Owe Back Income Taxes? Why Bankruptcy May Be Better than Making a Deal with the IRS Skip to main content

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Owe Back Income Taxes? Why Bankruptcy May Be Better than Making a Deal with the IRS


Income taxes

Past due taxes? Bankruptcy may help

Image Source: Flickr User Consumerist Dot Com

Owing back income taxes to the federal government can be very stressful. The IRS has many tools at their disposal to collect what you owe. North Carolina doesn’t allow commercial creditors, in most cases, to garnish your wages. If you owe NC state income taxes, they can garnish no more than 10% if your income. But the IRS is another matter. They can take most of your paycheck each week.

The maximum total creditor garnishment can’t exceed 25% of your pay, but the IRS can take far more than that and leave you with too little money to live on and pay your bills. After you file a return where you owe taxes, the IRS has 10 years to collect that amount. If you fail to file your tax return, the statute doesn’t start ticking, and the IRS can come back at you at any time to try and collect.

How does an IRS installment agreement work?

There are a couple of different types of deals you can make with the IRS - installment and OIC. An installment arrangement allows you to pay off your balance over time. This will see you pay the full amount of your debt, but, at least, you can do it in smaller monthly installments. So if your tax debt was incurred for a return you filed three years ago, that’s three years into the statute of limitations.

If you negotiate an installment arrangement that will last eight years, you should not have to make the final year of payments because it will exceed the 10-year statute of limitations. However, the IRS can sue for a judgment to extend the statute of limitations. But if you can negotiate an installment plan, this should not happen.

How does an Offer in Compromise work?

Another deal you can get is an Offer in Compromise (OIC). This is a negotiated offer to pay a lesser amount to the IRS. You can usually only get an OIC approved if you can demonstrate that you can’t afford to pay the full amount of your tax debt. However, an OIC will extend the statute of limitations. Here’s how. When you submit an OIC, the IRS will take the time to review it.

This can take six months, a year, or even two years. This period is useful to you because you can save up money to pay the amount you offered, in case it’s approved. But the larger problem is the statute of limitations pauses while the OIC is considered. If they take two years to decide, the statute restarts after they approve the plan. This can extend your liability period.

How bankruptcy can help you deal with tax debt

Past due income taxes can be discharged in bankruptcy – Chapter 7 can see older tax debts totally wiped out within months. There is a principle known as 3-2-240 that determines which taxes can be discharged. The taxes must have been owing for three years before when you file the bankruptcy. That means if you file bankruptcy in 2016, the taxes must have been for tax years 2013 or prior.

The two years part is that the tax returns must have been filed two years prior to the date you file bankruptcy. For instance, if you didn’t file your 2012 tax return but then file it in 2014, you should be able to discharge the debt since it would have been owing since 2012 (3 years) and filed in 2014 (two years) before the 2016 bankruptcy filing.

The last piece is a 240-day rule. Your taxes must have been assessed at least 240 days before your bankruptcy filing or NOT assessed at all. For instance, if you file your 2012 return on time, then a year later the IRS reviews your filing and assess additional taxes in 2015 (because they find an error, disqualify a deduction, etc), you must wait 240 days from that assessment date to file and have the taxes wiped out in bankruptcy.

All three of these provisions must be met – the three year, two year and 240-day requirements. If you owe many years of back income taxes, Chapter 7 bankruptcy can discharge much of your debt and only leave you with the most current years of back taxes to pay - so long as you meet the 3-2-240 requirements. 

Get the most complete income tax relief

If you owe back income taxes you can’t afford to pay, plus other debts including credit cards and medical bills, Chapter 7 bankruptcy can wipe your slate clean. And with Chapter 13 bankruptcy, you can include tax debts in your repayment plan to buy more time. Contact a reputable North Carolina bankruptcy attorney for more information about dealing with old taxes.

Contact the Law Offices of John T. Orcutt today. Call +1-919-646-2654 for a free North Carolina bankruptcy consultation at one of our offices in Raleigh, Durham, Fayetteville, Wilson, Greensboro, Garner or Wilmington.

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