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Archive for the ‘stopping tax garnishment’ tag

Avoiding Income Tax Interest and Penalties

August 10th, 2020 at 7:00 am

Bankruptcy timing can affect not only whether you must pay a tax debt but also whether you must pay certain tax interest and penalties.


This blog post is in a series about the importance of smart timing of your bankruptcy filing. Today we cover how good bankruptcy timing can prevent you having to pay certain income tax interest and penalties.

Avoiding Income Tax Interest and Penalties by Discharging the Tax Itself

Two weeks ago we discussed how to time a Chapter 7 “straight bankruptcy” appropriately to discharge an income tax debt. “Discharge” means to legally, permanently write off the tax. Then last week we discussed how to discharge an income tax in a Chapter 13 “adjustment of debts” case. When you discharge a tax in these ways what happens to the interest and penalties tied to that tax?

Generally, if you discharge an income tax debt, that also discharges any interest and penalties associated with that tax. That’s the most straightforward way to avoid such tax interest and penalties.

What If the Tax Does Not Qualify for Discharge?

If your tax debt doesn’t meet the timing and other conditions for discharge, what happens to the interest and penalties? That depends on whether you (with the help of your bankruptcy lawyer) file a Chapter 7 or Chapter 13 case.

Interest and Penalties on Nondischargeable Tax under Chapter 7

If you file a Chapter 7 bankruptcy you continue owing the tax, and the interest and taxes keep accumulating.

You do receive one brief benefit. During the 3-4 months of the bankruptcy procedure the IRS and/or state legally may not collect the tax. The “automatic stay” that stops just about all debt collection activity applies to all your income tax debts. But as soon as the Chapter 7 case is done, the tax collection activity can resume. The interest and penalties continues to accumulate even during your case. And after the case they will continue accumulating as normal until you pay the tax, interest, and penalties in full. So with taxes that don’t qualify for discharge, Chapter 7 does not help with tax interest and penalties.

Interest and Penalties on Nondischargeable Tax under Chapter 13

However, if you file a Chapter 13 case there is some help with tax interest and penalties. This can be true even with a nondischargeable income tax.

In most Chapter 13 cases you do not have to pay any ongoing interest and penalties after filing your case. Through your payment plan you pay the tax over the 3-to-5-year life of your case. But the IRS/state writes off any after-filing accumulating interest and penalties as long as you successfully complete your case. (If you don’t complete your case, the IRS/state tacks on any accumulating interest and penalties to whatever tax you didn’t pay.)

What about the before-Chapter-13-filing interest and penalties? You must pay the interest portion along with the nondischargeable tax that you have to pay.

However you usually don’t have to pay the before-bankruptcy-filing penalty portion in full. Sometimes you don’t have to pay any of it. The tax penalties are a “general unsecured” debt. You generally pay general unsecured debts only as much as you can afford to pay during the life of your Chapter 13 case. This means that you may pay as little as none of the pre-bankruptcy penalties.

Furthermore, in most cases these penalties don’t add a dime to the amount you must pay into your Chapter 13 case. That’s because in most cases you pay what you can afford into the pool of general unsecured debts over the life of your payment plan. A set amount filters down to these debts. So the dollar amount of tax penalties merely reduces how much other general unsecured debts receive. You don’t pay any more. The amount you pay just gets shifted around among these debts.

Exceptions

There are exceptions to the above. Sometimes the amount you pay into your payment plan is driven less by your budget than by non-exempt (unprotected) assets. Then you may need to pay more to your general unsecured debts (which includes the pre-bankruptcy penalties). You may even need to pay them in full—a so-called 100% plan. But that’s rare. Your bankruptcy lawyer will discuss this with you if you have this unusual situation.

What about the Effect of a Recorded Income Tax Lien?

That’s a great question. The recording of an income tax lien before filing a bankruptcy case can definitely create additional headaches for you. This can be true about both the underlying tax itself and the related interest and penalties.

So the simple timing preference is, when possible, file your bankruptcy case before the IRS/state records a tax lien.

The effect of a tax lien depends on whether the tax at issue qualifies for discharge, and whether you file a Chapter 7 or 13 case. We’ll cover these in our blog post next week.

 

Timing Bankruptcy to Discharge Income Taxes

July 27th, 2020 at 7:00 am

  

Usually you can discharge income taxes (write them off forever) by waiting to file bankruptcy long enough. Here’s how it works under Chapter 7.

