Can I Pay My Taxes With a Credit Card and Then Discharge Them in Bankruptcy?
Some folks struggle to pay their taxes on time and the IRS and other state tax agencies allow taxpayers to pay their taxes using a credit card. In some cases, these same folks need to file for bankruptcy protection and later list the credit cards they used to pay taxes on their bankruptcy schedules.
There are at least three reasons why paying your taxes with a credit card, prior to filing a bankruptcy, are a bad idea:
1) You may be converting a potentially dischargeable debt permanently into a non-dischargeable debt. In many cases, outstanding personal taxes assessed more than three years prior to a bankruptcy filing can be discharged. However, bankruptcy laws passed in 2005 prohibit you from being able to discharge the portion of credit card debt that was used to pay taxes or other nondischargeable debt prior to filing. You also face a quagmire in sorting out how much of the credit card statement can be discharged;
2) It doesn’t look good and you should expect some inquiry as to why you chose to use a credit card to pay the taxes prior to filing bankruptcy. You could risk your ability to receive a discharge if a trustee or creditor can show that you made charges to your credit card without the intent of paying it back;
3) Convenience fees and credit card charges and interest may exceed the late fees and penalties assessed by the IRS. You might be better off taking a loan from trusting relatives or friends, or taking out a small low-interest loan with a credit union or bank before considering a credit card to pay your taxes. A more in-depth article on the decision to use plastic to pay your taxes can be found here.
You should seek the advice of a bankruptcy attorney if you anticipate that you need help with your finances before making decisions on how to pay your taxes. A Chapter 13 bankruptcy can also provide assistance for those with non-dischargeable tax debts.
Cancellation of Debt Income & Bankruptcy
Cancellation of Debt Income
It’s that time of year again and I’ve had more than a few questions from existing clients and potential clients regarding the receipt of a 1099(c) form that asserts income from cancellation of debt (COD income.) I advise you speak with your accountant for your specific situation, and this article provides a general overview of what COD income it, how to except it and how bankruptcy eliminates it.
COD income is taxable income under Internal Revenue Code (IRC) § 61(a)(12). The COD income, or forgiveness of debt, is income to the individual, unless an exception applies. Many of the exceptions are enumerated in § 108 of the IRC, which excludes COD income if the debtor is insolvent: the debtor has more liabilities than the fair market value of their assets, immediately before cancellation of the debt. Generally, you have no COD income if your liabilities exceed the fair market value of what you own.
COD Income & Bankruptcy
One of the more frequent tax events that may occur after filing bankruptcy is the receipt of a 1099(c) from a creditor who is reporting income for the cancellation of your debt. The Internal Revenue Code (section 108) specifically excludes debt discharged from bankruptcy from the definition of ‘debt income’ that is canceled. Another means to prove that canceled debt should not be considered as income, outside of bankruptcy, is to show that you are insolvent.
The Internal Revenue Code §108 excludes the discharge of debt in bankruptcy from its definition of COD income. Bankruptcy debtor’s may file a Form 982 to inform the IRS that the COD income on the 1099 should be excluded from your income.
Consult an accountant if you have more complicated tax issues. For those who are more curious, or have trouble sleeping at night, you may learn more about bankruptcy and taxation by reviewing IRS Publication 908.