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Can bankruptcy resolve major income tax debts?

On Behalf of | Apr 14, 2024 | Bankruptcy

People can fail to meet their income tax obligations for a variety of reasons. There are some people who intentionally manipulate their income tax returns to reduce what they owe. However, the vast majority of people who find themselves facing income tax debts likely did not violate tax rules intentionally.

Instead, a misunderstanding about credits or deductions or mistakes regarding reporting of their income led to them owing a large amount to the Internal Revenue Service (IRS) for unpaid federal income taxes. The balance that someone owes can quickly spiral out of control, as the IRS assesses interest and fees on unpaid tax obligations. The IRS can take action against someone’s income or assets for tax debts.

Those worried about their financial circumstances might consider filing for bankruptcy when they fall behind on their income taxes. However, it is important to understand that personal bankruptcy filings can only eliminate income tax debts under certain circumstances.

Tax debts can be difficult to discharge

As a general rule, tax debts are among the financial obligations that are usually ineligible for discharge in bankruptcy proceedings. However, certain income tax debts are theoretically dischargeable. If someone has income tax debts that are more than three years old, they could potentially discharge those older past-due income tax balances. More recent income tax debts and other forms of tax debt are typically ineligible for discharge in a bankruptcy filing.

Can bankruptcy still help?

Theoretically, bankruptcy can still be a smart financial move for an individual who has fallen behind on their tax responsibilities. A timely filing could free up someone’s income to make payments on their tax obligations. Someone who has eliminated medical debts or credit card balances may be in a better position to propose a reasonable offer in compromise to the IRS. It is possible to settle tax debts in certain cases through a payment arrangement or a single lump-sum payment. A pending bankruptcy might also prevent aggressive collection efforts until someone has an opportunity to rework their budget.

Discussing income tax debts and personal bankruptcy with a skilled legal team can help someone to choose the right solution given their current economic circumstances. Those who understand their options can determine the best solution possible when they can’t reasonably cover their income tax debts.