Tax Debt Relief Help: Does Bankruptcy or Forgiveness Clear it?

Elizabeth Johnson

Financial Advisor
Updated: 01/2019

Debt from Unpaid Taxes

It is often said that the only two certainties in life are death and taxes. For many people, the thought of the second certainty is almost as scary as the first. There has been an increase in people not paying their taxes recently. One of the primary drivers of this phenomenon is the increase in gig economy and independent contractor positions.

In This Article

Background

When you work a job as an employee, your employer is responsible for taking the appropriate taxes out of your paycheck. These taxes include federal and state income taxes, social security, Medicare, and other taxes depending on where you live.

However, people who work in the gig economy, or work as independent contractors, don’t have taxes taken out of their pay. Instead they receive the entire of the amount they’re owed and it is their responsibility to set aside part of their income to pay their taxes. However, this isn’t explicitly stated anywhere. Therefore, many people find themselves with a huge tax bill once it’s time to turn in their taxes. If they haven’t been saving for taxes, or having been saving enough to cover their tax bill, then they can find themselves owing the government.

It’s not only gig economy and independent contractors that face this issue. Any income is taxable. That includes lottery winnings, gambling winnings, gifts, and more. Additionally, you can find yourself owing taxes even if you’re a W2 employee who has taxes taken out of your paycheck. The amount of tax you pay out of your paycheck depends on how you classify yourself when you fill out your paperwork for your job. If you fill this paperwork out, you may find that you still owe even after your taxes have been taken out.

As a result of these issues, more people find themselves with a tax bill they just can’t afford. Debt from unpaid taxes can have serious consequences. Moreover, the government has several aggressive ways to collect unpaid taxes. Thankfully, there are also solutions that can help you fix your unpaid tax debt.

Consequences of Unpaid Taxes

Debt from unpaid taxes can cause several consequences, depending on the specific situation. The biggest consequences are reserved for people who don’t even bother to file their taxes. The government has several different options for dealing with unpaid taxes, and none of them are pleasant. It’s important to note that this is true for state and local governments as well as the federal government.

Unpaid Tax Penalties

Failure to file taxes carries its own penalties, in addition to the penalties you’ll pay for not paying your taxes on time. Usually the penalty to failure to file is 5% of the amount owed to the government. However, this penalty can go as high as 25%, depending on the specifics. If you file your tax return more than 60 days after it was due, then you’ll pay either $135 or 100% of your tax obligations, whichever is smaller.

If someone continues to not file their taxes, then the government may choose to file a substitute tax return for them. This substitute return lets the government determine how much money you actually owe in taxes. Substitute returns are almost always higher than returns you file yourself because the government doesn’t apply deductions and credits that you would assign yourself. As a result, your tax bill will be even higher than it would be if you filed a return but didn’t pay your taxes.

Usually the government will just use tactics to get the money that you owe. We’ll cover these options next. However, it’s important to note that one consequence of failing to pay your taxes can be jail time. This is rare, but it can happen.

Government Collection of Unpaid Taxes

The government has several ways to collect unpaid taxes. It’s important to note that the government usually doesn’t resort to these options until they’ve exhausted other methods of getting you to pay, like letters and notices.

Tax Lien

One of the most common collection methods for unpaid taxes is a tax lien. A tax lien is applied to property you own. It states that the government has first access to your property or the proceeds of selling your property before any other creditors. A tax lien can seriously complicate the process of selling property, like a house, and incentivizes individuals to resolve their tax situation.

Wage Garnishment

The government can also garnish your wages. This process involves informing your employer to set aside a certain amount of your paycheck and to pay it separately to the government. A wage garnishment can be embarrassing and troublesome, as you’ll be making less, and your employer will know you didn’t handle your taxes responsibly.

Bank Levy

Another option the government can use is a bank levy. The relevant government authorities contact your bank and place a hold on funds that are in your account. They then seize any funds and apply them towards your outstanding balance.

Property Seizure

One of the most aggressive options the government takes to collect unpaid taxes is seizing property. The property might be a car, boat, house, or anything else of value. The government will then sell the property and apply the funds to your tax balance.

Fixing Unpaid Taxes

The government offers several options to resolve unpaid taxes. Many of these options work out best for the tax payer, so they’re all worth considering.

Installment Agreements

The most common agreement is to pay taxes back in installments. This lets you split your tax bill into smaller, easier to manage pieces and pay back over time.

Offer in Compromise

An offer in compromise is used for people who are unlikely to be able to pay back their taxes. The government agrees to settle your tax debt for less than you owe.

Partial or Part Pay Installment Agreement

This program is similar to the installment agreement, but the amount you pay each time is smaller than it would be with the standard installment agreement. Frequently the amount is so small that the statute of limitations for collecting the taxes passes before you’ve paid the full amount.

