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This chapter demystifies the issue of bankrupting on an income tax liability. The chapter also offers worksheets that make it clear whether bankruptcy is a valid “escape” option for you.

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Chapter 17:
Taxes & Bankruptcy

One of the best kept secrets around is that you can declare bankruptcy on most tax liabilities. In this chapter you will learn when, where and how you can make use of this important escape route. Many tax pros and even many attorneys do not know what you will soon discover.

For individuals there are two kinds of bankruptcy: Chapter 7 and Chapter 13, which I will call C7 and C13 respectively. With a C7 bankruptcy your slate can be wiped clean, as all your debts are canceled. With a C13 bankruptcy the court designs a payment plan in which you make payments on debts over a three- to five-year period. Although there are strict federal guidelines about bankruptcy, each state determines what property you can retain.

In general, I prefer a C7 bankruptcy to a C13 bankruptcy when it comes to handling excessive tax debt. You can have your entire tax debt wiped off the books if you play it right! You will be amazed how relieved you will feel when your tax burden is completely taken off your shoulders. However, many tax attorneys prefer the C13. Clearly, both have their advantages. Let me begin by discussing the practicalities of a C7 bankruptcy. Then we will look at the advantages of the C13.

HOW A CHAPTER 7 BANKRUPTCY WORKS

Bankruptcy experts often state that if a person’s total debt equals one-half or more of their annual income, they should consider a C7. I think this makes sense if your annual income is $25,000 or more, but it rarely makes sense to declare bankruptcy if your debt is less than $12,500, although there are some exceptions. You should seriously consider a C7 if:

• Your tax debt seems impossible for you to pay.
• Any monthly installment payments you could make would barely or wouldn’t even cover the ever-growing interest charges.
• You will take at least eight or more years to pay off your tax debt.
• You also have high credit card debt, such as $10,000 or more.
• Your total assets are less than $15,800 or, if in excess of this amount, are pledged as collateral for a loan.
• You own a home which is legally “homesteaded” and therefore protected in case of bankruptcy.
• You have not declared a C7 bankruptcy in the last six years.