Practical Bankruptcy: Stopping an IRS Garnishment with Chapter 7

Even though a 3-to-5-year Chapter 13 case is often the best option for income tax debts, sometimes all you need is a simpler Chapter 7.

What Chapter 7 Can Do

If you owe income taxes and the IRS is chasing you hard, a Chapter 7 “straight bankruptcy” will definitely do one thing: it will immediately stop the IRS in its tracks. An ongoing garnishment of wages or seizure of assets will be stopped. A threatened tax lien recording against your home will be stopped. The threatening letters and phone calls will stop.

At least for a few months.

Chapter 7 is an appropriate option IF it will ALSO do one of the following three things to resolve the tax debt permanently: 1) “discharge” the income tax debt (legally write it off forever), 2) discharge enough of your other debts so that you can afford to enter into a reasonable monthly payment plan with the IRS, or 3) a combination of these two.

We illustrate each of these three situations with an example:

1) Discharging the Taxes

Janet lost her job in 2007 at the beginning of the Great Recession and decided to start her own business. During the year and a half that her business was operating, she was able to make some money but not nearly as much as when she was employed. So Janet reluctantly shut down the business and found a job, although one paying her less than her previous job. While she was self-employed she did not pay any income taxes, leaving her owing for 2007 and 2008. Janet filed the tax returns for those two years on time—on April 15, 2008 and April 15, 2009, respectively. She tried to pay on those tax debts as much as she could but could only pay irregularly because of severe financial pressure from all her other debts. As a result, plus the continuously accruing interest and penalties, she currently owes $6,800 to the IRS. Because she could not and did not consistently make her agreed regular monthly payments, the IRS has just begun garnishing her wages.

So Janet’s attorney files a Chapter 7 case for her, which stops the garnishment. The 2007 and 2008 taxes, interest and penalties are all discharged. That’s because they meet the conditions for discharging income taxes. First, they are of a tax year for which the returns were due more than three years ago. (The three-year period after she filed the 2008 tax return ended on April 15, 2012). Second, more than two years have passed since Janet actually filed the tax returns. (There are some other technical conditions that do not cause any problems in her situation.) So, her Chapter 7 case solves her immediate problem of the IRS garnishment, as well as her overall tax problem by discharging the debt so she does not owe it any more.

2) Discharging Other Debts So You Can Pay the Taxes

Imagine the same facts except Janet was afraid to file the tax returns for 2007 and 2008 until just a few months ago. She is not being garnished yet by the IRS. She has a significant amount of other debt, totaling $89,000 in unsecured debts, as well as a vehicle loan and home mortgage. She has managed to stay current on her vehicle and home, both of which she has been absolutely committed to retain. But because of intense pressure by other creditors, including an ongoing garnishment of her wages by an old credit card creditor, she cannot afford to pay anything on the $6,800 that she owes to the IRS. She wishes she could enter into a monthly payment plan with the IRS but there is just no available money with which to do so. 

So Janet files a Chapter 7 case through her attorney. It immediately stops the garnishment by the credit card creditor, and prevents the IRS from taking any collection action against her as well. The unsecured debts of $89,000 are all discharged in her Chapter 7 case. She keeps her vehicle and home, maintains her regular payments on them, and, as she intended, remains legally liable on those two debts. Right after her Chapter 7 case is finished, she enters into a monthly installment payment agreement with the IRS to pay $225 per month, which she can afford because of discharging her other debts. This will pay off the $6,800, plus accruing interest and penalties, in about three years.

3) Discharging Other Debts and Some Tax Debts So You Can Pay the Remaining Taxes

Lastly, consider if Janet not only owes $6,800 in 2007 and 2008 income taxes, which in this example she can discharge because of filing the returns on time, but she also owes another $5,000 for 2011 and 2012 income taxes. She also owes $89,000 in unsecured debt. She is being garnished by both a credit card debt and the IRS.

Janet’s Chapter 7 filing under these facts would stop both garnishments. It would then discharge the $6,800 in older taxes but not the $5,000 in recent taxes (because of not meeting the 3-year timing condition stated above).  She would discharge her $89,000 in unsecured debt. Immediately after her Chapter 7 case was completed, Janet would enter into a monthly installment payment agreement with the IRS to deal with the nondischarged $5,000 tax debt, paying $200 per month to finish that off in about two and a half years.

 

In each of these three examples, Janet did not need to file a Chapter 13 case. In the first example, the whole situation was resolved in less than four months, with no debt owed to anyone. In the other two examples, after 4 months all her debts were discharged except for the vehicle and home debts because Janet wanted to keep the collateral, and all or part of the IRS debt. Janet could then afford to pay the remaining nondischarged IRS debt through a reasonable monthly payment plan.

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