A lot of Americans are drowning in IRS tax debt. Many of them consider bankruptcy for tax debt relief. However, bankruptcy would wipe out or reduce your tax debt only under certain circumstances. Read on to know more.
When can you discharge tax debt in bankruptcy?
You can clear IRS tax debt only if the following conditions are met:
I. The three year rule: Your taxes can be discharged in bankruptcy only if they are pending for more than three years.
II. The 240 day rule: Your tax debt is eligible for discharge if the IRS has assessed your pending taxes at least 240 days before filing bankruptcy.
III. Tax evasion: The debtor must not try to evade taxes by changing his social security number, spelling of his name etc. He should not deliberately hide information to skip taxes. Any kind of fraud would disqualify the debtor from tax discharge in bankruptcy.
Tax liens and bankruptcy
Did the IRS put a lien on your property prior to bankruptcy? That's bad news because the lien will survive Chapter 7 bankruptcy. Nonetheless, the value of the lien will be equal to the value of equity in the property. If you have little equity in your home, then the value of the tax lien will also be less.
A few things to remember
I. Only income taxes can be discharged in bankruptcy. Other types of taxes like payroll taxes, tax penalties, and trust fund taxes are usually not dischargeable in bankruptcy.
II. Tax debt arising from unfiled tax return is not eligible for discharge.
III. Filing bankruptcy will stop the IRS from garnishing your wage and seizing your bank accounts.
Tax debt reduction in Chapter 13 bankruptcy
You cannot wipe out your tax debt completely in Chapter 13 bankruptcy. But this type of bankruptcy involves reduced payments. Therefore, you may not have to pay back your entire tax debt if you file Chapter 13 bankruptcy. Also, all collection activities of the IRS come to a halt when you file Chapter 13. Moreover, interest and penalties on tax debt will stop immediately, if you file this type of bankruptcy.
Alternative to bankruptcy
You can also reduce your taxes through an "Offer in Compromise (OIC)". With this agreement, the IRS forgives a part of your debt. The IRS will accept an OIC based on the following grounds:
I. You are not in a position to pay the entire tax debt.
II. There are doubts about the tax assessment.
III. Under special circumstances, the IRS will consider an OIC. For example, if the debtor is facing extreme economic hardship, then the IRS might agree to settle his tax debt for a reduced amount.
If you are planning to clear your tax debt through bankruptcy or an OIC, then do remember the above points. Good luck.