Bankruptcy and Taxes: All you Need to Know

Filing for bankruptcy and dealing with Taxes problems are the two most painful things you can do and both are quite challenging.

There are several federal, states, and local policies that you need to understand before filing for bankruptcy.

Most importantly, you have to think about whether you will fall in chapter 7 or chapter 13 bankruptcies. Even after your claim, you need to go through several legal processes. You also need to make some payments if there are any due to bankruptcy.

If you file for bankruptcy and also have tax debts, the entire process becomes even more complex. You may also need to hire an attorney to understand and evaluate your tax discharging options.

If you have a massive amount of tax debts, you may have to pay most of them. Of course, you need to know several things before filing for bankruptcy if you want to reduce your tax debts.

Therefore, here we have mentioned everything you need to know about taxes and bankruptcy to help you make a well-informed decision.

Do Taxes go away with Bankruptcy?

Although there are some debts that are not dischargeable, the laws for other types of debts such as tax debt are not as clear as others. First, you need to understand that the penalties for tax fraud and taxes you deliberately try to avoid are not dischargeable if you go bankrupt. Income taxes can only go away in certain circumstances even if you haven’t committed any fraud.

To benefit from the tax dischargeable, you need to satisfy the three elements mentioned below.

• You can’t discharge taxes in bankruptcy without waiting for three years after taxes were due. For instance, you need to pay off your 2020 taxes on April 2021. This way, you will not be able to discharge them until April 2024.
• You need to file a tax return for all the taxes you owe. This way, if an individual doesn’t file 2016 taxes until 2020, they have to wait until 2022 to file for bankruptcy and to get their debt discharged. If they never file a tax return, the debt can never be discharged.
• Your taxes need to be assessed within 240 days before you file bankruptcy. This way, if you were audited and your taxes have to go through reassessment, you will have to wait for 240 more days after the audit.

Furthermore, if your taxes can be discharged, the tax liens will not be discharged. You need to pay the tax liens if you file for the bankruptcy after IRS recorded your tax liens. This problem will make it harder for you to sell your house without paying the debts.

What are the Tax Consequences of Bankruptcy?

There are no tax consequences for discharging debts and filing bankruptcy if you are an average consumer. However, if your debts are settled or forgiven outside of bankruptcy, the amount of money you have forgiven might be subjected to tax and added to your income. This is known as the cancellation of debt income.

Some people opt for bankruptcy due to its tax-free feature, instead of applying for debt settlement. This is why, many people file for bankruptcy if there is a risk of foreclosure, even when they decide to let go of the property.

Note that a foreclosure will lead to the taxable income that experts measure by the difference between the amount owed on the home loan and the value of the house.

Is there a One-Time Tax Forgiveness?

The answer to “is there a one-time forgiveness option?” is: yes. The one-time forgiveness or IRS first-time penalty abatement is a beneficial and long-lasting IRS forgiveness program. It is designed to offer amnesty to taxpayers who haven’t made tax payments or made an error in the tax filing, which leads to a great amount of fines and penalties.

The IRS’ one-time tax forgiveness plan is made to define a consistent and clear approach for specifying the main categories of IRS penalties. This include issue with reporting agency, issues with payment, and filing issues. In the 1980s, the IRS conducted an important study of civil IRS tax penalties to make recommendations and analyze inconsistencies.

This study encouraged IRS to develop several opportunities for the taxpayers and allow them to correct their mistakes if they have made any errors. To facilitate people and meet this requirement, the IRS established the First Time Abate (FTA) waiver. This program allows the taxpayers facing penalties to opt for the penalty abatement.

Does the IRS Forgive Tax Debt after 10 Years?

For starters, the law offers IRS a maximum of ten years to collect all the unpaid taxes. If the time expires, the obligation to pay taxes on a taxpayer will be removed. This ten-year obligation is called Collection Statute Expiration Date (CSED) or Statue of Limitations on tax balances.

Taxpayers may find it hard to identify this limitation, as IRS doesn’t write off a liability. Additionally, this ten-year time period begins when you file for the tax returns. Also, the IRS has three years to find any additional taxes which can lead to IRS liability.

