Introduction to Tax Debt and Bankruptcy

How Common is Tax Debt Today?

Tax debt has become a prevalent issue for many individuals today, especially in the current economic climate. Barry notes that it’s not uncommon for people to have not filed tax returns for years, which complicates their financial situation. Generally, taxes may be discharged in bankruptcy after a certain period, but when returns aren’t filed, they never become non-dischargeable, creating a long-term burden.

Barry shared an example of a case where a client has 1,800 Bitcoin but hasn’t filed returns for five or six years. The IRS then files estimated returns, which can be beneficial in some cases but not always. In Massachusetts, Barry points out, the state tax authority is more aggressive than the IRS, especially when people neglect quarterly taxes or are self-employed.

Common Reasons People Accumulate Tax Debt

Several factors contribute to overwhelming tax debt, including underwithholding or overwithholding, which leads to tax liability. Many individuals are unprepared come tax season and may scramble to cover their taxes. Business owners, especially those with closely held businesses, often use employee withholding taxes to cover other financial needs, creating tax liabilities.

Another major issue is trust fund taxes, which are non-dischargeable and can lead to severe consequences. The IRS has a collection statute of limitations of either six or ten years, and when a tax lien is filed, it can remain in place for up to ten years. For some, the strategy is to wait out that time period, which can be a risky move.

Understanding Bankruptcy’s Role in Tax Debt Relief

Bankruptcy, specifically Chapter 7, can be a tool to hold off collection activities by providing an automatic stay. However, bankruptcy does not necessarily eliminate tax debts in their entirety. When filing for bankruptcy, some tax liabilities can be discharged if certain criteria are met. Barry highlights that filing for bankruptcy can offer relief, especially for taxpayers facing tax debts that would otherwise be non-dischargeable.

Another option for dealing with tax debt is the IRS’s offer in compromise program, which allows individuals to settle their tax debt for less than the full amount. This process involves evaluating the liquidation value of assets and the amount that could realistically be collected from an individual over six years. Barry even shared that the IRS has an online offer in compromise calculator that anyone can use to estimate potential settlements.

Asset Liquidation in Tax Debt Resolution

Barry explains that asset liquidation is a more common tactic in business settings than personal ones. Despite the fear many have of the IRS, the reality is that the IRS rarely seizes assets unless it’s a significant issue. The threat of an asset seizure often remains just that—a threat. Most of the time, dealing with IRS notices involves navigating computer-generated communications until a personal visit from a revenue officer occurs.

Once a personal visit or action is initiated, the situation becomes more urgent. In many cases, individuals may not need to take drastic action immediately, especially if they’re waiting for the discharge of their taxes in bankruptcy. For example, Barry is currently advising a client who is waiting for his tax debt to become dischargeable in August, after which they plan to file bankruptcy and eliminate the debt.

When to Consider Bankruptcy vs. an Offer in Compromise

For individuals facing substantial tax debt, bankruptcy may be an option, but it’s not always the first course of action. Barry typically recommends filing Chapter 7 bankruptcy to discharge other debts and then pursuing an offer in compromise for the remaining tax liabilities. This strategy ensures that only the taxes owed at the time are addressed, rather than dealing with a broader spectrum of financial issues.

Bankruptcy may not always be the best option, especially if the tax debt is not dischargeable. In such cases, individuals may need to explore options like the offer in compromise, which allows for the settlement of tax debts at a reduced amount. However, choosing this route depends on one’s willingness to face aggressive collection tactics from the IRS or state tax authorities.

Pros and Cons of Bankruptcy for Tax Debt

The major benefit of filing for bankruptcy in cases involving tax debt is that it can lead to the discharge of qualifying taxes. Barry has a specialized program that runs tax transcripts to determine exactly when taxes will be dischargeable, which helps clients strategize their filings. If there’s a delay, it might make sense to wait until taxes are dischargeable rather than file prematurely.

On the flip side, if taxes are non-dischargeable, bankruptcy won’t provide much relief. In such cases, individuals might want to focus on other methods like negotiating an offer in compromise to resolve their tax debts without the threat of IRS action.

Dealing with Tax Debt Over Time

Barry frequently works with clients who have neglected taxes for several years, often because of poor advice from accountants or confusion regarding tax returns. One client, for example, had not filed returns for several years, which led to an eventual tax liability of $65,000. Barry’s approach was to wait until the tax debts became dischargeable, which is expected in the near future. This strategy can provide clients with the relief they need while the statute of limitations runs its course.

Conclusion

Tax debt and bankruptcy intersect in complex ways, and it’s crucial to understand when each option makes sense. Whether it’s negotiating an offer in compromise, filing for bankruptcy, or waiting out the statute of limitations, individuals need solid advice and careful planning to manage their tax liabilities effectively.