Credit Card and Tax Debt? Bankruptcy Might Be the Solution
Large credit card debt is bad enough with it's high interest rates and payments that never end. Mix in some tax debt and you've really created a serious problem.
The primary reason the two debts together can be such a problem is that the IRS won't usually agree to include the full amount of the minimum credit card payments or other unsecured debt payments into the calculation of a monthly budget.
When this happens…it creates what we call phantom income. An example:
David owned a small business. The industry he chose wasn't profitable, and over a period of time he created a large amount of credit card debt to keep the business going. The payments were so big at $1700.00 per month, that he stopped withholding taxes and filing returns. Eventually the IRS caught up to the situation and forced him to file the returns. The debt was large enough with penalty and interest, that a revenue officer was assigned to his case. The revenue officer reviewed all of his finances to determine what he could afford to pay per month. (read more about IRS partial payment plans) The IRS rules allowed the revenue officer to ignore most of the credit card payments as a budget item. The payment plan was imposed and David began making the payments. Within a few months he realized that something had to give and he was forced to choose which type of debt to continue paying.
This situation is common, and this phantom income forces a person like David to make a difficult choice.
If he can't settle the IRS Debt in an Offer in Compromise or if the tax debt is so large he can't use a “time based” payment plan…he is going to have to either stop making the IRS payment risking levy, or stop making the credit card payments.
Or…he's going to have to win the lottery.
Sometimes the solution to this problem is bankruptcy and for a few reasons.
If David qualifies for a chapter 7 bankruptcy, the bankruptcy would discharge his obligation on the credit card debt, removing this phantom income problem from the equation and providing him the money to actually make the IRS payment.
If he doesn't qualify for a chapter 7 bankruptcy, a chapter 13 bankruptcy may still help. The chapter 13 bankruptcy may allow him to use a friendlier budget than the IRS allowed him. It would also treat the large tax penalties, the interest on the penalties, and the credit card debt as dischargeable debt. This might result in a payment in the chapter 13 that would be substantially less than the IRS payment plan and the credit card minimums were prior to bankruptcy.
What if some time had passed between the date David entered the IRS payment plan and the date he filed the bankruptcy… making some or all of the tax debt dischargeable debt like the credit card debt.
It's possible that David would be debt free.
But even if the bankruptcy only got rid of a portion of the tax debt…the reduction in the tax debt amount might allow David the ability to pay the remainder tax debt after the bankruptcy was over using a payment plan based on time, rather than his actual finances.
With the credit card debt wiped away and the much lower tax debt payment, David would be free to move on with his life.
There are lots of people in David's situation or at least something similar.
You might be one of them.
If you are, it's important to have your situation looked at…or analyzed, to see whether bankruptcy might make sense. If it doesn't…it may in the future.
You'll want to know that ahead of time so that you can plan accordingly and avoid the phantom income problem.