If You Already Owe Income Taxes

Law Office of Robert L. Firth April 12, 2021

What do you do (and not do) if you already owe 2018 or 2019 income taxes, or earlier, and haven’t yet sent in the latest tax returns?

What if you owe 2020 income taxes even though the IRS is not taxing $10,200 of unemployment income that year? That was our topic last week. The first $10,200 of unemployment is not being taxed because of last month’s American Rescue Plan Act. This week’s topic covers your options if you owe income taxes for prior tax years. Even if you don’t owe for 2020, or owe less, that may not help much if you were already behind.

If You HAVEN’T Submitted Recent Tax Returns

For tens of millions of Americans the last year has been the most financially disruptive in their lifetimes. Many lives were turned upside down around a year ago. If that includes you it’s understandable that you had trouble preparing and sending in your 2019 income tax returns.

The IRS recognized this to some extent by extending its tax return deadline from April 15 to July 15, 2020. So did virtually all states with income taxes (which include 41 out of the 50 states). But if your financial challenges went beyond last July, you may still not have made that deadline. Indeed you may not have submitted them even now, if you owe and have no ability to pay. That may be especially true if you were already a year or more behind on taxes at that point.

If any of this is true, you most likely realize that you’re in a scary and rather dangerous situation. It’s only natural to try to avoid something that’s scary, especially when there seems to be no practical way out.

The reality is that this is indeed a dangerous situation. The IRS imposes a series of penalties for not sending in income tax returns when due. For individuals there’s an initial $435 failure-to-file fee. (That’s for returns due starting 1/1/2020. It’s a more than doubling jump from $210 for returns due during the years 2018 and 2019.). In addition, there are significant steep penalties for each month you don’t file. On top of that there are monthly penalties for the failure to pay the amount due. IRS’ Common Penalties for Individuals. States with income taxes impose similar penalties.

So the sooner you send in your tax returns the less failure-to-file penalties you’ll owe. But what if you can’t pay what you owe?

If You HAVE Submitted Prior Tax Returns

Now what if you did submit tax returns for a prior year or two—for 2018 and/or before—and you already owe income taxes?

That may further tempt you not to submit the 2019 tax returns if you think or know that you also owe for that year. If you’re in an IRS payment plan and you can’t pay more, you don’t want to upset that payment plan. If you’re not in a payment plan and lying low, you may not want to catch the IRS’ attention. You sensibly figure nothing will catch their attention more than a new tax return showing that you owe even more.

But you know that this can’t end well because the IRS knows that you haven’t submitted the 2019 tax return. If you are in a payment plan with them you violate that plan by not timely submitting subsequent tax returns. If you’re not in a payment plan you know that it’s only a matter of time. Indeed the missing 2019 tax return may well spur the IRS into action.

Besides, the not submitted 2019 tax return is accruing serious failure-to-file penalties, quickly increasing the amount you owe.

So you’re in a real conundrum.

The Only Practical Solution

There’s only one way out of this serious Catch-22: find out your real options. Consider the following:

  1. Do you owe prior year’s income taxes for which you’ve submitted tax returns? You may be able to write them off in bankruptcy. If you meet certain conditions you can “discharge” them and owe nothing. That usually includes the tax and the accrued penalties and interest.

  2. What if you owe income taxes which don’t qualify for discharge? Discharging other debts with a Chapter 7 “straight bankruptcy” may enable you to afford to pay the tax. The IRS and many states have reasonable payment plans, allowing you to stretch out the payments over a long period. The Chapter 7 filing would even stop any immediate collection efforts by the IRS/state for a few months. During that time you’d set up the payment plan. You can even likely minimize your contact with the IRS by applying online, and getting immediate approval.

  3. What if you still can’t afford an IRS payment plan? Or what if the IRS is amenable but your state is not? Or what if you have other aggressive creditors whose debts Chapter 7 does not discharge? Examples are child or spousal support, or vehicle loans or mortgages you’re behind on and need to bring current. Chapter 13 “adjustment of debts” stops tax collections, as well as by other special creditors, much longer than Chapter 7. Then through a court-approved payment plan you can prioritize paying the more urgent debts. The other creditors—including the IRS/state—have to wait their turn in line. Tax interest and penalties usually stops accruing—for up to five years—saving you a ton.

Your Next Step

These give you just a small taste of the many ways Chapter 7 or Chapter 13 could get you out of the seemingly impossible situation you’re in.

The additional really good news is that finding out more would likely cost you nothing. What you need to know is whether and how Chapter 7 or 13 could help your personal situation. Your local bankruptcy lawyer’s job is to understand your situation and give you honest advice about your options. Not just about your income tax conundrum, but about all your debts and financial life.

A significant step in that direction will happen at your initial consultation meeting, which is free. Of course you have no obligation to hire the lawyer or to file any kind of bankruptcy after that meeting. But you’ll leave with crucial information about whether and how you can get out of your tax Catch-22. You’ll learn about options for getting your financial house in order. Most of the time people are deeply relieved, and often really surprised, at how good the solution is. Often our clients very much wish they would have come to see us earlier, avoiding the anguish they’ve been feeling for way too long.