Bankruptcy tends to get a bit of a bad rap. You probably picture financial ruin and losing everything. But that’s not always what it means, especially when you’re facing a mountain of tax debt.
While you might think your only choice is a rigid payment plan or a long-shot Offer in Compromise, there’s another powerful, court-backed tool that could be an option for your situation: Chapter 13 bankruptcy (aka: the wage earner’s plan).
With a Chapter 13 filing, you can reorganize your finances and get a fresh start, often while preventing foreclosure of your Mount Vernon home or the liquidation of your assets. And yes, it can be a game-changer for your tax debt as well, and that’s what I want to focus on today.
The moment you complete your Chapter 13 filing, a legal shield called the “automatic stay” goes up. This immediately stops IRS collections. No more threatening letters, no more wage garnishments, no more bank levies—instant relief.
And even better news: while you’re repaying through your Chapter 13 plan, the IRS is prevented from collecting, and penalties typically stop accruing. In many cases, interest on certain tax debts may also be paused, especially when it comes to older, dischargeable tax obligations.
However, interest on priority tax debts may still accrue during the plan, depending on the specifics of your case and local court interpretations. So while you’re gaining breathing room, it’s important to understand how your exact tax profile fits into the repayment plan.
A Chapter 13 plan allows you to repay your taxes over a manageable three to five years, on your terms, approved by the court, not the IRS’s potentially aggressive demands. Plus, it can protect your Westchester County home, car, wages, and licenses from IRS seizure.
Now, you might not be completely off the hook for what you owe. The IRS categorizes taxes in bankruptcy, and this is crucial: taxes like recent income tax generally must be paid in full through your plan.
Older income tax debt might be partially or completely discharged (forgiven), only if it meets specific criteria, often called the “3-2-240 rule.” This rule looks at when the tax return was due, when it was filed, and when the tax was assessed. It’s possible you’ll discover that some of your old tax debt doesn’t have to be repaid at all.
Now, while some tax debt can be cleared with Chapter 13 filing, tax liens are a bit different. If the IRS has already filed a tax lien against your property, you’ll likely need to pay the value of that lien through your plan, but not necessarily the entire underlying tax debt.
So, what would make this a better option than an IRS Installment Agreement or an Offer in Compromise (OIC)? Let’s break it down:
- IRS Installment Plan: You’re still paying interest and penalties, and the IRS can still file liens. It’s their game, their rules.
- Offer in Compromise (OIC): These are tough to get approved. According to the IRS Data Book, the acceptance rate in 2021 for OICs was around 30.7 percent. That means over two-thirds of applicants are rejected!
Chapter 13 filing, however, offers…
- Court protection from IRS aggression.
- Predictable repayment with no added penalties (and often no added interest).
- The possibility of discharging old tax debts.
- A definitive end to the cycle of falling behind.
There is a caveat that is crucial to note here: during your 3-5 year Chapter 13 plan, you must file and pay all new taxes on time. This is absolutely critical. Falling behind on new tax obligations can jeopardize your bankruptcy protection and lead to the IRS resuming collections. With that in mind, having a plan in place to ensure timely payments is needed.
Navigating the nuances of tax debt and bankruptcy is complex, and it’s not a one-size-fits-all situation. As a tax resolution specialist, I can help you classify your debts correctly, identify what may be dischargeable, and work with legal professionals to design a plan that keeps you compliant moving forward.
Let’s weigh whether a structured repayment plan through Chapter 13 filing—or another tax resolution strategy—makes the most sense for your unique situation. Grab a time on my calendar if you’re ready to stop fighting the IRS on your own:
calendly.com/l-karam/prospect-schedule
Here to bring the right solutions to your tax problems,
Lynn Karam