Currently Not Collectable

If you’re facing an unforeseen financial hardship, you can convince the government to declare your taxes currently not collectable. In this situation your tax payments are put on hold until you start making more money. This can last past the statute of limitations for tax collection, which relieves the tax debt.

As you can see, there are many penalties for not paying your taxes. However, the government is surprisingly flexible, and is willing to work out a deal with you. Contact a debt relief specialist or tax expert today if you’re facing debt from unpaid taxes.

FAQ

General Unpaid Tax Debt Questions

This section answers your general questions about unpaid tax debt. Use this section to get a good foundation so you can handle more complex questions.

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How to calculate after tax cost of debt?

You can calculate the after-tax cost of debt by subtracting a company’s effective tax rate from 1. After that multiply the difference by its cost of debt.

What does no non tax debts mean?

Non-tax debt is debt that you owe to organizations that aren’t the government. If something doesn’t cover non-tax debt then it can only be used for tax debt.

What is tax debt forgiveness?

Tax debt forgiveness is when the IRS releases you from paying all or part of the money that you currently owe the federal government.

How do tax debt relief companies work?

Tax debt relief companies work with the IRS to find a way to cover your unpaid tax debts. They’ll help pled your case to lower the amount of debt you owe.

What is the pre-tax cost of debt?

The pre-tax cost of debt is the principal and interest owed, as most interest payments for companies are tax-deductible. That means your post-tax cost of debt will be different.

Does IRS debt show on credit report?

In most cases, no. However, if the IRS files a tax lien on your house, then that lien will show up on your credit report.

What is the interest rate on IRS debt?

Interest on IRS accrues quarterly and the IRS charges interest at the federal short-term rate plus 3%. Interest is calculated from the date payments are due.

Are IRS debts public record?

IRS debts are not public record by themselves. However, any liens the IRS places on your property would be public record.

Are the IRS responsible for IRS debt?

Yes, the IRS is the agency in charge of handling your federal tax debt and tax returns. You’ll need to talk to them if you have a problem with tax debt.

Does the IRS use private debt collectors?

Yes, as of 2015 the IRS uses four different private debt collectors for tax debt. These are CBE, ConServe, Perfomant, and Pioneer.

Understanding Liability for Unpaid Tax Debt

This section will help you understand who is liable for tax debt and how long tax debt can be collected.

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Is a director liable for the company tax debt?

Not usually, however it depends on the way the company is structured. If it is a LLC, S Corp, or other type of corporate entity, then no.

Is there a statute of limitations on state tax debt?

That varies from state to state. The statute of limitations on federal tax debt is set at 10 years.

How long does tax debt last?

Tax debt is considered collectible for 10 years from the date that it was originally due. This is also known as a statute of limitations.

Is a widow responsible for husband's tax debt?

Not usually. However, if she is the executor of the husband’s estate then she will have to pay unpaid taxes out of the estate.

Can the IRS collect debt on a defunct S Corp?

Yes – the IRS doesn’t waive its right to unpaid taxes just because an S Corp dissolves. However, it will back off if the company’s assets are involved in a court case.

Resolving Unpaid Tax Debt

We’ll answer your questions about how to resolve unpaid tax debts in this section.

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How to reduce tax debt to IRS?

There are a few different ways you can reduce your tax debt to the IRS. You can negotiate with them directly. You can also hire a tax debt settlement company to lower your tax debt.

Does bankruptcy clear tax debt?

That depends on several factors – bankruptcy will clear income tax debt but you must have filed a legitimate tax return for the two years prior to your bankruptcy.

How to settle tax debt?

You can settle tax debt by contacting the IRS or by hiring a tax debt settlement company. Both are good options for getting out of debt.

Can I get a loan to pay off tax debt?

In most cases no. However, some banks might be willing to include your tax debt in the form of a consolidation loan. However, the interest rate on these loans is probably going to be higher than what the IRS charges.

Does IRS forgive tax debt after 10 years?

The IRS can’t collect tax debt that is 10 years old or older. That doesn’t mean the debt is forgiven, but rather that the IRS can’t compel you to pay.

Does IRS write off tax debt?

Not usually – however, the IRS has a statute of limitations that prevents it from collecting debt once that debt is 10 years old or greater.

Can I negotiate my tax debt with the IRS?

You can. You’ll need to contact the IRS and explain your situation and see what, if any deal they will work out with you. You can also contact a tax debt relief company for more specialized help.

How to check IRS debt balance?

The best way to check your IRS debt balance is to call them. You can call 1-800-829-1040 M-F from 7AM to 7PM local time.

How to repay IRS debt?

You have three options to repay IRS debt. You can make a payment plan, ask for a delayed payment, or seek a settlement. The IRS will help you figure out which option is best for you.

Will the IRS forgive my tax debt?