The primary reason why the IRS doesn’t discuss the ten-year time period is that they fear that you will wait for ten years to pass. People who are waiting for this time to expire must prepare for the IRS’ methods to collect money from them. You can expect IRS to become more aggressive over time.

The serious actions can include issuing a tax levy on your wages and bank accounts and filing tax liens.

If you want to avoid these problems, you can simply agree to follow the payment plans given by the IRS.

Before making any other decision, it’s best to discuss the matter with tax professionals who know the tricks to negotiate with the IRS. So, now you may get the answer of does the IRS forgive tax debt after 10 years?

Are Taxes Dischargeable in Chapter 7?

Chapter 7 bankruptcy or straight bankruptcy is one of the most common approaches people use to file for bankruptcy. It also works on straightforward laws and obligations. The tax debt will be discharged if you fulfill all the requirements mentioned below.

• You have income taxes
• Your taxes were due two years before
• You have filed for tax return accurately
• You have filed the tax return two years before the bankruptcy
• Your taxes are assessed 240 days before filing for bankruptcy

If you qualify for the tax debts then the discharge will include interest and penalties generated by that tax debt. But if you don’t fulfill all the requirements, then tax debts and penalties that occurred due to these debts will not be discharged.

After getting the answer of are taxes dischargeable in chapter 7, you might be thinking about whether or not you can apply for bankruptcy. Well, you can apply for bankruptcy to discharge other debts, but you need to pay your taxes.

Are Taxes Dischargeable in Chapter 13?

If you are planning for the chapter 13 bankruptcies in which the court trustee develops a partial repayment plan, then this plan will include all your tax debts. If you meet the following criteria, then the IRS will consider your tax debts as non-priority debt. This is the criteria:

• You want to discharge income taxes
• The taxes payment date way two years before
• You have met all the requirements and filed the tax return properly
• You have filed for bankruptcy after two years of filing the tax return
• IRS has assessed your taxes 240 days before filing for bankruptcy

Once you qualify for the tax discharge, the court will determine the amount of tax you can easily afford to repay. Hence, you can’t discharge the entire tax amount through chapter 13. You need to repay some of the tax debts to the state tax or IRS office by following the payment plan. After that, your remaining balance will be discharged.

But if you don’t meet the mentioned criteria, you will be subjected to “priority debt.” This way, you will have to pay your tax debts in full but through the repayment plan.

How do I get my IRS Debt Forgiven?

IRS offers you several opportunities to get rid of your tax debts. All these options have different requirements and qualification criteria.

One-Time Forgiveness

Some of you reading this might be wondering “is there one-time tax forgiveness?” If you are planning to benefit from the one-time tax forgiveness, then it’s best to hire experts. This is because they have an understanding of the penalty abatement guidelines. What’s more, they also have enough experience to compose effective penalty abatement requests.

A major problem in applying for the penalty abatement plan even if you qualify is that there are no hard and fast rules that determine whether the IRS will approve your application. This forgiveness plan entirely depends on the IRS representatives who you are dealing with.

There are several ways to apply for penalty abatement. Your hired professional will choose the ones that will work for your circumstances. They might choose to request for one-time forgiveness through a written letter, verbally, or official form. The easiest way to apply for this forgiveness program is by discussing the matter in person. You might have to offer documents and other proof to support your claim.

IRS Fresh Start Program

This tax forgiveness program is designed to help small businesses and indebted taxpayers so that they can get rid of their tax debts. Although there were tax relief options available before IRS developed this program, Fresh Start Program has several other laws that make tax relief approachable for many people. The Fresh Start Program includes two main options, IRS installment agreement and Offer in Compromise.

·         IRS Installment Agreement

This program is for people who owe the IRS a great amount of money in penalties, interest, and tax debt. If you have these debts, experts recommend you first try applying for the installment agreement program. This agreement is predominantly a payment plan of the IRS. It gives you an opportunity to pay back your debt on a designated time period. When you opt for this plan, you don’t need to worry about the tax liens or levies.

