Bankruptcy might be the answer to your tax debt prayers. Filing a bankruptcy petition can often -- but not always -- erase tax debts. Alternatively, if you can't erase your tax debt in bankruptcy, you may be able to use bankruptcy to buy time and force the IRS to accept a payment plan -- a plan that is likely to be better than any the IRS would force on you. Bankruptcy isn't for everyone and won't work in many situations, but we can show you how it works, focusing on tax debts. It is up to you to decide the practical, as well as moral or ethical, implications for choosing bankruptcy to deal with your debt burden.
Types of Bankruptcy Relief
Bankruptcy is a legal procedure in which you ask for help sorting out your debt problems, including your tax debts, by filing a petition in a bankruptcy court. There are two basic types of bankruptcies:
The Automatic Stay
One of bankruptcy's most alluring features is something called the automatic stay. The moment you file for bankruptcy, the automatic stay stops all creditors and bill collectors from collecting their debts. This means the IRS cannot issue a tax lien or seize your property. (The automatic stay has its limits, however, and the IRS can continue an audit, issue a tax deficiency notice, demand a tax return, issue a tax assessment or demand payment of such an assessment.)
While your bankruptcy case is active, the only way a creditor or bill collector can resume collection activities is to ask the bankruptcy judge to remove, or lift, the automatic stay. Judges will lift a stay only if the action the creditor wants to take has no impact on your bankruptcy, such as an eviction. The IRS rarely applies to have a stay lifted -- meaning that enforced tax collection will stop.
When Taxes Are Wiped Out in Bankruptcy
You can discharge (wipe out) debts for federal income taxes in Chapter 7 bankruptcy only if all of these five conditions are true:
Effect of Federal Tax Lien
If your taxes qualify for discharge in a Chapter 7 bankruptcy case, your victory may be bittersweet. This is because prior recorded tax liens are not affected by your filing. A Chapter 7 bankruptcy will wipe out only your personal obligation to pay the debt. Any lien recorded before you file for bankruptcy remains. After your bankruptcy, the IRS can seize any property you owned at the time the bankruptcy was filed. But this doesn't mean that after your bankruptcy case is over the IRS will come and grab your property. After bankruptcy, the IRS tends to seize only real estate and retirement accounts or pensions. And even then, IRS seizures generally take place only when a taxpayer has made no efforts to otherwise resolve the problem. Furthermore, IRS collectors must obtain approval from their supervisors before seizing a house or pension. The IRS is very concerned about negative publicity.
If Your Tax Debts Aren't Wiped Out or Paid Off in Bankruptcy
If you still owe the IRS when you emerge from bankruptcy, the IRS gets extra time to collect the balance. You might still owe the IRS after your bankruptcy ends if:
The IRS normally has 10 years to collect tax bills, penalties and interest from you. Once your bankruptcy case is over, the IRS gets whatever time remains on the original ten years, plus the time your bankruptcy case was pending (usually four to six months in a Chapter 7 bankruptcy; up to five years in a reorganization bankruptcy), plus an additional six months.