Income Tax Obligations In California
California is one of the forty-three (43) states that impose a state income tax. In addition to the state income tax obligation, residents must satisfy any applicable federal income tax obligation each year. Unfortunately, tax debt can add up just like credit card or medical debt and be just as hard to pay off. When you file for bankruptcy, your unsecured debt will be discharged. Does that apply to income tax debt?
Options To Consider Before Filing Bankruptcy
Prior to filing bankruptcy, you have several options for dealing with income tax debt. These include “offer in compromise” (OIC), installment agreements, or filing an amended past tax return. Because each person has different financial obligations and circumstances, there is no perfect solution. You’ll need to look at all of the facts of the situation and weigh each option carefully when deciding how to proceed.
The OIC is available to taxpayers who have no delinquent returns, have made all estimated tax payments, and are not in an active bankruptcy. An OIC is like a debt settlement; you’ll make an offer to the IRS for less than you owe and, if they accept it, your debt will be fully satisfied. The OIC option is generally a better solution for those who have a higher tax liability and lower ability to satisfy the debt. In an OIC program, the taxpayer typically must make an initial high payment and must remain in full compliance with the terms of the program during its pendency and for five (5) years thereafter.
The IRS may also allow you to make installment payments on your tax debt. Entering into an installment agreement effectively makes the taxpayer compliant in the eyes of the IRS and prevents any additional steps toward collection of the debt. Installment agreements will reduce hassling phone calls and letters from the IRS as it shows the agency the taxpayer’s desire to satisfy the tax debt. The downside to the installment agreement is the continual accrual of interest on the tax obligation and the length of time it may take to complete.
If the taxpayer chooses, there is an alternate method of addressing delinquent tax debt: filing an amended past due tax return. This option is best considered when filing would result in a direct reduction in tax liability to the taxpayer, either due to preparer error or some other occurrence. This option and all other options should be reviewed with the help of a professional who has knowledge of the applicable tax codes and the statutes of limitations.
Is Bankruptcy A Viable Option?
Filing bankruptcy may discharge some of the tax liability for California state and federal income tax. Whether or not your tax debt is dischargeable will depend on several factors, including:
- The age of the tax debt, which is based upon the date the tax returns were due to be filed.
- The date of assessment of the taxes, which is determined by the taxing agency (state or federal).
- Whether you attempted to avoid the tax debt willfully or fraudulently.
- Additionally, to discharge California state and federal tax debts in a bankruptcy, you’ll need to satisfy these requirements:
- The tax debt is over three (3) years past due, from the more recent of either the original filing deadline or any extension.
- The taxpayer has filed the returns in a timely manner OR it has been at least two (2) years since the returns were filed.
- The taxpayer is not attempting to commit fraud or evade the tax debt AND the taxes have not been assessed in the last 240 days (the 240 day rule).
- NOTE: in California if the taxpayer has received a notice of tax due, the assessment date will be sixty (60) days AFTER the date of the letter. In other words, the taxpayer must wait 300 days from the date of the letter before filing. If you’ve committed to an OIC, it will delay the 240 day rule further.
Understanding The Automatic Stay
When you file for bankruptcy, you’ll get the protection of the automatic stay against your creditors. The automatic stay stops all collection actions during the bankruptcy. In other words, if you’re on the verge of foreclosure or engaged in a lawsuit, the commencement of the bankruptcy action will temporarily halt any further action against you while the automatic stay is in place. However, a creditor can file a motion to lift the automatic stay for a variety of reasons. If the bankruptcy court grants the creditor’s motion, despite the continuation of the bankruptcy case, the automatic stay, as it applies to that creditor, would no longer offer any protection.
Types Of Bankruptcy
Consumers generally file under one of two types of bankruptcy. Under Chapter 7, your bankruptcy will discharge your unsecured debt. That may include income tax debt, as long as the debt meets the requirements listed above. In a Chapter 13 reorganization plan bankruptcy, you’ll commit to a payment plan for 3 to 5 years. The plan includes regular payments to the bankruptcy court trustee, who in turn makes the agreed upon payments to the debtors’ creditors, including the IRS and state income taxing agencies. Occasionally, you may be able to enter into an agreement with the IRS and adjust the amount of the debt owed as it is paid over the life of the plan. You’ll need to remain compliant with the plan throughout its duration and not become delinquent. At the end of the plan, your remaining unsecured debt will be discharged. Your income tax debt will also be discharged, if it meets the requirements listed above.
While you may not be able to discharge all of your tax liability in a reorganization bankruptcy, it is likely that you’ll be able to work with the state and federal tax creditor to reach a workable repayment agreement within the bankruptcy. This may be a more favorable repayment option than if you attempted to work an agreement outside of the bankruptcy.
If the IRS has already obtained a lien against your property, bankruptcy won’t wipe it out. They’ll still have a claim against that property. However, your personal liability for the lien will be wiped out. That means that if the IRS seizes and sells the property, but gets less than you owe, you’re not liable for the deficiency. The IRS will not be able to sieze any assets during your case without permission from the bankruptcy court.
What You Need To Do
Review the IRS Bankruptcy Tax Guide to understand fully the rights and implications relating to federal taxes that accompany a bankruptcy filing. If you’re struggling with tax debt and wondering if bankruptcy is the right option for you, take advantage of a free consultation with one of our experienced consumer bankruptcy attorneys. Contact us today to schedule an appointment. We’ll look at your tax history and determine if bankruptcy can help you wipe out your tax debt