If you have an IRS tax problem, don’t be fooled into thinking bankruptcy will permanently wipe out all of your IRS tax debt.
Bankruptcy relief is immediate. It puts creditors, including the IRS, on immediate hold. They can’t can’t levy your bank account, can’t garnish your paycheck, can’t seize your property. At least for awhile.
Bankruptcy also discharges some of your IRS debt completely. But it will totally cleanup all your IRS tax matter only if the following four conditions are met:
- the return’s filing deadline was due at least three years ago, and
- you actually filed the return over two years ago, and
- the IRS assessed the tax at least 240 days (or 8 months) ago, and
- you did not commit any fraud or tax evasion along the way.
If the total tax you owe–or any part of the balance due–does not meet the criteria above, it’s considered a ‘priority’ debt. Priority tax debt cannot be discharged in bankruptcy.
A Chapter 7 bankruptcy case will usually be completed after 5 or 6 months. After that, the IRS is free to pursue you again on the priority tax debt. Then it starts all over again. The IRS can resume their collection activity, levy your bank account, take part of your paycheck, and so on, on priority tax debt that you owe.
The sad tale of Joe and Martha
Perhaps it’s best to illustrate this with the sample tale of Joe and Martha. They prepared their 2009 tax return back in 2010, and filed it without paying the $3,000 balance due. The next year, on their 2010 tax return, the tax due would have been another $3,000, but they decided to ‘stay low’ and not file the return in fear of IRS collection actions that might result.
Then their financial hardship snowballed, and they did not file returns for either 2011 or 2012. However, the IRS took action in May of 2013 and filed ‘substitute for returns”, assessing $9,000 in additional tax due liability for those two years, based solely on Joe’s reported W-2 income, married filing single status, and no deductions. (Ouch!)
By October of 2013, Joe and Martha owed the IRS nearly $20,000 in taxes, interest and penalties. They also owed roughly $7,000 to other creditors, mainly doctors, but their primary concern was the IRS. They met with an attorney, and decided to file for Chapter 7 bankruptcy protection. By doing so, they obtained an immediate “hold” on IRS collection efforts. Unfortunately, the bankruptcy protection was short-lived. Their 2009 return qualified for discharge, however, their 2010 return (never filed) did not, nor did the 2011 and 2012 returns due to their recent assessment dates.
By early 2014, an IRS revenue officer resumed his efforts to collect $12,000 in back taxes plus interest and non-filing penalties in excess of $4,000. When they contacted their bankruptcy attorney, he stated “that is the IRS’s decision; I had nothing to do with it.”
ANCHOR ON THIS: Bankruptcy laws can provide powerful protection for consumers who fall behind on IRS and other debts. However, when considering bankruptcy, require your attorney to obtain transcripts from the IRS and perform a thorough Bankruptcy Discharge Analysis before proceeding. Knowing in advance whether bankruptcy will discharge your income tax debt is important in helping you make an informed decision regarding the tax aspect of your bankruptcy case.