The Motor City is getting a lot of attention today. Unfortunately, it's because Detroit has filed for bankruptcy.
Detroit, Mich., viewed from Windsor, Ontario, Canada, across the Detroit River; photo by Andrea_44 via Flickr
The process is different for a municipality that files bankruptcy than when a company or an individual goes broke. But the bottom line is that all entities have determined that this last-ditch effort is the only way to get their finances back in any kind of workable shape.
Taxes obviously are a part of the equation. In Detroit's case, the falling individual and corporate population has left the Michigan city with a drastically reduced tax base that simply cannot cover all the needs.
How taxes are treated in bankruptcy: In individual bankruptcies, the filer's taxes also come into play. I'm not a tax or bankruptcy attorney, so I'm deferring to Kathleen Michon, who is a lawyer and legal editor and author at Nolo.com.
If you file a Chapter 7 bankruptcy, you will continue to owe your tax debts at the end of the process, says Michon. If you file Chapter 13, she says, you will have to repay them in full.
In her piece on taxes and bankruptcy, Michon notes that in some Chapter 7 bankruptcy situations you can wipe out, or discharge in legal parlance, your federal income tax debt. But you must meet several conditions:
- The taxes are income taxes. Other types of taxes, such as payroll taxes, cannot be eliminated.
- You did not commit fraud or willful tax evasion.
- The tax debt must be from a return that was originally due at least three years before you filed for bankruptcy.
- You actually filed the tax return covering the debt you wish to discharge at least two years before filing for bankruptcy.
You also must pass the "240-day rule." This, says Michon, is income tax debt that was assessed by the IRS at least 240 days before you file your bankruptcy petition, or must not have been assessed yet.
And if the IRS had filed a tax lien on your property before you filed for bankruptcy, that lien will remain.
Before bankruptcy: Filing for bankruptcy obviously is a last resort. But if you are financially struggling and tax debts are part of the burden, the Internal Revenue Service might be able to help.
In 2009, with so many people suffering from the economic recession, the IRS created its Fresh Start Program. Basically, the program allows IRS employees the flexibility to work with struggling taxpayers to assist them with their situations. Depending on the circumstances, taxpayers in hardship situations may be able to adjust payments for back taxes, avoid defaulting on payment agreements or possibly defer collection action.
Over the years, Fresh Start has been adjusted, but it still offers help in three key areas:
- Federal tax liens,
- Installment payment agreements, and
- Offer in Compromise proposals.
Of course, the more compassionate IRS won't do you any good if you don't take advantage of the less taxing attitude. Uncle Sam is not coming looking for you. You need to let him and his tax collectors know that you're having financial trouble that is making it hard for you to pay your taxes.
And reach out before things get really, really bad.
The best move is to file your taxes and pay what you can of your tax debt. That's a good indicator to the IRS you are trying to meet your tax responsibilities. It also will stop or ease some of the possible penalty charges.
Then talk to the IRS about how to deal with the remainder before it's too late.
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