Chapter 13 Bankruptcy – Or IRS Offer Of Compromise?

If you’re behind on your income taxes in a big way, the IRS might have an offer you can’t refuse – or, maybe you can! The IRS Offer of Compromise program allows some taxpayers to settle their tax liability for less than the full amount owed.

As a bankruptcy attorney for almost twenty five years, one of the big issues I deal with when meeting clients who are in serious debt is the back taxes they owe. Of course, the question comes up as to whether it’s more advantageous for them to file bankruptcy in order to gain relief from taxes or for them to apply for an Offer of Compromise with the IRS.

As I explained in yesterday’s blog about taxes in a Chapter 7 bankruptcy, only income tax debt that is old enough is eligible to be discharged (partially or totally forgiven) under bankruptcy. Actually, Chapter 13 is the most frequent kind of bankruptcy filed by people with tax debts. This kind of bankruptcy involves a three to five year debt repayment plan supervised by the bankruptcy court trustee. The repayment plan would include tax debts.

There are several potential advantages to dealing with back income tax debt through Chapter 13. First, the tax debts may not have to be paid in full. Depending on the facts of each case, the bankruptcy judge has the power to “cram down” or discount some debts, including older tax debt. Even if the judge does not order a “cram-down”, the bankruptcy filing buys time for the debtor to make installment payments without the harassment of tax collectors. During the debt repayment plan period, the IRS cannot seize any assets, nor can they garnish the wages of the debtor.

In the event back taxes need to be paid in full, why would a three-to-five year bankruptcy debt repayment plan be any better an idea for a debtor than an IRS Offer of Compromise plan? Interest and penalties, that’s why! Chapter 13 bankruptcy stops interest and penalties the moment it’s filed (remember the automatic stay?) When the bankruptcy debt repayment plan is complete, the tax debt is paid off, because the IRS cannot collect any more than the bankruptcy judge approves under the plan. In an IRS installment plan, by contrast, interest and penalties continue to run. With the Offer of Compromise Plan, “It’s not over ’til it’s over”, and, typically, debtors end up paying a lot more money before it is.

Each situation is different, to be sure, and, before any strategy is selected, debtors should consult a bankruptcy specialist. Choosing and faithfully executing the right plan is the first step in starting that new chapter in debtors’ financial lives!