Deciding whether it is best to submit an offer in compromise or file bankruptcy on your taxes involves thoughtful consideration of many factors. Those factors include how long each can take, which option will have the lowest settlement payment, which is most likely to be successful, and post-settlement terms (like tax lien releases in bankruptcy or future compliance in compromises).
Each of these factors is worthy of their own post. For now, let’s focus on how long each option takes – when should you expect to get to the finish line in an offer in compromise vs. the filing of bankruptcy?
1. Offer in compromise – how quickly does the IRS work?
An offer in compromise is not necessarily a quick fix. It can take the IRS, on average, 6-9 months at a minimum to complete its initial investigation. But here’s the catch: many offers are not initially accepted. That means an appeal of the errors the IRS made in the initial review is usually necessary. An appeal of a rejected offer can take another 6-9 months. With the initial review and appeal, go into an offer in compromise presuming a 12 -18 month time frame to completion.
If you get a “yes” on the compromise, then you have to pay the amount offered to the IRS. The IRS will give you up to two years to pay the settlement to them. But your “yes” is conditioned on the final payment being made – meaning you still owe the IRS and have not been given your fresh start until then. If you want your tax lien released and credit cleared, presume it stays on until final payment is made. It is not until final payment of the compromise settlement that the IRS makes an entry into their database to reduce your account balance to zero (yes, they really do that).
So, 12-18 months for investigation (and appeal), then up to two years for payment. Yes, it can be shorter if appeal is not necessary, or if you can pay in the settlement quickly, but there is a wide time range to completion.
Let’s compare that to bankruptcy.
2. Chapter 7 bankruptcy – quick relief without IRS passing judgment.
A Chapter 7 bankruptcy is a swift and efficient way to eliminate an IRS debt. (Yes, bankruptcy can eliminate IRS tax debt.) A Chapter 7 should be completed within 4 months of filing.
Here is what happens in a Chapter 7 bankruptcy: Approximately 5 weeks after the filing, a hearing is scheduled with a bankruptcy trustee. This trustee is employed by the Department of Justice – generally speaking, his or her job is to make sure that you have been honest in your bankruptcy filing, and to determine if you have any assets available to sell to pay your creditors (rest easy, most assets are protected from creditors by state and federal law, very few Chapter 7 bankruptcies on the IRS result in loss of any property). After your hearing with the trustee, your creditors – and the trustee – then have 60 days to object to your bankruptcy. This is also rare – usually in cases where the bankruptcy laws are being “abused.” If no one objects, the court issues you what is known as a “discharge.”
The court sends a copy of this discharge to the IRS. If your taxes are eligible to be wiped clean from the bankruptcy (determined before we file by analyzing IRS account transcripts of your taxes, and applying that the tax bankruptcy discharge laws), the IRS then makes an entry in their database that reduces your account balance to zero from the bankruptcy filing. After the bankruptcy, fresh IRS transcripts can be obtained that verify that the bankruptcy eliminated the taxes (your account balance will be cleared to zero).
3. Chapter 13 bankruptcy – good option to installment agreement.
A Chapter 13 bankruptcy can last between 3 to 5 years, making it potentially the longest option in the world of bankruptcy v compromise, with most cases lasting 5 years. (There are other IRS solutions, like temporary forbearance on collection – known as uncollectible, and the 10 year time frame the IRS has to collect.)
There are differences between filing a Chapter 7 and Chapter 13 bankruptcy on the IRS. The main distinguishing factor is that Chapter 7 is a liquidating bankruptcy (but remember most cases do not result in property being lost) for those that cannot afford to repay their taxes and other debts (credit cards, medical bills). A Chapter 13 is for those that can afford monthly payments on these debts after their reasonable living expenses are paid – in other words, extra cash. Chapter 7 is quick because there is no repayment plan – your case passes through trustee review, and is over. Chapter 13 involves repayment – because you can – and the payment term generally depends on how much money you earn (most filers earn enough to be required to commit to a five year repayment term).
That may sound grim, but Chapter 13 is a good alternative to an IRS-approved installment agreement as the length of the bankruptcy is capped at 5 years (vs. the 10 years that the IRS has to collect), can result in less than full payment of what is owed (called a cramdown, even on the IRS), and usually stops interest and penalty accruals. After the final payment is made in a Chapter 13, the court sends a discharge to your creditors, and the IRS clears your account balance to zero (even if you did not pay them back in full).
Just a little on the basics of getting the IRS discharged in Chapter 7 or for a Chapter 13 cramdown. As a starter, your taxes must be from a tax return that was due to be filed more than three years before you file the bankruptcy. And your tax return also had to have been actually filed – regardless of due date – more than two years prior to the bankruptcy. So, as a beginning, bankruptcy works best on somewhat older taxes.
Sometimes, consideration is given to the comprehensive effect of bankruptcy – it impacts not only the IRS, but other debts, too. And that includes state taxes, credit cards, medical bills, mortgage and car arrearages.