When paying off your creditors becomes hopeless, and you exhaust all means of settling debt, you may want to consider filing bankruptcy. But if most of your outstanding debt comes from tax debt to federal and state authorities, think twice before going down to the courthouse. Bankruptcy does not always discharge tax debt.
Why File Bankruptcy?
When you file bankruptcy, you can stop to harassing phone calls, most wage garnishments, and even home foreclosure proceedings. Specifics vary by state and by the nature of your creditor, but in most cases, creditors are forbidden from pursuing further collection activities while your case is working its way through bankruptcy. At the end of the process, you may have to sell much of what you own, but you may be able to discharge certain debts completely (under Chapter 7), or work out a realistic debt repayment plan under Chapter 13 for individuals, and Chapter 11 for small businesses.
Dischargeable and Non-Dischargeable Debts
Not all debts can be discharged through bankruptcy proceedings. The law prohibits you from obtaining a discharge on court-ordered child support, most federally guaranteed student loans, fines incurred as a result of criminal activity or damages awarded as a result of vindictive criminal behavior, and certain kinds of tax debt.
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Discharging Tax Debt
Generally, you will not be able to discharge tax debt that has become payable or been assessed within the past three years. This is true for federal, state and municipal taxes. Furthermore, you cannot game the system. You cannot run up dischargeable debts just prior to bankruptcy to pay off a student loan or back taxes that are not dischargeable.
The IRS has options for people who have trouble paying their taxes. For example, you could request a delay in collection until your financial situation improves. You can work out a payment plan, as long as your plan will pay off the entire debt owed in the 10-year statute of limitations. If your tax debt is less than $25,000, you can request a payment plan via the IRS's website. You may also request an offer in compromise, which will settle the tax debt for less than the full amount owed. The IRS may not accept your request but will generally enter offers in compromise if there is doubt about whether you owe the tax, about whether the tax is collectible in full, and whether you or a dependent will experience a severe hardship as a result of continued collection efforts.