Based on your tax debt, you can choose between long-term and short-term payment plans. In the case of a short-term plan, you need to pay for the debts within 120 days. This plan is also free and has simple regulations to follow. On the other hand, a long-term payment plan requires you to pay tax debt between 121 days and 3 years and you need to pay the fees from $31 to $225 based on your circumstances.

That said, the organization can partially waive fees if you are a low-income taxpayer. You will continue to accumulate fees and penalties while you are on this program. Therefore, it’s best to pay tax debts as early as possible.

You can easily qualify for this program if you owe less than $10,000. The IRS will approve your request for the IRS Installment Agreement if you meet the following criteria:

• You have not missed payment or filing deadlines in the past 5 years
• You agree to pay for debt within 3 years
• You are agreeing to meet deadlines in the future.

·         Offer in Compromise

If you are thinking about how do I get my IRS debt forgiven, offer in compromise is the ideal option for you. Offer in compromise provides you an opportunity to settle your debt.

This way, instead of paying in full, you need to pay a specific tax debt. It is a legitimate approach if you can’t pay your taxes through the other options. The IRS considers several factors to decide the settlement amount for you. This includes:

• Asset equity
• Ability to pay
• Expenses
• Income

After assessing these factors, the IRS will offer you an amount that they expect you to pay in the designated time period. The organization recommends people explore all the other options before opting for this method. What’s more, this option is also not for everyone as you still need to pay debts.

Bankruptcy Payment and Tax Deductibles

Are Bankruptcy Payments Tax Deductible? Generally, payment of personal bankruptcy is not tax-deductible on an individual’s return. However, if the cause of personal bankruptcy is a business failure, you might be able to get the deduction on the amount of the business failure that relates to personal bankruptcy.

A factor that can impact the request of the origin-of-the-claim doctrine is that the relationship between personal bankruptcy and business failure can be complicated and hard to understand. This problem generally occurs when the business failure happens a year before you file for bankruptcy.

Additionally, the taxpayer’s employment status can also hide the underlying business problem that leads to bankruptcy. Several company owners use personal credit to get business funds to pay personal debts. Therefore, it is vital for you to know your personal debts. You also need to provide proof and documentation that can separate business and personal debts.

Bankruptcy Fees and Tax Deductibles

Are Bankruptcy Fees Tax Deductible? Only one type of bankruptcy expense is deductible, while you are obliged to pay others. If you take the help of an attorney for your bankruptcy process, you have the option to claim for the deduction on the expert’s fees. The IRS offers you this opportunity because professionals can help you understand your tax refund.

If your attorney offers you legal advice for the bankruptcy along with several other services, the attorney has to categorize the bill and mention the tax advice fee separately so that you can get deductions on fees.

This way, you can deduct a particular portion you have paid to your attorney. It’s important to discuss this before you hire an attorney. You need to clarify that they have to separately categorize the fee cost on the payment slip so that you can claim for tax deductibles.

Bottom Line

Eliminating tax debts is possible by filing for bankruptcy. However, you need to consider several factors before filing a tax deduction. Filing for tax debts is vital before opting for bankruptcy, as the IRS will only consider your tax deduction application if you have applied for it a few years before. Also, it would be best to take advice from experts who can guide you throughout the process.

Learn More

Is Cancellation of Debt ( 1099-C ) Income Taxable?

3 Most Common Types of Bankruptcies

Can You Sell a Property With a Tax Lien?

How to Pay IRS Taxes?

Sources

https://smallbusiness.chron.com/bankruptcy-legal-fees-taxdeductible-63605.html

https://www.thetaxadviser.com/issues/2009/aug/deductibilityofbankruptcycostsandtheoriginoftheclaim.html#:~:text=Normally%2C%20costs%20of%20personal%20bankruptcy,on%20an%20individual’s%20tax%20return

https://www.irs.gov/payments/offer-in-compromise#:~:text=Apply%20With%20the%20New%20Form%20656&text=An%20offer%20in%20compromise%20allows,so%20creates%20a%20financial%20hardship

https://www.bankruptcyinbrief.com/codincome/#:~:text=For%20the%20average%20individual%20consumer,called%20cancellation%20of%20debt%20income