Owing federal taxes is not uncommon. Internal Revenue Service (IRS) data shows that in 2017, about 14 million people owed an estimated $131 billion total in taxes, penalties and interest. When faced with a difficult financial period, paying off that tax debt in full can be near impossible.
There are ways to resolve the issue, however, and settle that tax debt. While a few options exist, we’re going to focus on two here, bankruptcy and offers in compromise, and look at how one can impact the other.
Bankruptcy and back taxes
Contrary to what many people think, there are circumstances in which individuals can discharge past due federal taxes through Chapter 13 bankruptcy. It is not automatic, however. In order to have federal tax debts discharged, you have to:
- Ensure you have filed all required tax returns for the prior four years
- Keep filing taxes while the bankruptcy process plays out
- Pay current tax debts as they come up
If you don’t stay up to date on federal taxes, your bankruptcy case may be dismissed.
In addition, only certain federal tax debts are dischargeable, and specific thresholds must be met. For example, debt from a non-filed return is dischargeable only if that debt is at least three years old.
Submitting an offer in compromise
An offer in compromise is another option. Essentially, you are trying to strike a deal with the IRS in which you pay a portion – but not all – of your tax debt, and the IRS considers the debt settled. The agency will consider these offers if you can’t pay your full debt, or if doing so would create financial hardship.
The IRS won’t accept any old offer. The agency will consider your ability to pay, income, expenses and asset equity, as well as whether the offer you make is the most it can expect to receive from you within a reasonable period of time.
Can a bankruptcy threat lead to a better offer?
In 2017 the IRS received about 62,000 offers in compromise to settle tax liabilities. It accepted less than half of those (about 25,000).
In some cases, leveraging the possibility of bankruptcy could lead to the IRS accepting an offer of compromise that is more favorable to you. Consider the situation: If you file bankruptcy and your federal tax debts are discharged, the IRS may see little, if any, of what you owe. With an offer of compromise, the IRS will receive something – and likely more than if you go through with bankruptcy.
If you have tax debt, these factors are important to keep in mind while considering options and consulting with your tax attorney.