If you’re struggling with debts you can’t afford to repay, you might have wondered whether bankruptcy could help you achieve a fresh financial start. However, before applying, it’s important to check whether all your debts can be included.
The good news is, bankruptcy can be used to deal with most types of unsecured debt, including tax debt. What’s more, tax debts from both current and previous years can be included.
What is bankruptcy?
Bankruptcy is a legal process that can help you deal with your unaffordable debt before writing it off after a set period. It’s an individual solution, meaning it can’t be applied to companies or partnerships.
Most bankruptcies last 12 months, during which time you usually won’t have to pay anything towards your debts and the people you owe money to won’t be able to contact you. This is to help you focus on rebuilding your finances.
There are certain eligibility criteria you must meet before you can apply for bankruptcy. For example, you must be able to prove you’re insolvent (unable to pay your debts as they’re due) and have multiple debts worth at least £5,000. Because of the negative impact it can have on your finances, it should only be considered as a last resort.
Most unsecured debts are covered by bankruptcy, including credit cards, personal loans, overdrafts, payday loans, store cards, utility arrears, catalogues, and council tax arrears. Other debts, such as student loans, child maintenance arrears, criminal fines, and debts accrued by fraud, cannot be included in a bankruptcy filing.
How much debt do you have?
How does bankruptcy work?
Knowing how bankruptcy works can help you know whether it could potentially help you deal with your unaffordable debt. We’ve broken down the steps typically involved in a standard bankruptcy timeline below:
Seek free debt advice
Before applying for bankruptcy, it’s important to seek free debt advice from a professional organisation or charity. They will assess your financial situation and let you know if they believe bankruptcy is the right solution for you.
Even if you qualify for bankruptcy, there may be another solution that can still help you deal with your unaffordable debt but cause less damage to your credit score. For example, a Debt Relief Order (DRO) is often considered a simpler, cheaper alternative to bankruptcy.
Complete a bankruptcy form
Once a debt advisor has confirmed that bankruptcy is right for you, the next step is to complete an application. The form – which can be accessed via the GOV.UK website – will ask for details of your income, debts, and assets.
There is an application fee required for bankruptcy, which is currently £680. This can be paid in instalments (minimum of £5), but it must be received in full before your bankruptcy can begin.
Withdraw money for living costs
Once you’ve submitted your bankruptcy application, an ‘Official Receiver’ (OR) from the Insolvency Service will manage the initial stages of your arrangement. Then, an Insolvency Practitioner might take over, taking control of your money and assets.
Because of this, it’s advised to withdraw money from your bank account for at least a few weeks’ worth of living expenses to ensure you’re able to afford your housing, bills, and groceries during this time.
Wait for the adjudicator’s decision
Once your bankruptcy application has been submitted, the adjudicator will have 28 days to make one of three options: make a bankruptcy order, reject your application, or request further information.
They will contact you with specific instructions if they require further information. They will then be given an extra 14 days to make a decision.
Begin your bankruptcy
Once your bankruptcy order is made, you’ll be officially declared bankrupt.
From this point on, your assets will be taken over by your OR to form part of your bankruptcy estate. Things like savings, pension funds (as long as it’s a UK state pension scheme), and vehicles under a certain value are usually not considered assets in a bankruptcy.
If you’re in a position to pay something towards your debts, you might be asked to make payments for up to three years under an Income Payment Agreement (IPA) or Income Payment Order (IPO). This could mean you’re making payments for another two years after you’re discharged.
Receive your bankruptcy discharge
If you’ve cooperated with your OR for the duration of your bankruptcy and your financial situation hasn’t changed, you’ll be discharged after 12 months. When this happens, the debts will be written off and you’ll be free to make a fresh financial start.
Failure to uphold your side of the agreement or not being honest and upfront about your circumstances can mean you’re not discharged on the expected end date.
Instead, you’ll be served with a Bankruptcy Restrictions Order (BRO), which is a court order that can extend the restrictions placed on you for up to a maximum of 15 years.
“No fuss, just simple, honest advice. Communication is good and they make the process as easy as they can.”
Does bankruptcy clear tax debt?
Bankruptcy is a formal and legally binding debt solution that can help you deal with most types of debts, including tax debt.
Debts owed to HMRC used to be given special status during bankruptcy proceedings, meaning they were always paid before any other creditor. However, since 2013, HMRC has been bound by the requirements of insolvency law and must be treated like any other creditor in a bankruptcy order.
This means that tax debt will be written off after the bankruptcy ends in the same way as every other debt included in the arrangement.
HMRC will also change your tax code to (NT) when you go bankrupt which tells your employer not to deduct any income tax from your wages from the start of your bankruptcy until the end of the tax year. It’s important to note that you won’t be any better off financially from this as the extra money saved will go to the OR to cover some of their costs.
Once the new tax year begins, your tax code will go back to normal and you’ll be liable for income tax again – even if your bankruptcy isn’t over. This means that, if you go bankrupt towards the end of the tax year, you might find that your tax code doesn’t change as it can take a while for this to take effect.
Can council tax debt be included in bankruptcy?
