It is tax season. My clients (and myself) are trying to find ways to pay the taxes that they owe to the IRS and State Franchise Tax Board.
Paying your taxes with a credit card may seem like a good idea. And in some cases it may indeed be a clever way to deal with the tax debt.
But it does not always accomplish what you may think, at least not from a bankruptcy perspective.
Before I get into that, let’s look at an important first step.
Filing Tax Return On Time Is Important
Filing your tax returns on time (or within a granted extension period) is very important.
Even if you make no payments at the time you file your returns, filing the returns starts important time periods running!
But regardless, you have a legal obligation to file the returns which is independent from the duty to pay your taxes.
Tax debts can be discharged in bankruptcy if enough time has passed from the date the returns are filed, the date the returns were due to be filed, and date of assessment of the taxes.
So one of the requirements is that the returns must have been actually filed.
For a recap of what is required, see my bankruptcy tax discharge page.
You do not accomplish anything by delaying or failing to file your tax return.
If you don’t file a return, the IRS and state Franchise Tax Board will file what’s called a Substitute Return (SFR) on your behalf and assess taxes based on what they think your income was without any deductions.
And if you think that’s bad, it gets worse. Once a Substitute Return is filed, it is virtually impossible to ever discharge those taxes in a future bankruptcy case.
So always file your tax returns on time, even if you make no payment.
As Jack Nicholson famously bellowed in the movie A Few Good Men, “Are we clear??”
Paying Taxes With A Credit Card
Obviously it is best to pay your taxes when they are due, if you are able.
That avoids paying penalties and interest later on.
So what some do is use their credit card to pay their taxes, and then pay off their credit card.
This can be fruitful, but there’s a couple of issues with doing this.
- The credit card or loan requires repayment with interest (usually) higher than your taxing agency would charge.
- The credit card debt or loan will not be dischargeable in a Chapter 7 bankruptcy case until the underlying tax becomes dischargeable.
Repaying with credit card or loan interest is not a good idea unless it’s a very short term issue (e.g. you plan to pay it off in full within a couple of months).
Otherwise, you’re simply better off working out payment arrangements with the taxing agency. They will give you terms, with some penalties and interest, but likely less than a credit card would charge.
If you think you may want to eliminate the credit card debt in a future bankruptcy case, you may run into problems.
For a Chapter 7 case, you would need to wait until the taxes that were paid with the credit card become old enough to be dischargeable. (again, see my bankruptcy tax discharge page for the requirements).
Chapter 13 May Allow You To Eliminate The Debt
Chapter 13 requires a repayment plan based on your budget (and on the value of your assets).
You can eliminate any debts you can eliminate in a Chapter 7 case, plus more.
If a tax debt is not dischargeable in Chapter 7 (e.g. because it is not old enough yet), then it would not be dischargeable in a Chapter 13.
HOWEVER, if the debt owed is for a credit card or other loan taken to pay taxes, that debt may be dischargeable in a Chapter 13 even if the taxes that were paid would not be.
Whether it makes sense to file a Chapter 13 in that situation depends on the amounts involved, among other things.
But it is a possible option if the repayment of the credit card becomes too burdensome.
As always, it is best to have a consultation with a bankruptcy attorney BEFORE incurring the debt so you can discuss your options and plan properly.
This will allow you to optimize your decisions and put you in the best position to eliminate your debts.
Image courtesy of Tax Credits