Taxpayers who are unable to pay past due federal taxes have several options to choose from, including working with the IRS to create a payment plan or an offer in compromise to fulfill their tax obligations. However, if those options do not meet an individual taxpayer’s needs, bankruptcy might be an option to consider.
It may be possible to repay tax debt through a Chapter 13 bankruptcy or have it discharged through a Chapter 7 bankruptcy. It is best for delinquent taxpayers to consult with bankruptcy lawyers before deciding which bankruptcy option is best for their financial circumstances.
Filing a Chapter 13 Bankruptcy
The most common type of bankruptcy for individuals to file with bankruptcy lawyers is a Chapter 13 bankruptcy. This bankruptcy option allows individuals to repay their creditors under the supervision of the courts. Instead of putting a trustee in charge of the debtor’s assets, the debtor usually remains in control of his or her assets as a debtor-in-possession. The tax debt is not treated as a separate entity when the petition for Chapter 13 is filed.
When including tax debt into a Chapter 13, the IRS requires that the debtor:
- File all required tax returns for the four years prior to the bankruptcy filing
- Continue to file or apply for an extension to delay filing of all required tax returns
- Pay current taxes when they are due throughout the length of the bankruptcy
If the debtor fails to file his or her returns or pay taxes that are due during the bankruptcy, the IRS may dismiss their case. The debtor may also have his or her bankruptcy petition converted into a Chapter 7 bankruptcy. Under the Internal Revenue Code, the debtor will be responsible for any interest and penalties that may be assessed for returns that have not been filed by the due date.
Filing a Chapter 7 Bankruptcy
When an individual files for Chapter 7 bankruptcy, a trustee will be appointed to administer his or her estate. The trustee will proceed to liquidate any assets that have been determined as nonexempt. During a Chapter 7 bankruptcy, the debtor is still required to file his or her own individual tax forms. For married couples, regardless if they file their taxes jointly, they will need to file two separate bankruptcy estates. A separate estate is set up as a taxable entity that is kept separate from the taxpayer. The trustee will file a Form 1041 estate form for that estate. Monies due for taxes within 3 years prior to the filing of the bankruptcy petition are considered an eighth priority.