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Struggling With Past-Due Tax Debt As A Self -Employed Person? Can Bankruptcy Help?

If you're an independent contractor or otherwise self-employed individual who is required to pay estimated taxes, you may find it difficult to come up with the required 15.3 percent (plus your federal tax rate) every three months. This financial crunch can be compounded if you find yourself dealing with hefty medical bills or other expenses that eat away at your monthly income. Unfortunately, once you find yourself falling behind on taxes, penalties and interest on the unpaid balance can add up quickly. Can bankruptcy help you discharge your IRS debt? Read on to learn more about how back taxes are treated in a bankruptcy proceeding.

Can you declare bankruptcy on debt you owe to the IRS?

Once you've fallen behind on your taxes, you'll be assessed penalties and interest that can reach 25 percent of the total unpaid balance. This can make it all but impossible to repay your debt on top of paying your quarterly estimated taxes and other bills. However, it's generally difficult (if not impossible) to have this debt discharged in a Chapter 7 bankruptcy unless it's been at least three years since the return on which the taxes are owed was first due. This means that ridding yourself of your debts once and for all may require you to make at least minimum payments for a few years until you can file for bankruptcy and have these debts discharged. 

Fortunately, once you file for bankruptcy protection, an automatic stay will be entered. This stay prevents creditors (including the IRS) from contacting you or attempting to collect debt until after the stay has been lifted, either through the granting or dismissal of your bankruptcy case. Having the automatic stay put into place can help give you the breathing room to organize (or reorganize) your finances so that you're able to make a fresh start after your bankruptcy has been granted.

Is a Chapter 7 or Chapter 13 bankruptcy the better option to eliminate your outstanding tax debt?

In a Chapter 7 bankruptcy, your outstanding tax debt will be wiped out (as long as it's old enough). A Chapter 13 bankruptcy, on the other hand, requires you to enter into a repayment plan where the bankruptcy trustee makes monthly payments to each of your creditors according to priority. Because the IRS generally gets top billing when it comes to priority, you'll usually be able to pay off your tax debt faster than otherwise possible.

As a result, the right choice often depends on your lifestyle and the amount of time it's been since your tax debts were incurred. If you're fine with waiting a few years until you can receive a Chapter 7 discharge of your tax debts, this may be the right choice for you. On the other hand, if you just need some help with your daily finances and are able to pay off the IRS debt quickly pursuant to the Chapter 13 plan, this should save more money in the long run. 

One factor you'll want to consider in all this is your ability to continue to pay estimated taxes on income earned. If you file a Chapter 13 bankruptcy, you're prohibited from incurring additional debt once the bankruptcy is in progress -- so failing to pay your quarterly estimated taxes on time and incurring penalties (or simply not paying your taxes at all) can get your case dismissed from bankruptcy court and the automatic stay lifted. If you're worried about your ability to continue to make tax payments, a Chapter 7 discharge may be a better option. 

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