Bankruptcy can provide tax relief, if your timing is right.
Tax troubles are at the heart of so many bankruptcy filings. It makes sense: bankruptcy is a powerful and predictable tool to get out of tax debt.
But filing bankruptcy before the end of the year may fix only a part of your tax problems. Any taxes for the current year aren’t part of the bankruptcy.
So I’ve been telling clients for weeks now: don’t file bankruptcy…..yet.
Time your bankruptcy filing for maximum tax relief: wait til January.
Why wait to discharge taxes
Because most people who owe back taxes are facing similar trouble for the current tax year.
Come the end of this tax year on December 31st, they’ll owe taxes for 2024 because their withholding doesn’t match the taxes due in April, 2025.
In Chapter 13, which is almost always the better chapter for tax troubles, the Chapter 13 plan doesn’t address tax years that aren’t closed when the case is filed.
That means that your liability for the year in which you file bankruptcy doesn’t get priority for payment over your credit card debts (unless you elect a short tax year in Chapter 7). In fact, the open tax year often can’t be paid through the plan.
And I hate to see money go to general unsecured creditors when tax debt remains.
So, I’m counseling clients to wait til January to file. Get this current year’s tax troubles rounded up and corralled in the Chapter 13.
Buy yourself 5 years to pay whatever you owe for this year along with the taxes that brought you in my door in the first place.
Tax liens in bankruptcy
Another one of Chapter 13’s superpowers is the ability to cut tax liens down to size.
No matter how huge the tax liens are, in Chapter 13 those liens get paid only the value of your possessions when you file your case.
Really, the liens get paid only the value in your assets that remains after liens that were filed before the tax lien.
So even if the tax lien is $100,000, if the equity in your possessions is only $10,000, ten thousand is what you pay over the 5 years of the plan
And after the case is over, the balance of the lien is voided along with the tax liability that it secured.
Pretty neat, eh?
When IRS threatens to levy
A notice of intent to levy is often what makes folks call up a bankruptcy lawyer. That notice seems to promise doom and the end of life as you know it.
Know that an actual levy is the IRS’s last resort. There are processes and procedures built into the Service’s collection process.
Also, a levy gets only what’s in the levied bank account on the day the levy is served. If the bank balance is tiny, the IRS’s recovery is tiny.
Usually, if you engage the IRS in discussions about a payment plan, or even make a payment on your debt, your case becomes a lower priority for an understaffed IRS.
It depends on the numbers, of course, but usually, the advantages to waiting til January 1 outweigh the risk of collection between now and then.
Once your case is filed, the IRS, along with every other creditor, is forbidden to continue collection action.
Before you file bankruptcy
There’s lots to do to prepare for a bankruptcy filing. These weeks won’t be wasted.
Why your bankruptcy papers are critical
Your bankruptcy attorney will need lots of paper from you to get your schedules right and to calculate a plan to get you out of debt.
Some of the things you’re likely to need include:
- Pay stubs for the past six months, including December’s
- Tax return
- Contract for any financed vehicles
- Tax notices from federal and state
- Appraisal or broker’s opinion on the value of your real estate
- Proof that your retirement accounts are exempt
- Bank and investment account statements
You also need to prepare to get your tax return for this year filed quickly after your bankruptcy is filed. You have 45 days from the filing of your Chapter 13 to get the return filed. So start gathering whatever you’ll need to get the return on file promptly after your bankruptcy case is filed.
And, readjust your withholding for next year so you are adequately withheld for the coming year. Owing more taxes once you are in bankruptcy is grounds for the dismissal of your case.
Find a good bankruptcy lawyer
Bankruptcy is difficult enough. You need to have confidence and rapport with your bankruptcy lawyer.
Use the time between now and the first of the year to interview a bankruptcy lawyer and find one with experience in tax matters.
It’s equally important to find a lawyer to whom you are willing to confide your secrets and your worries. The problem I can’t protect you from is the one you don’t tell me about.
So when you hear those screeching commercials that say “don’t file bankruptcy”, you can add, “yet”.
File bankruptcy at the right time for the right reason.
