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Unfiled Tax Returns and Bankruptcy

June 29th, 2020 at 7:00 am

  

If you’re considering filing bankruptcy, should you first prepare and submit any unfiled income tax returns? Should you prioritize paying them? 


Our last two blog posts have been about what you should and should not do before filing bankruptcy. These are important to consider even if you hope to avoid bankruptcy but are sensibly admitting it’s possible.

So two weeks ago we focused on keeping, and not selling or giving up your:

  1. assets
  2. especially any retirement funds
  3. collateral on debts, such as your home, vehicles, or furniture

Last week we discussed whether to take on more debt to buy time and maybe avoid needing to file bankruptcy.

Today we look at whether you should file any unfiled income tax returns, and possibly prioritize paying unpaid income taxes.

The Quick Answer

In general you should:

  1. prepare but not submit your tax returns to the IRS/state before seeing your bankruptcy lawyer;
  2. not hold off on getting advice from a lawyer if you can’t get your tax return(s) prepared beforehand;
  3. avoid paying any income taxes before getting advice about doing so from a lawyer;
  4. if you’ve recently paid income taxes or are being forced to, all the more reason to get legal advice about how to proceed now.

Prepare Tax Returns

There’s a simple reason why it’s good to have any unfiled tax returns prepared before seeing a lawyer. The more information you can provide to your lawyer the more concrete his or her advice to you can be.

Bankruptcy can be a surprising good way to solve your tax problems, in numerous ways. It can virtually always stop tax collection, both forced (garnishments) and voluntary (installment payments). Bankruptcy can sometimes reduce payment of tax interest and penalties. Bankruptcy can buy you time, and protect you while you prioritize who you pay. And under the right conditions bankruptcy can even completely wipe out (“discharge”) an income tax debt.

But as you might expect the interplay between tax law and bankruptcy law can get complicated. For example, whether bankruptcy discharges an income tax debt depends on whether that tax meets some detailed conditions. So the more details about your taxes you bring to your lawyer the more specific the legal advice you’ll receive.

Therefore, if you haven’t prepared any outstanding tax returns, it helps to do so before visiting your lawyer.

But Do Not Submit the Tax Returns

There’s just as simple of a reason not to submit your tax returns to the IRS/state tax authority before seeing your lawyer. Once you submit them you can’t un-submit them.

Of course you are legally compelled to send in your income tax returns. And there’s a legal deadline to do so. And you can submit an amended return if you need to correct the original return.

But submitting a tax return is in effect a legal act which has consequences. For example, it may affect the timing of your bankruptcy filing, and impose otherwise avoidable timing pressure.  

So, when possible, it generally makes sense to see your lawyer before submitting the outstanding tax return(s).

Don’t Delay Getting Legal Advice

Life can get complicated, financial and otherwise. You may have big roadblocks to getting your tax returns prepared. You may not have the necessary information or documents available to do so. Your tax returns may need the help of a tax preparer and you don’t have the money.

However, your financial circumstances may be crying out for bankruptcy and/or other legal advice. You may simply not be able to prepare the tax return(s) beforehand. While doing so would likely be helpful, this should not stop you from getting advice when you need it.

Prioritizing Paying Income Taxes

Every situation is different but, generally, see your bankruptcy lawyer before paying taxes.

Again, obviously you have a legal obligation to pay your income taxes.

However, if you have more debts than you can pay, it’s legitimate to ask which you should pay first. What order should you pay an income tax debt vs. an unpaid home mortgage vs. a late vehicle loan payment?

If you owe more than one income tax, which should you pay first? The IRS or the state? The older or newer one? Can you earmark the payment and should you do so between the tax itself vs. the unpaid interest vs. accrued penalties?  

How does the timing of tax payments affect the timing of the possible bankruptcy filing?

So you can see that there are various fair questions about paying your income taxes when you’re considering bankruptcy. All of these questions, and likely more, would greatly benefit from legal advice.

If Paying Taxes Now

So what if you are making income tax payments now. Consider three scenarios.

First, you’re making agreed monthly installment payments on an older unpaid income tax. You know the IRS/state will come after you hard and fast if you stop paying.

However, the tax you’re paying may qualify for discharge—a complete legal write off. It may make sense to stop paying the monthly payments so you can put that money for better use. You need to determine your game plan and coordinate the timing with your bankruptcy lawyer.

Second, the IRS/state is garnishing your paycheck for an income tax debt. Whether or not that tax debt qualifies for discharge, a bankruptcy filing would stop the garnishments. Clearly you would benefit from learning about how this works, and especially the pertinent timing. Plus of course you need to learn about the different bankruptcy options for your entire financial situation.

Third, you’re paying an older income tax monthly, either voluntarily or by garnishment. As a result you’re not paying any or enough current tax withholding or quarterly estimated payments. As a consequence, you may be paying an older tax debt that bankruptcy would discharge and not paying one that you could not discharge. You may be using your precious money to pay a not-required-to-pay debt instead of one you must pay after bankruptcy. It would certainly make sense to get legal advice to prevent such a less-than-best use of your money.

