Jan 21, 2025
While millions of Americans owe the IRS money in back taxes, some unfortunately owe a lot more than others.
Take this 33-year-old California man, for example. His dire situation, in which he owes about $170,000 in tax debt, was the subject of a Reddit post titled “Large tax and credit card debt. Debt relief or bankruptcy?”
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As the Reddit post explains, this California man had the opportunity to buy shares of a company he used to work at and decided to purchase “a ton” of shares just before leaving the company. But as our unfortunate investor explains, he didn’t quite understand the tax implications of his purchase, which has left him dealing with significant debt.
“I have built up a large amount of debt, about $170K in tax debt ($145K to federal and $25K to California) which was due to purchasing a ton of pre-IPO (Initial Public Offering) shares at a previous company and not knowing the tax implications,” the man explained on Reddit.
Pre-IPO investing is considered a high-risk, high-reward endeavour that investors typically don’t engage in unless they’re willing to take on a long-term commitment. In this case, the California man purchased a lot of pre-IPO shares, likely anticipating the company to eventually go public, but since the company remains private, the man has to pay taxes on his stock options as he waits for them to start churning a profit.
“Now the company is still private with no IPO or acquisition in sight, they won't buy back any options, and don't allow for any selling on secondary markets, so I'm just sitting on a large amount of Monopoly money that who knows if/when will turn into something real but I have to pay taxes on it like it is real.”
To make matters worse, the man also has more than $25,000 in credit card debt, not to mention a credit score hovering around 600 thanks to the loans he took out in order to cover expenses. It’s “a vicious cycle,” he explained on Reddit.
As noted in the title of his Reddit post, the California man is left mulling two options: declaring bankruptcy or going into debt relief. Here we’ll take a look at his options and how they can help him navigate through his financial troubles.
Option 1: Declaring bankruptcy
According to the Burr Law Office, you can declare bankruptcy to potentially wipe out tax debt but only on debt that is at least three years old. In this case, the California man’s back taxes are much more recent, so he’d have to wait until his debt becomes three years old before he could file for bankruptcy.
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But even if the California man were to eventually file for Chapter 7 bankruptcy when he’s able, that doesn’t guarantee his tax debt will be discharged.
“Most types of tax debt are not dischargeable in bankruptcy,” Oberon Copeland, CEO of Very Informed, shared with Debt.org. “That means that even if you file for bankruptcy, you’ll still be responsible for paying any outstanding tax liability.”
Chapter 13 bankruptcy, which is also known as “wage earner’s” bankruptcy, is designed to help people who have extreme debt but make enough money to pay off that debt over time, whether in part or in full. It’s often called reorganization bankruptcy, and usually includes monthly payments over 3-5 years that, when complete, can cancel many of your remaining debts.
Bankruptcy could be an option for this California man, but his debt is unlikely to be discharged completely and there are other drawbacks worth considering. For instance, his personal possessions could be sold off to pay for what he owes, and his credit report will keep his bankruptcy on file for 7 to 10 years. This could make it a lot harder to get a credit card or a lease in the future.
Bankruptcy is also a matter of public record, meaning anyone who wants to know about your financial situation can potentially find out, if they know where to look.
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Option 2: Debt relief
If your back is up against the wall, debt relief is another solution that could help alleviate the pressure of debt.
There are different types of relief, such as debt settlement, where you stop paying your normal bills and instead start making smaller monthly payments to a debt settlement company. That company would then use the money to build lump-sum payments that it'll offer to your creditors. The amounts usually end up being much less than what you initially owed.
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There’s also debt consolidation, where you merge your loans into one and end up paying lower interest. You take out a new loan, ideally with better terms and a lower interest rate, and use it to pay off all of your debts. With debt consolidation you haven’t reduced your overall debt, but it’s more organized and you might save a lot in interest.
Debt relief isn’t for everyone and it can hurt your credit, but it is another viable option for this California man to investigate.
Option 3: Currently not collectible status
If you’re in debt to the IRS and you simply can’t afford to pay your back taxes, this may be your best option.
The IRS has a temporary debt-relief program referred to as “currently not collectible (CNC)” status. This status allows you to pause your tax debt and enter into a debt repayment plan with the federal agency. But there’s a catch: your total debt will increase as interest and other penalties are charged until the entire debt is paid off.
This is a helpful option, but CNC status is only granted to people who can prove that they can't afford to pay back their taxes at that time. The IRS will look at how much money you make and your living expenses before it decides on whether to pause your payments until your financial situation improves. The IRS will also consider if your financial situation is temporary, and if you potentially qualify for other government debt-relief programs.
Though CNC status may help many people in debt, our friend from California revealed in the comments section of his Reddit post that he makes $200,000 annually. With that kind of income, he likely wouldn't qualify to have his debt paused under CNC status.
This investor from California has certainly found himself in a tough financial position, but there are a few different routes he can take that will help him pay off his massive debt. Of course, if he had understood the implications of his stock purchase at the time, he could have avoided this mess entirely. As stated above, purchasing pre-IPOs is a risky bet, and investors would be wise to speak with a financial advisor before purchasing stock options that come with such inherent risks.
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William Koblensky Varela is a Staff Reporter at Wise who has worked as a journalist for seven years covering finance, local news, politics, legal issues and the environment.
