Many people ask us whether or not you can use bankruptcy to resolve back tax debt with the IRS. The answer is… yes! Let's take a look at the different types of bankruptcies available to taxpayers, along with some of the advantages and disadvantages of each.
Chapter 7 – Can completely wipe out IRS debt
Chapter 7 bankruptcy is the most common type of bankruptcy that we see. It is primarily used for those who have income tax debt but are unable to pay anything back. Chapter 7 can be a lifesaver for insolvency because it completely eliminates all dischargeable back tax debts. In layman's terms, you pay nothing.
However, while Chapter 7 has the ability to hit the reset button on income tax debt, it doesn't work with payroll taxes. Additionally, rules on previously unfiled returns are not uniform and newer liabilities are unable to be resolved. It's definitely worthwhile to keep note of the disadvantages of Chapter 7 and to discuss them with proper counsel before you commit to declaring bankruptcy.
Chapter 9 – The rarest of the bunch
Chapter 9 bankruptcy is incredibly rare. Why? Primarily because Chapter 9 bankruptcy is for municipalities who owe back taxes — along with any other debts — that they can't repay. While this probably doesn't relate to any of our readers, take some comfort in the fact that Chapter 9 exists! If a municipality (who has the ability to collect taxes and foreclose on those who don't pay) can get behind with the IRS, then maybe you — a regular taxpayer — shouldn't feel so bad. After all, you don't have the ability to force repayments from people who owe you money or to levy taxes when you are short of funds.
Chapter 11 – Reorganizations for IRS taxes
Chapter 11 bankruptcy is available to every business — whether organized as a corporation, partnership, or sole proprietorship — and, believe it or not, to individuals as well. Even though individuals are included, it is predominately used by corporate entities. Chapter 11 is more of a reorganization plan – some debts will be repaid, some won't be. The entity's affairs will be run by a bankruptcy trustee, who balances the competing interests of creditors, including the IRS. The advantage of a Chapter 11 bankruptcy — really the only advantage you ever see — is that there is no clear disadvantage once a business is insolvent.
Chapter 12 – For fishermen and farmers who get behind on their taxes
Chapter 12 bankruptcy is just like Chapter 13, which we will discuss below, except that it applies to fishermen and farmers (and apparently offers additional benefits).What makes fishermen and farmers so special? Well for one, they are special. Without fishermen you could not enjoy a tasty Captain's Platter. And without farmers, you would spend your day in frustration, foraging for sparse calories, only to turn up at home empty-handed to a hungry, disappointed family.
But in all seriousness, the reason appears to be that historically, family farmers and fishermen are business owners that tend to be the first ones affected by economic downturns or acts of God; the law took note of that. Or, I could be making this all up. It's your call.
Chapter 13 – Repayment plan for IRS problems
The IRS claims that for individuals, the most common type of bankruptcy is a Chapter 13 bankruptcy. Before you consider filing a Chapter 13, here are some things you should know:
- The statute of limitations on collections is tolled; if the plan fails, the IRS will have more time to collect the entire debt.
- You must file all required tax returns for tax periods ending within four years of your bankruptcy filing.
- During your bankruptcy, you must continue to file — or get an extension to file at a later date — all required returns.
- During your bankruptcy case, you should pay all current taxes as they come due.
- If all you owe is back taxes, you may be better off negotiating with the IRS directly. Or better yet, hire the tax team at IRSMedic to do it for you (there's nothing we love more than going Rocky Balboa on the IRS in a case of verbal boxing).
- Failure to file returns and/or pay current taxes during your bankruptcy may result in your case being dismissed.
Considering filing bankruptcy for your IRS tax debt?
Filing bankruptcy can be the best option for an IRS debt. But sometimes, there may be better options. In particular situations, you may be able to ever so subtly use the threat of filing bankruptcy to assist the IRS in seeing that your proposal, while lower than the "Realistic Collection Potential" calculations, may still be the best deal for the government.
If you and/or your bankruptcy attorney would like to speak to one of our tax attorneys about your case, please feel free to contact us and we will do everything we can to help find the right strategy for resolving your tax problem. Call us at 888-727-8796 or email info@irsmedic.com.
