Tax Withholding: How it Relates to Bankruptcy

Tax withholding is the amount of funds withheld from paychecks, pensions, bonuses and other forms of income in order to pay an individual’s annual federal income tax. Ensuring enough tax is withheld is crucial to managing household finances properly and, in the end, preventing the need for bankruptcy.

When an individual fails to withhold enough taxes on income throughout the year, he or she may not be able to afford to pay the taxes when it comes time to file a tax return. This can lead to owing back taxes and, over time, could require the individual to file bankruptcy to discharge certain debts.

Withholdings and Bankruptcy 

If inadequate tax withholdings have led a person to owe back taxes, this may lead the Internal Revenue Service (IRS) to send a “lock-in” letter to the individual’s place of employment. This requires the employer to withhold a specific amount of taxes on each of the employee’s paychecks.

Individuals who get behind on taxes also may choose to file for Chapter 7 or Chapter 13 bankruptcy, which can help pay off back taxes and other debts over time or discharge some of them in full. According to data from the U.S. Courts, more than 1.1 million Americans filed for Chapter 7 and Chapter 13 bankruptcies in 2011.

It’s important to note, however, that filing for bankruptcy stays on a person’s credit report for up to 10 years (for Chapter 7; Chapter 13 stays on the history for seven years), affecting his or her ability to take out loans, seek financing and obtain credit cards.

More Information from Plano Bankruptcy Attorneys 

To learn more about the relationship between bankruptcy and taxes or for help in the filing process, individuals or couples who are considering filing for bankruptcy can discuss the advantages, disadvantages or the implications of tax withholdings with a Plano bankruptcy attorney.