Making the decision between bankruptcy or an Offer in Compromise with the IRS can be tough. An Offer in Compromise is a tax settlement whereby it is shown you do not have the ability to pay your debt back, and thereby settle for a smaller sum. Bankruptcy is simply a legal declaration that an individual is unable to repay their outstanding debts, to all creditors. Certain tax debts may not even be covered in a bankruptcy.
Check out our video below to watch the explanation or keep reading on for the written version.
There are many factors to consider which could take up several pages, but we will go through the most important points here. It is also important to talk with a qualified bankruptcy attorney in your area for legal advice regarding what type of bankruptcy you qualify for and the specific details regarding your case. Most of this information is referencing Chapter 7, which is the more common type of bankruptcy.
1) Do you have a lot of other debt besides taxes?
A lot of our clients have only taxes as their major debt. In this situation, an Offer in Compromise is preferred. If you have substantial other debts that you are not going to be able to pay off either, then bankruptcy might be a better option. You would save the fee on a tax attorney and put it towards a bankruptcy attorney and all your debts are covered. The bankruptcy might not cover more recent tax debts however and often we have post-bankruptcy clients that also get an Offer in Compromise for their remaining debts after a bankruptcy.
If you choose to go with bankruptcy, make sure your bankruptcy attorney knows about all your recent tax debts, so they can advise you on the appropriate filing date for the bankruptcy. I have seen cases where the client should have filed a few months later, they would have been free of more tax debt, and would not have had to hire us after their bankruptcy had their bankruptcy attorney been properly informed.
2) Do your tax debts qualify to be discharged in bankruptcy?
Not all taxes can be discharged. In Chapter 13 often you will end up paying taxes back in full. In Chapter 7 you can get out of most tax debts that are on file from a filed tax return that has been on file for at least three years. There is a good guide on Chapter 7 and tax debts by Nolo available here. The best way to be sure if your debts qualify is to talk to a local bankruptcy attorney in your state if you end up going with bankruptcy.
3) How important is your credit?
A Chapter 7 bankruptcy usually hurts your credit to take away the tax debt if it qualifies. Offer in Compromise resolves the tax debt and gets your credit score back up. After your offer is accepted and you have made the required payments, the IRS sends out a release of lien. This reflects at the credit reporting agencies within a few months, and your credit score should rise substantially.
4) Do you own your home and intend to keep it?
A Chapter 7 bankruptcy may cost you to lose your home should you have sufficient equity. You may be safe if you live in a state with a homestead exemption. These options should be discussed with a local bankruptcy attorney if you are considering bankruptcy.
The IRS on the other hand rarely takes a person’s personal residence but will take a vacation or rental property if the past due balances are big enough and they are not resolved. When you file an Offer in Compromise, your home equity is considered in the settlement amount. However, this will be at the home’s quick sale value, often resulting in no actual equity being considered in the calculation. I have had cases where homes have been paid off in full, but due to the market making it hard to sell and the taxpayer having low income, they still accepted the settlement. There is much more discretion when it comes to home valuations in Offer in Compromise than in bankruptcy.
If you are considering doing either an Offer in Compromise with the IRS or a full discharge of all your debts through bankruptcy, you really should consult both a bankruptcy attorney and a tax attorney to find out what is right for you.
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