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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.

 

Tax Filing and Payment Extended to July 15

March 23rd, 2020 at 7:00 am

The federal April 15, 2020 tax filing and payment deadlines have been postponed to July 15, 2020.  Also, no interest or penalties accrue. 

 

Federal Income Tax Return Deadline Postponed

Responding to the COVID-19 pandemic, the IRS has postponed the deadline to file federal income tax returns by 3 months. This was announced (on Twitter, no less!) on Friday, March 20, and then explained in more detail on Saturday.

This tax return postponement applies to all individuals, but also more broadly. It includes every legal “person”:  “an individual, a trust, estate, partnership, association, company or corporation.” IRS Notice 2020-18. So it covers all individuals and businesses.  

Federal Income Tax Payment Due Date Postponed

Just as important, the date that tax payments are due is also postponed from April 15 to July 15, 2020. (The IRS actually announced this two days earlier, on Wednesday, March 18, 2020. IRS Notice 2020-17.)

This applies more broadly than just taxes due for the 2019 tax year. For those paying estimated income taxes quarterly, the payment that was due April 15 is now instead due on July 15, 2020.

There’s no limit to the amount of tax amount postponed. There was a prior maximum amount postponed (in IRS Notice 2020-17) but that maximum has been eliminated. IRS Notice 2020-18, Section III, paragraph 2.

No Interim Interest and Penalties

Since taxes previously due on April 15 are now due on July 15, 2020, no interest or penalties will accrue during those 3 months. As the official Notice states:

the period beginning on April 15, 2020, and ending on July 15, 2020, will be disregarded in the calculation of any interest, penalty, or addition to tax for failure to file the Federal income tax returns or to pay the Federal income taxes postponed by this notice. Interest, penalties, and additions to tax… will begin to accrue on July 16, 2020.

IRS Notice 2020-18, Section III, paragraph 5.

No Extension Needed

This postponement of tax returns and tax payments is automatic. You don’t need to file any extension forms.

If you’ll need more time past July 15, the IRS says:

Individual taxpayers who need additional time to file beyond the July 15 deadline can request a filing extension by filing Form 4868 through their tax professional, tax software or using the Free File link on IRS.gov. Businesses who need additional time must file Form 7004.

IR-2020-58.

Tax Refunds Not Affected?

You may well be expecting a tax refund and so want to file as soon as possible. The IRS is encouraging you to do so:

The IRS urges taxpayers who are due a refund to file as soon as possible. Most tax refunds are still being issued within 21 days.

IR-2020-58. If you need your refund, the pandemic makes it all the more important to file as soon as possible.

ONLY April 15, 2020 Deadlines Affected

Things are changing fast, but at the moment this postponement does not apply to any other deadlines. For example, there’s no current extension for the March 16, 2020 deadline for corporate tax returns for tax year 2019 or the May 15, 2020 deadline for tax-exempt organizations. Also, the regular filing/payment date of July 15, 2020 still applies for quarterly filers. Again, these may also change.

State Income Tax Deadlines

Many states with income taxes have already matched the IRS’s postponement of tax returns and payments. For example:

  • California had earlier postponed to June 15 but extended to July 15 to match the IRS.
  • New Jersey’s legislature unanimously passed a bill last week to the likely same effect.
  • Montana’s governor on Friday postponed state filing and payment deadlines to April 15.
  • Arizona’s governor and then its Dept. of Revenue postponed the April deadlines to July.

It’s reasonable to believe that all or most states will follow the IRS’ lead, and do so quickly. So, please check with your own state’s taxing authority for updates.

 

What Does an IRS Tax Levy Mean in Texas?

October 30th, 2013 at 10:19 am

san-antonio-irs-tax-levySince the economy has taken a turn for the worse, the IRS has be relatively aggressive in coming after income tax debt. If you are being contacted by the IRS about existing tax debt and you are feeling overwhelmed with your finances, you need the advice of a San Antonio bankruptcy attorney.

The IRS can use levies to pay your taxes if you do not make payments or arrangements for payments to cover a tax debt. The IRS can take and sell any type of personal property that you own or have interest in. This includes the cash loan value of your life insurance policy, commissions, your wages, bank accounts, licenses, rental income, dividends, and retirement accounts. The IRS may also seize and sell property such as houses, boats or cars.

The tax levy can be completed after the IRS assessed the tax and provided you with a Notice and Demand for Payment, you refused to pay the tax or ignored the notice, and you received a “Final Notice of Intent to Levy and Notice of Your Right to a Hearing.” Generally, you will receive this last piece of information about 30 days before the levy. Taxes are extremely complicated and contacting the IRS may not clear up your questions. This is a sign to reach out to a bankruptcy lawyer.

If you are being contacted by the IRS about an impending levy, now is the time to act. The automatic stay provision of bankruptcy will stall all attempts by creditors to collect on a debt. Filing for bankruptcy is one way to stop the attempt to levy you as a result of an outstanding tax debt.

You should only work with a professional who understands the challenges of an IRS tax levy. If you’re ready to talk about bankruptcy and your opportunity to get a fresh start in life, contact an experienced Texas bankruptcy attorney today.

Call today for a FREE Consultation

210-342-3400

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