A chapter 13 bankruptcy allows you to stop collection actions by creditors, including wage garnishments. You must draw up a plan for partial repayment of unsecured debts, such as credit card balances and personal loans. After you've completed payment according to the plan, the bankruptcy court discharges any remaining unsecured debts allowed by law. You get a clean financial slate with the exception of some nondischargeable debts, like federal taxes.
If you are unable to pay overdue taxes, the IRS will usually agree to an installment plan, which allows you to pay a certain amount monthly until the bill is settled. If you don't follow through, or can't satisfy a past-due balance, the IRS has the authority to levy bank accounts, place liens on your property or garnish your wages -- all without a court judgment or order. However, wage garnishment is subject to state and federal regulations, which limit the percentage of your income that can be seized.
Read More: Filing for Bankruptcy Vs. Paying Old Collections and Charge-Offs
Initial Filing and Schedules
When you file a bankruptcy petition, an automatic stay goes into effect, which stops all collection actions, including lawsuits filed by your creditors and garnishment of your wages by the IRS. The court notifies the tax authorities that you filed for chapter 13 bankruptcy. However, you must list the tax debt on a bankruptcy schedule to file with the court. You must also list your current income from all sources, including wages from your employer. This income determines the amount of your monthly payments in your chapter 13 repayment plan.
Although you stop garnishment by filing a bankruptcy petition, you still owe the taxes and must repay the IRS through your repayment plan. Normally, the IRS will not agree to any reduction in the amount you owe, nor will the court discharge back taxes. This is true whether or not the tax debt is secured by a lien on your property. If a balance due remains after the bankruptcy is discharged, or if the court dismisses your case prior to discharge, you will be subject to IRS garnishment once again, until the full amount of back taxes -- including interest and penalties -- is paid.
Limits on Tax Collections
Some older tax debts are subject to discharge in bankruptcy. To discharge your overdue taxes, the tax return associated with the debt must have been due at least three years prior to the bankruptcy filing. Also, the IRS will not allow the discharge of taxes, interest or penalties due in association with a fraudulent return, or if you were found guilty of tax evasion. The agency may also claim the right to any tax refunds that come due during the bankruptcy.
Founder/president of the innovative reference publisher The Archive LLC, Tom Streissguth has been a self-employed business owner, independent bookseller and freelance author in the school/library market. Holding a bachelor's degree from Yale, Streissguth has published more than 100 works of history, biography, current affairs and geography for young readers.