 

Our blog post of two weeks ago introduced the importance of timing your bankruptcy filing right. We gave a list of 15 examples of timing considerations. Last week we started with the first one, timing the filing to cover as many debts as possible. Today it’s about discharging/writing off income taxes, specifically under a Chapter 7 “straight bankruptcy.”

Here are a few eye-catching facts:

  • It is possible to discharge many income tax debts, so that you do not owe a dime of that tax.
  • You just have to meet a list of conditions.
  • Most, but not all, of those conditions involve the passing of time. You need to wait long enough before filing bankruptcy to permanently discharge a tax debt.
  • If you don’t meet the conditions, bankruptcy does not discharge the tax at all. You owe it in full. If you filed a Chapter 7 case, you have to pay the tax after completing the case.
  • In that situation you’d also have to pay the continuously incurring tax interest and penalties.
  • But if you do meet the conditions, your Chapter 7 case will discharge the entire tax. You will owe nothing after your case is finished (usually only about 4 months after filing it).
  • You will also not owe any of the related tax interest or penalties.
  • There are various additional factors—such as recorded tax liens—that can complicate the situation and the tactics involved.

Timing is Often Crucial

Although there is a list of conditions, often the ones that matter are the ones involving timing. Specifically they pertain to when you file your Chapter 7 case.

Much of the time a Chapter 7 case will discharge an income tax debt if you meet two timing conditions. The date that you and your bankruptcy lawyer file that bankruptcy case must be both:

  1. at least 3 years after the tax return for that tax was due, and
  2. at least 2 years after that tax return was actually submitted to the IRS or state tax authority.  

See Section 507(a)(8)(A)(i) of the U.S. Bankruptcy Code for this first timing condition; section 523(a)(1)(B) for the second.

Note: Regarding the first 3-year condition above, add any time given through an extension to file the pertinent tax return. Section 507(a)(8)(A)(i) of the Bankruptcy Code. For example, assume you got the usual 6-month tax return extension from April 15 to October 15 for the pertinent year. Then you don’t start the 3-year time period until that October 15 instead of April 15.

Applying these Timing Rules

These two timing rules will make more sense when applied to an example.

Assume the following. You:

  • owe $10,000 in income taxes for the 2016 tax year, plus a bunch of accruing interest and penalties
  • had asked for a 6-month extension to October 15, 2017 (actually to October 16 since the 15th that year was a Sunday)
  • actually did not submit the tax return until December 1, 2017

If you file a Chapter 7 case before October 16, 2020, you would not discharge the $10,000 tax. You’d continue owing the $10,000 tax, plus the accruing interest and penalties.

However, under many circumstances if you file on or after October 16, 2020 you would discharge all of the $10,000. You would no longer owe any of it, including the interest and penalties.

Why the total difference? Because as of October 16, 2020:

  1. At least 3 years would have passed since the extended tax return due date of October 16, 2017, and also
  2. At least 2 years would have passed since actually submitting the tax return on December 1, 2017.

Other Conditions

Earlier we said that are other conditions to meet besides the two timing ones referred to here. So what are those other conditions that would result in an income tax not being discharged, even after meeting the above 2-year and 3-year conditions?

There are three other conditions or situations to look out for:

  1. Tax Fraud or Evasion:  The Bankruptcy Code says you can’t get a discharge of a tax for which you “made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.” Section 523(a)(1)(C).  The problem is that language is quite vague. So bankruptcy judges interpret this language differently. For example, is it a willful attempt to evade a tax if you don’t submit the tax return when due, even if you submitted it voluntarily a year later? Talk with your bankruptcy lawyer about how your local bankruptcy court interprets this language. 
  2. Income Tax Liens: Once the IRS or state tax agency records a tax lien, that puts a legal cloud over either all your personal or real property, or both. Depending on what you own, that can turn a tax debt that bankruptcy will discharge in full into one that you still have to pay in full or in part. A tax lien creates complications that you need to thoroughly discuss with your bankruptcy lawyer.
  3. Offer in Compromise/Prior Bankruptcy: Have you made an “offer in compromise” to the IRS or state to settle the debt? Have you filed a prior bankruptcy case involving this same tax debt? Under these rather unusual circumstances there are some additional timing rules. Tell your lawyer if either of these circumstances applies to you, in order to meet the special rules.  

Conclusion

Assuming these three special conditions do not apply, and you’ve met the 2-year and 3-year conditions, a Chapter 7 case should discharge your tax debt.

 

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.

 

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