clear your outstanding balance. Simply filing for bankruptcy under chapter 7 will not get rid of the tax lien on your assets.
Auto-Stay and IRS Debt Post Bankruptcy
When you file for bankruptcy, the automatic stay will protect you against creditors you had before the filing of the bankruptcy. However, if you incur other debts after filing for bankruptcy, the creditors will be allowed to collect. This is known as the post-petition debt. It is essential to understand that filing for bankruptcy does not exempt you from the other bills you encounter later, and you must pay for them.
For instance, if you filed for bankruptcy and you had a mortgage, the debt that is put on hold is the overdue mortgage payments. However, even as the bankruptcy case is ongoing, you will be expected to keep up with your monthly mortgage payments.
Similarly, a stay will give you temporary relief from IRS demanding payment from you. However, you will still be required to keep up with subsequent tax returns. If you incur another IRS debt post-filing for bankruptcy, the stay will not protect you, and you will be required to pay for it.
Tax Lien and Personal Property
The IRS can also file a notice for tax lien against personal assets such as household furniture or cars. But as earlier discussed, most people that apply for chapter 7 bankruptcy do not have enough assets that can be liquidated by a trustee to offset debts owed. Equally, most of the assets listed are also tied to other liens such as auto loans, among others.
However, if the IRS imposed tax lien on your personal property, you will have to keep paying for it until you clear it.
How to Handle Tax Lien Following Bankruptcy
Even after you are declared bankrupt, there are liabilities you cannot escape, as discussed. To effectively deal with your tax lien, you have a few options. This will include:
- Paying the lien in full and obtaining a release from it
- Discuss a compromise or a plan of payment that will enable you to get it released
- Surrender a particular asset and pay its value according to the court to cover the tax lien debt
- File for a chapter 13 bankruptcy option to enable you to pay the lien debt in installments after you have filed for the chapter 7 bankruptcy.
- Take no action and hope they will not collect on the debt.
Doing nothing is often a good option if the worth of the asset subjected to tax lien is ordinary, or your liability to the obligation had been discharged when you filed for chapter 7 bankruptcy.
Offer in Compromise to Pay Your IRS Debt
This is an offer the IRS gives to enable one to settle tax debts at a lesser amount than what is owed. When you file for bankruptcy, and you legitimately show that you are unable to pay your accrued taxes, you can apply for an offer in compromise. The IRS, before granting you the offer will look at the following facts:
- Your ability to make payments
- Your current income
- Your expenses
- The value of the assets you have.
The IRS grants an offer in compromise only when the amount a bankrupt petitioner will offer is the best they can collect in a specified amount of time.
Installment Payment of Your IRS Debt
As earlier mentioned, on applying for bankruptcy, you can apply for chapter 13 option to allow you to make installment payments. The IRS allows this when the bankruptcy petitioner succeeds in being declared bankrupt under chapter 13. This is another relief for a person facing hefty IRS debts to enable them to make payments.
Find a San Diego Bankruptcy Lawyer Near Me
The decision to file for bankruptcy is often not an easy one. Even when you are declared bankrupt, some debts cannot be discharged and must be paid. Bankruptcy is not an easy way to get out of debt, but it works to relieve the financial burdens a person is facing as they find their stability again. If you are facing financial hardships and need advice on how to file for bankruptcy and the requirements, you need to speak to a bankruptcy lawyer. At San Diego Bankruptcy Attorney, we will advise you on the implications of bankruptcy and help you through the process. Call us at 619-488-6168, and let us discuss your financial situation together.