If you owe council tax, it must be included in your bankruptcy – even if your local council has started legal action against you to collect it. This includes debts from the current year accrued at your current address as well as debts from any previous years or addresses (including those owed to different councils).
Despite being a priority debt, council tax debt is treated like any other debt in bankruptcy and is not given any special status.
Once your bankruptcy order has been made, the council must accept your bankruptcy status and stop pursuing you for the money owed. This includes contacting you about the debt, asking you to pay it, or taking legal action against you.
From the moment your bankruptcy order is made, you also won’t have to pay council tax until the start of the new tax year. This will happen regardless of the month you go bankrupt, meaning you might only be exempt from paying council tax for a few months.
However, in the unlikely event you move home during your bankruptcy, you’ll have to start paying council tax on the new property as you didn’t owe that money at the time the bankruptcy order was made.
What happens if I ignore tax debt?
In most cases, HMRC will be willing to come to an agreement with you over your tax debt as long as you inform them that you’re struggling as soon as possible.
They might agree to a payment plan where you make monthly payments over an agreed period until the debt has been cleared, check if you have any overpaid tax that can be used to pay off what you owe or adjust your tax code to allow them to recover the debt.
HMRC can also visit you at home and most HMRC collectors carry card payment machines that allow them to take full or partial payment from you safely and securely.
If you don’t cooperate with HMRC or purposely ignore all attempts at getting in touch with you, they might resort to enforcement action. This might mean they send debt collectors to collect the money owed on their behalf.
When HMRC instruct a debt collection agency to recover the debt on their behalf, they will contact you to let you know by letter, text, or phone. It’s important to pay what you can or agree to a payment schedule where you clear your outstanding balance over time.
How can I avoid tax debt?
Dealing with tax debt can be stressful, but there are some things you can do to help you keep on top of your tax affairs and avoid it in the first place.
Here are our tips for avoiding tax debt:
Submit your tax return on time
If you’re self-employed, it’s important to complete and sumit your tax return on time. Filing your tax return up to three months late will result in you being charged a penalty of £100.
Continuing to ignore HMRC will lead to further charges being added, which will increase your total debt and make it more difficult to eventually pay off.
Check your tax code
It’s your responsibility to check you’re paying the right amount of tax.
If you discover you’ve been paying less than you should have been, you’ll need to pay it back. The only situations in which you might not need to pay back underpaid tax is if your employer put you on the wrong tax code despite HMRC sending them the right one, you made an underpayment of £50 or less in the last year, or the underpayment happened more than a year ago.
Ask for help if you need it
If you’re struggling to pay your tax bill, it’s important to speak to HMRC as soon as possible. By being upfront about the situation you’re facing, they might let you spread your payments over a longer period to make them more affordable.
This can prevent HMRC from adding extra fees or taking legal action against you.
Debt help tailored to you
From writing off a large portion of your debt, to readjusting your budget, we’ll find a solution that suits you.
What other debt solutions can clear HMRC debt?
Bankruptcy can be used to help you clear your tax debt, but it isn’t the only option available. Here are some alternative debt solutions that might also be suitable for you:
Individual Voluntary Arrangement (IVA)
An IVA is a formal and legally binding agreement between you and your creditors to repay what you owe in manageable monthly instalments for a set period. It typically lasts five years, but it can be extended to six years if you fail to uphold your side of the agreement.
Most unsecured debts can be included in an IVA, including income tax and council tax arrears, which are treated like any other debt in the arrangement.
During an IVA, your creditors won’t be able to contact you about the debt or take legal action against you. Furthermore, all interest and charges will be frozen, meaning you’ll only pay what you owe and nothing more.
Once your IVA concludes, all debts included in the arrangement (including those that haven’t been repaid) will be written off and you won’t have to pay them.
Debt Relief Order (DRO)
A DRO is often described as a cheaper and less formal alternative to bankruptcy. It works by freezing all payments, interest, and charges for 12 months and writing off all included debts at the end of this period if your financial situation doesn’t improve.
To apply for a DRO, you must contact a debt advisor. They will assess your eligibility by checking you owe less than £5,000, your assets are worth less than £2,000, and your vehicle is worth less than £4,000 if you were to sell it today.
Some of the debts that can be included in a DRO include credit cards, overdrafts, personal loans, utility arrears, council tax, and income tax.
One of the biggest differences between bankruptcy and a DRO is that bankruptcy costs £680 to apply for while there is no application fee required for a DRO. DROs also don’t affect your assets as much as bankruptcy, meaning you should be able to keep your home and car.
Conclusion
Bankruptcy is a formal debt solution that can help you deal with a wide range of debts, including council tax and HMRC tax debts. Once 12 months have passed, all of the debts included in the bankruptcy will be written off and you’ll be free to make a fresh financial start.
If you’re struggling with tax debt, it’s important to know that HMRC will usually be willing to reach an agreement with you if you let them know about your financial situation as soon as possible. This might include setting up a payment plan, where you make monthly payments until the debt has been cleared.
Taking steps to keep on top of your tax affairs can help you avoid tax debt altogether. To do this, submit your tax return on time, check your tax code, and ask for help if you need it.
