If you were already on the financial edge and just found out you owe a bunch of income taxes, here is how bankruptcy can help.
If you owed nobody but the IRS for last year’s income taxes, you wouldn’t likely need to think about filing any kind of bankruptcy. In many circumstances, the IRS is actually reasonably decent to work with, such as in setting up a monthly payment plan for catching up on a single year’s tax shortfall. Sure, you’ll pay some penalties and interest, but if you can pay it all off in reasonable monthly payments in the next year or so, that wouldn’t be such a bad thing.
But if you owe for more than one year, or are just filing for the 2011 tax year because you got an extension, but here you are a couple months from the end of 2012 knowing you’ll also owe for 2012, then it looks like you’re getting into a vicious cycle. And if on top of that you have a whole bunch of other debts, you owe it to yourself to check out Chapter 7 and Chapter 13 as possible ways out of that vicious cycle. Today we’ll briefly explore how Chapter 7 helps, and then how Chapter 13 does in the next blog.
Chapter 7 and Income Taxes
You may well have other reasons for choosing to file a Chapter 7 instead of a Chapter 13, but the rule of thumb as far as taxes is pretty simple, especially if the only taxes you owe are from the last year or two:
File a Chapter 7 case if after doing so you will be able to get caught up on your back and current taxes through manageable monthly payments made over a reasonable period of time. In other words, file a Chapter 7 if you don’t need the extra protection and benefits provided by Chapter 13.
Both Chapter 7 and 13 can legally write off (“discharge”) income taxes, but can never do so until at least three years from the time the tax returns for those years were due to be filed (including extensions). So as of now you could discharge 2008 income taxes, but not later ones. That’s because 2008 taxes were due either April 15, 2009 or October 15, 2009 depending on whether you got an extension, and you could discharge a 2008 tax debt starting three years later, after April 15, 2012 or after October 15, 2012. You’d have to meet some additional conditions as well, but this three-year condition is a good starting point.
So unless you currently owe income taxes going back further than 2009, Chapter 7 is not going to discharge any of them. The benefit it will give you instead is discharging all or most of your other debts. So the analysis we will go through with you when you meet with us involves two questions:
1) How much will filing Chapter 7 improve your monthly cash flow? In other words, how much will you be able to pay to the IRS realistically on a monthly basis, both to catch up on the back taxes and to make any necessary adjustments to the current withholdings or estimated quarterly payments?
2) How much do you owe in back taxes? Will the amount that you can realistically afford to pay each month enable you to get current in a reasonable time (so you’re doing so within the length of time the IRS will allow, and without incurring a crippling amount in additional penalties and interest)?
Unless we confidently believe that Chapter 7 will solve your tax problem, we’ll look at whether Chapter 13 would do better. It’s wise to consider Chapter 13 regardless, so you’ll know the advantages and disadvantages of both options. See the next blog for that.