Now that a new year has begun, some debtors might consider changing their tax withholdings to free up income to pay debts. The idea is that they can stay current on their bills now and repay the IRS next April. In most circumstances, reducing withholdings to pay debts is a bad idea and New York bankruptcy is often a better option. Before explaining why, though, I’ll briefly discuss what withholdings are. Undoubtedly everyone who has held a job has dealt with them, but some may not remember or understand the reason for them.
The IRS requires workers to pay their income taxes as they become due and not in a giant lump sum every April. Self-employed workers must pay their estimated taxes four times per year by scheduled deadlines, and payroll employees’ taxes are withheld (there’s the word) from their paychecks based on the withholding allowances they chose on their W-4 forms, which they first submitted to their employers when they began working. Workers who choose fewer allowances will have less of their paychecks withheld, and they’ll take home more income from their paychecks. Conversely, those who choose more allowances will have more withheld and will receive a tax refund after they pay their taxes.
In principle it’s not such a bad thing to over-withhold your income. Naturally, it’s possible a scammer will file a tax return on your behalf and snatch your refund from you, but otherwise, the IRS pays what it owes workers. For distressed debtors, one advantage of over-withholding is that they can use their tax refunds to pay their chapter 7 bankruptcy filing fees. It’s been documented.
Under-withholding, though, is not a good idea because ultimately it’s just choosing one creditor over another—in this case other creditors over the government. Debtors are almost always better off paying the IRS rather than other creditors because the tax debt is a priority claim that cannot be discharged easily in a chapter 7 bankruptcy and must be repaid in chapter 13. More likely, it’s the other creditors whose debts can be discharged. If in all probability the IRS is going to be paid anyway, then debtors are better off doing so in the first place.
Another reason debtors should not alter their withholdings for more take-home income is that the IRS penalizes workers who pay too little in taxes when they’re due. Debtors who pay 100 percent of what they owed last year or 90 percent of what they will owe this year will be fine, as will debtors whose underpayments are less than $1,000. Thus, debtors who try to pay other creditors at the expense of the IRS pay both creditors whose debts may have been dischargeable and perhaps additional penalties to the IRS.
If you are experiencing serious financial hardship, then instead of fiddling with your withholdings to pay creditors, talk to an experienced New York bankruptcy lawyer to help you assess your options.
For answers to more questions about bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced Brooklyn bankruptcy attorney Bruce Weiner for a free initial consultation.