Sometimes – the IRS has a debt relief and debt forgiveness program that you can qualify for. A tax debt relief company will be able to help you get the best chances at having your debt forgiven.

Does IRS debt go away when you die?

No – Your estate will still be responsible for any IRS debt that’s within the statute of limitations for collection.

How to deal with IRS debt?

You have several options for dealing with IRS debt. You can pay your debt in full within the approved timeframe when you file your taxes – normally 120 days. You can also seek forgiveness, a settlement, or a payment plan.

How to pay off IRS debt fast?

The fastest way to pay off IRS debt is to reach a settlement. The IRS will take a lump sum of money and consider your debts paid.

Are IRS debts dischargeable?

In certain cases, yes. You can only discharge debts resulting from income tax and you must have filed a legitimate tax return for the two years prior to when you claimed bankruptcy.

Can I finance a debt with the IRS?

The IRS does offer payment plans for unpaid debt. You’ll need to contact the IRS to see what kind of options can be worked out for your situation.

Can I make extra payments to my IRS debt?

Yes – you can make extra payments on your IRS debt through the same method that you make your regular payments.

Can I pay IRS debt online?

You can make IRS debt payments online. You can go to www.irs.go/payments and you’ll see the option to pay now with a bank account, a debit card, or a credit card.

Can I pay IRS debt with a credit card?

Yes – however you should be careful about doing so. The interest rate on credit cards is much higher than the interest rate the IRS charges on unpaid taxes.

Other Unpaid Tax Debt Questions

This section covers other questions about taxes and debt that don’t fit into our other categories.

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How to report bad debt on tax return?

That depends on the nature of the bad debt and your particular filing status. You should talk to a certified CPA or tax specialist to find out how to write off your bad debt.

Does debt affect tax return?

It can – however tax law and the way that different things affect a tax return is very complicated. You should talk to a qualified tax preparation specialist about your specific situation.

How does debt cancellation affect taxes?

In most cases cancelled debt is considered as income. That means you’ll need to pay taxes on it as if you had earned the money.

How to avoid taxes on cancelled debt?

The best ways to avoid taxes on cancelled debt is to see if you qualify for an exemption from the IRS. You can find more information on the IRS website or by talking to a tax debt relief agency.

What is a federal agency non tax debt?

Federal agency non-tax debts are debts you owe the government other than taxes. This can be in the form of student loans, HUD Loans, or any penalties from another federal agency.

Do you have to pay taxes on settled debt?

In most cases, no. Settled debt is different than debt forgiveness, in which the forgiven debt would be counted as income.

What does cancellation of debt mean for taxes?

The cancellation of debt can cause your tax bill to spike. That’s because most debt forgiveness counts as income for tax purposes.

What debts can be taken from state taxes?

That depends on what state you live in. Every state has their own system of taxation and tax codes. A qualified tax specialist can help you understand how your state’s taxes interact with debt.

What is IRS form 1099 c cancellation of debt?

The IRS form 1099 C shows that a company forgave $600 or more of debt that you owe them. The IRS requires companies to file this form if they forgive your debt, as it is then counted as income.

Are IRS payments considered debt for a mortgage loan?

That depends on the type of mortgage loan you’re applying for. You should talk to the lender to see what kind of debts qualify for your purposes.

Are siblings responsible for parent's IRS debt?

Not directly. However, the IRS requires that back taxes are paid out of an estate before any remaining assets are distributed to beneficiaries.

Can a spouse be responsible for IRS debt?

Not in most cases. The IRS will only target the individual that owes the taxes. However, a spouse could still feel the impact if both spouses own a house that gets hit with a tax lien.

Can IRS debt be pursued after charge-off?

Any debt can be pursued after a charge-off.  Creditors can continue to collect on the debt until it’s been repaid or it passes a statute of limitations on collections.

Can debt cancellation be counted as income by IRS?

Yes – in fact it usually is. There are some exceptions, such as federal student loan forgiveness programs, but most debt cancellation counts as income.

Can IRS debt affect naturalization?

Yes – in most cases owing back taxes to the IRS will cause your application for naturalization to be denied. However, it doesn’t automatically prevent you from being naturalized.

Can IRS debt prevent issuance of passport?

Yes, the State Department has the ability to deny passport applications to allow you to resolve any tax debt issues you may have with the IRS.

Can IRS garnish wages for credit card debt?

The IRS can’t garnish your wages for credit card debt. However, the credit card company can seek a judgement against you to enforce collection of the debt through wage garnishment.

Elizabeth Johnson


Elizabeth is an expert on Debt Consolidation as she provides helpful advice to people who are dealing with debt problems. She graduated college with a BS in Finance. After college, she took a job working at a non-profit debt counseling program. It was at this position where Elizabeth honed her expertise for helping people understand how different financial products work and finding ways to help people pay off their debts.