Options for Discharging Federal Tax Debt

Many people may think there is no way to eliminate tax debt to the Internal Revenue Service (IRS). Actually, however, there are several options for lessening or discharging tax debt, including filing for bankruptcy protection or through an offer in compromise agreement with the IRS.

If a tax debt is forgiven or discharged, the debtor is no longer responsible for payment of the amount owed, and all collection activity of the IRS - like wage or bank account garnishments or real property liens - must stop from that point forward. However, liens that were levied prior to the discharge of tax debt through bankruptcy must still be paid.

Discharging Tax Debt Through Bankruptcy

It is more likely that a debtor who qualifies for Chapter 7 bankruptcy will be able to successfully discharge some types of tax debt than one who is enrolled in a Chapter 13 debt repayment plan, but it is important for anyone facing insurmountable tax debt to thoroughly investigate all bankruptcy and tax relief options.

While not all tax debts are dischargeable even through the more generous debt forgiveness provisions of Chapter 7 bankruptcy, federal income tax is more likely forgivable if:

• The debt is solely for income taxes, not for payroll or sales taxes and not for penalties for unpaid taxes
• The debtor seeking the discharge properly filed tax returns at least two years before filing for bankruptcy
• The tax debt itself is at least three years old (based on a tax return the debtor filed)
• The tax debt was assessed by the IRS at least 240 days before the date of the bankruptcy filing
• The debtor seeking discharge did not commit any actions evocative of willful tax evasion or tax fraud (i.e. filing the tax return under a different name or different social security number to delay its processing or purposely filing an incomplete return for the same purpose)

Certain types of tax debts are simply not eligible for discharge, including trust fund taxes, business taxes, and penalties accrued on non-dischargeable tax debts.

In a Chapter 13 bankruptcy, a tax debt might not be outright dischargeable, but it might be included in a Chapter 13 repayment plan. Additionally, current penalties may be discharged and future penalties avoided.

Tax Debt Options Outside Bankruptcy: Offer in Compromise

It may be possible for a debtor to negotiate directly with the IRS in order to make a large and seemingly insurmountable tax debt manageable with the use of what is known as an offer in compromise (OIC). An OIC is an agreement between the debtor and the IRS to accept less than the full amount of an established tax liability.

To obtain an OIC a taxpayer must file the appropriate forms along with an application fee, and provide a down payment on the debt. To determine if a taxpayer qualifies for an OIC, the IRS will weigh the applicant's ability to pay all or part of the debt, his or her income, expenses and assets/equity. Most offers in compromise are accepted if the IRS determines that the lower amount is the most that can be collected in a reasonable time from the debtor.

Other Tax Debt Options

Outside of the offer in compromise process, there are other ways to negotiate with the IRS to make tax debt more manageable. For example, it is usually possible to establish a monthly payment program instead of being forced to make a single lump sum payment to pay off a tax arrearage.

A similar installment payment program that is relatively new to the IRS is what is known as the "partial payment installment agreement" wherein the IRS agrees to accept a lower amount over a longer period of time, and lowers the total amount due based on the taxpayer's willingness to continue to make payments.

It might also be possible to put IRS collection efforts "on hold" for a short time by requesting that the debt be labeled "not currently collectible." This designation means that the IRS has voluntarily contractually agreed to not make collection attempts on a particular tax debt for a certain period of time, usually one year.

Regardless of what method you choose to manage or discharge your tax debt, having a skilled tax law or bankruptcy attorney by your side can be invaluable to getting an agreement with the IRS in place, and starting back on the road to financial recovery.