Dealing with Tax Problems Inside and Outside of Bankruptcy

You owe income taxes for a number of years, let’s say tax years 2012 to 2019, and you are continuing to incur unpaid income taxes for 2020. What do you do?

Of course with COVID-19 going on, most actions by the taxing authorities are with being put off or put on hold. But the virus is not going to last forever (thank God) and things will return to normal someday, including attempts to collect taxes. They may be on you already and the virus does not seem to be slowing them down.

The best thing you can do is consult with a bankruptcy attorney who either is or works with a tax professional who helps resolve tax issues. The tax professional may be your CPA although not every CPA helps with tax resolution issues.

How do you get from here to there, i.e.  file bankruptcy, and what do you do after you come out of the protection of bankruptcy?

Alternatively, how can you avoid bankruptcy and just deal with the taxes outside of bankruptcy?

While almost every situation is different, I am going to use a fact pattern that I find is fairly common. The numbers for you may increase or decrease depending on your situation,  but the approach maybe the same. You owe income taxes of $40,000 for tax years 2012-2016. You owe another $40,000 for 2017-2019 and thus far in 2020, you owe an additional $5,000.

Your monthly income is down right now but you hope to have it to where you are bringing home $5,000 in the next 6 months.

You owe about $50,000 in credit cards that you are becoming delinquent in paying. You have loans secured by your home and vehicles but are up to date with those payments. The equity in your assets is minimal when you take into consideration the value, less the liens and the exemptions you are entitled to under the law.

The best approach is to be in contact with the taxing authorities. I have rarely seen when the IRS will garnish your wages if you are in contact with them. On the other hand,  it is in situations where the taxpayer has thrown the IRS notices into the circular file ( the trash can)  where I have seen garnishment take place. While it is best to have the contact made by your tax professional, sometimes  that is not possible for several reasons. The other thing you need to do is to catch up on any of your delinquent filings.

Normally your tax professional will know enough to delay any action by the tax creditors (as I like to say: “kick that  can down the road”), while I am looking at your options. Another very successful tool,  either before or after bankruptcy, or as an alternative to bankruptcy, is to get into the currently non-collectable status (CNC). This keeps the tax creditor from taking any action against you until your income reaches a certain level.

If we decide a Chap 7 bankruptcy is your best option, (the reasons why one would file bankruptcy at all or will file a specific type of bankruptcy is beyond the  scope of this paper), the good news is that 2012 -2016 will be discharged or legally forgiven in the bankruptcy.  It would be best if your returns had been filed on time but even untimely filed returns can often still be included in the discharge. Your credit cards will also be discharged. What to do with your home and vehicles will depend on your situation but the best advice is:  if you want to keep your home and keep your vehicles, try to keep your payments  up to date and continue making the payments.

The taxes for 2017-2019 will not be discharged so that you will owe those taxes coming out of the Chap 7 bankruptcy. At that point, now outside of bankruptcy, you could get into the CNC status ( taxes have a collection period of 10 years), a payment plan (to do so, it might be best if you are up to date with the 2020 taxes), or if things go really bad for you, then you could take a look at filing a Chap 13 bankruptcy, just to deal with the undischarged taxes.

This brings in an idea that maybe you should have filed a Chap 13 to begin with, which leads to a question: why file a Chap 7 bankruptcy case over a Chap 13? Chap 7 is normally going to be over (you will get a discharge so that you can begin restoring your credit in 150 days.) Alternatively, IN a Chap 13, you are in bankruptcy for 5 years. Why would you go into a 5 year bankruptcy over a 150 day bankruptcy?

There are 3 basic reasons:

This is where taxes could come in. In a Chap 7, you will come out of bankruptcy still owing the non-discharged taxes. How to handle them? In a chap 13, you could come up with a plan to pay your tax creditors over 5 years.

But a big question for you is: do you really want to be in bankruptcy for 5 years?

While it would be best to avoid bankruptcy at all, but if you had to file, it might be best to keep it to 150 days rather than 5 years. But sometimes that is just the way it goes. Chap 13 is not that bad. You can have a good life and will come out without any taxes. However, if the option you chose is a Chap 7, so that you can deal with most of your debt, reduce the taxes down to a manageable level that your tax professional tells you can be dealt with outside of bankruptcy,  the Chap 7 might be the better way to go.

I hope this helps.

*Kevin Campbell is certified as a specialist in bankruptcy and creditor-debtor law by the South Carolina Supreme Court. The statements provided by Mr. Campbell cannot be construed as an opinion for you financial matter. You should contact Mr. Campbell or your bankruptcy professional for an opinion regarding your situation.