Combine a large IRS debt, a lengthy IRS statute of limitations period (CSED), and a “good” income, and you may have a recipe for a large monthly IRS payment plan. Many people are living this “recipe” and as a result are paying thousands of dollars each month to the IRS and will continue to do so until the CSED ends, or their situation changes.
On the bright side, the payment plan keeps the IRS collection machine at arm's length while the CSED continues to run, but on the dark side, the debt remains and continues to grow tremendously as a result of penalty and interest. The debt can double every 5 years.
Meanwhile, the person in the large payment plan keeps his or her head down and struggles to pay the bill each month while feeding a family.
It feels hopeless for many people in this situation of course. They usually aren't good Offer in Compromise candidates, they may not be good chapter 7 bankruptcy candidates, and in the long run they feel like there isn't anywhere to turn.
But…there may be. Chapter 13 Bankruptcy.
What follows is a list of the most common reasons someone stuck in a high monthly IRS payment plan may want to look more closely at a chapter 13 bankruptcy.
1. The budget used to determine monthly payment is typically higher in a chapter 13 bankruptcy than in an IRS payment plan
This is a good thing and important to understand. Specifically, when the IRS is negotiating with you about how much you can afford to pay each month on the debt, it is allowed to use a standardized budget as a starting point. You can find it here. For most higher income earners, that budget is nothing like their actual budget.
The Chapter 13 Bankruptcy Judge is going to use a similar budget in determining how much you can pay overall, but there are certain things about how that budget is calculated vs. the IRS' standard budget that make it more friendly. Here are a few.
a. Priority tax debt is considered a “budget item”
The tax debt you owe may be relatively new. If it is it may fit into what is called the “priority” debt category. This means that when the Chapter 13 Judge is determining how much you can afford to pay each month, he or she will use 1/60th of that priority debt as a monthly budget item.
b. 401k Loan is considered a “budget item”
The IRS isn't going to consider your 401k or your 401k loan as monthly budget items. The Bankruptcy Judge in a Chapter 13 will consider the 401k loan payment a budget item in determining how much you can afford to pay.
c. Children's School Activities
The IRS doesn't have to consider these costs in your monthly budget. They Judge typically will.
d. Baby Supplies
Babies are expensive. The IRS doesn't typically care. The chapter 13 Judge should consider diapers and other out of the ordinary expenses related to your baby as a monthly budget item in determining how much you can pay.
e. Social Security Income
Social Security is income to the IRS. In a chapter 13 bankruptcy it isn't counted as income.
2. Penalty and Interest Stop Accruing
Chapter 13 bankruptcy stops the IRS' penalty and interest accrual on most tax debts. In an IRS payment plan the penalty and interest continue to accrue to their fullest extent and add lots of debt to your overall debt load.
3. Penalty, Interest, and the Underlying Debt can be Reduced or Eliminated
In a chapter 13 bankruptcy, tax penalties that exist on the date of filing are treated as “dischargeable” debt like credit cards and medical bills. Depending on how the payment plan ends up being structured the IRS may end up receiving little or nothing on that penalty by the end of the plan.
Certain tax debts are treated the same way. Read more about that here. If the tax debt is non-trust fund and certain other factors exist, bankruptcy law will treat it as “dischargeable” again like a credit card or medical bill. Depending on how the plan is structured, the IRS may receive little or nothing on the debt by the time the plan ends.
In an IRS payment plan you are going to continue to pay the debt off, until the 10 year period (CSED) runs out.
4. Property is Safe in a Chapter 13 Bankruptcy
A chapter 13 bankruptcy isn't a liquidation bankruptcy like a chapter 7 bankruptcy. No one seizes your assets, income, or bank accounts…including the IRS. Bankruptcy law places an automatic stay in front of the IRS and while the case is opened the IRS' hands are tied.
5. Entire Debt Situation is solved
The IRS payment plan only solves the IRS debt collection situation. It doesn't deal with other debts, and it's budget doesn't treat most other debt payments as budget items.
Depending on your circumstances however, a chapter 13 bankruptcy can do the following:
a. Treat your credit card debt medical bill debt, business debt, 2nd mortgage debt, and even possibly your student loan debt as dischargeable and eliminate it or reduce it.
b. Catch up any arrears on a home.
c. Save a car from repossession.
d. Cram the car loan down to the value of the car.
e. Cram the interest rate on the car loan down.
f. Provide an avenue for re-paying past due child support
g. Stop collection activity from other creditors
In many cases, a Chapter 13 bankruptcy will be a far better situation from a debt and monthly payment situation, than a high IRS payment plan. It must at least be considered as a long term option.