 

Filing Chapter 13 in 2019 to Write Off More Income Taxes

January 14th, 2019 at 8:00 am

Chapter 13 is a riskier, longer, and maybe more expensive way to escape a dischargeable income tax debt—but may still be your best option. 


Last week we showed how to permanently write off (“discharge”) more of your tax debts through Chapter 7 “straight bankruptcy.” Today we show how to do this with Chapter 13 “adjustment of debts.”

Why Use Chapter 13 If Chapter 7 is Faster and Cleaner?

Chapter 7 is a very fast way to discharge an income tax debt that qualifies for discharge. You would very likely no longer owe the tax only about 4 months after filing a Chapter 7 case.

But Chapter 13 case could be much better for you than Chapter 7 for other reasons. Those other reasons may outweigh the benefit of discharging your dischargeable tax debt quickly.

You may owe some other income tax debt(s) which do not meet the conditions for discharge. These other taxes that may be too large to pay off reasonably through a monthly payment plan with the IRS/state.  The other taxes may not qualify for an Offer in Compromise or other settlement. You may well save money and avoid significant risks by handling all of your taxes in a Chapter 13 case.

There are also many other reasons that Chapter 13 would be worthwhile for you, reasons not involving income taxes. It may save your home from foreclosure or your vehicle(s) from repossession. Chapter 13 can deal with a child or spousal support arrearage much better than Chapter 7. There are many other situations where Chapter 13 gives you extraordinary and unique powers. So it can be worthwhile overall in spite of its disadvantages in dealing with a dischargeable tax debt.

How Does Chapter 13 Deal with Dischargeable Income Taxes?

Determining whether a particular income tax debt can be discharged in Chapter 13 is the same as in Chapter 7. Please see our last blog post for the conditions of discharge. These conditions mostly involve how long it’s been since the tax return for the tax at issue was due and when the return was actually submitted to the IRS/state. Sometimes there are other pertinent conditions, but usually it’s just a matter of timing.

Because of how the timing works, there are certain points of time in 2019 when a tax that hadn’t earlier qualified for discharge would then qualify. Again, see our last blog post about those crucial times happening this year.

If your tax does meet the conditions for discharge, it can get discharged in your Chapter 13 case. But this works quite differently than under Chapter 7.

One key difference is that under Chapter 13 there’s a good chance that you would pay something on your dischargeable tax debt.

Under Chapter 13 dischargeable income tax debts is treated like the rest of your “general unsecured” debts. Under your payment plan all such debts get paid the same percentage of their total amounts. That percentage may be any amount from 0% to 100% of their amount, depending on your budget and other factors.

Consider two situations: First, if you have a “0% plan” then you’d pay nothing on the dischargeable tax just like in a straightforward Chapter 7 case. Second, even if you do pay some percentage, often that actually doesn’t increase the amount you pay into your payment. We’ll explain these two situations.

A 0% Payment Plan

In some Chapter 13 cases all the money that the debtor can afford to pay goes to special creditors. All the money going into the Chapter 13 payment plan goes either to secured or to “priority” debts. These would include home mortgages, vehicle loans, nondischargeable taxes, child and spousal support, and such. These usually have to be paid in full before the “general unsecured” debts receive anything.  So during the 3-to-5-year payment plan no money goes to the dischargeable income taxes. That’s a 0% Chapter 13 plan.

Assuming the bankruptcy approves the plan, and you successfully complete it, at its conclusion the dischargeable taxes get discharged, without you having to pay any of it.

Payment Plans Which Do Not Increase the Amount You Pay

In many Chapter 13 plans the amount available for the pool of the “general unsecured” debts is a fixed amount. That amount is based on what you can afford to pay over the required length of the plan. (That required length is usually 3 or 5 years.) That fixed amount does not change regardless how much in “general unsecured” debts you owe. The amount just gets distributed to all those debts pro rata. The more you owe in “general unsecured” debts the lower the percent of the debts that fixed amount can pay.

For example, assume you can afford to pay the pool of “general unsecured” debts a total of $2,000 during the course of the payment plan. All the rest of the money you pay into the plan is earmarked for secured and “priority” debts. Assume also that you have $20,000 in unsecured credit card and medical debts and $5,000 of dischargeable income tax. Without the income tax, the $2,000 would be paid towards the $20,000 in “general unsecured” debts, resulting in a 10% plan. ($2,000 is 10% of $20,000.) Now when you add in the $5,000 tax, there’s a total of $25,000 of “general unsecured” debt. $2,000 is 8% of $25,000, resulting in an 8% plan.

You would be paying no more—the fixed amount of $2,000—over the length of your plan. The fact that you owe the $5,000 in dischargeable tax would not increase the amount you would pay. Then at the successful completion of the case all remaining “general unsecured” debts, including whatever was remaining on the dischargeable tax, would be forever discharged.

Conclusion

So you see that Chapter 13 is a slower and somewhat riskier way to discharge an income tax debt. Plus you may have to pay a portion of the tax instead of quickly discharging all of it under Chapter 7. But then again you may not have to pay anything on it, as described above. In any event, the delay and risks may well be worthwhile. Your bankruptcy lawyer will help you weigh all the advantages and disadvantages so that you can make the right choice.

 

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210-342-3400

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