BANKRUPTCY

When Can a Tax Debt Be Discharged?

There are various myths surrounding bankruptcy. One of the most common questions people often ask is, can my IRS debts be discharged if I file for bankruptcy? Sometimes, they may not ask and assume filing for bankruptcy will automatically wipe out their IRS debts. Unfortunately, the bankruptcy law has certain restrictions that allow only certain kinds of taxes to be discharged.

Although a tax debt is more likely to be discharged in Chapter 7 than Chapter 13 bankruptcy, sometimes taxpayers can find themselves in the worst situation after filing for bankruptcy if they did not obtain proper information. Some taxes are chargeable in bankruptcy if the following conditions are not met:

• The tax debt is at least three years old. To eliminate a tax debt, the tax debt must be from a tax return that was originally due at least three years before filing for bankruptcy.
• The tax must be an income tax. Payroll taxes and penalties for fraud are excluded.
• You filed a tax return. Your tax return for the debt must have been filed two years before filing for bankruptcy.  In most courts, if you file a late return (meaning your extensions have expired and the IRS filed a substitute return on your behalf), you have not filed a “return” and cannot discharge the tax. 
• The “240-day rule.” The IRS assessed the tax debt at least 240 days before the debtor filed for bankruptcy. 

Debts that cannot be discharged in Chapter 7 bankruptcy:

Tax liens. When all of the above conditions are met, the IRS will discharge your personal income tax obligations. However, all assets that a lien is attached to are still subject to collection, since bankruptcy does not usually release IRS tax liens. This rule applies only to tax liens recorded against your property before you file for bankruptcy. The IRS may still be able to execute on its tax lien or any property acquitted at a later date.  In effect, this means you’ll have to pay off the tax lien in order to sell the property. Every taxpayer’s situation is different, and before filing for bankruptcy, we strongly recommend a taxpayer schedules a FREE consultation to learn the pros and cons. 

• Tax debts from unfiled tax returns
• Trust Fund taxes or payroll taxes – Withheld from employee’s, and sales taxes the debt is required to send to the taxing authority
• Trust Fund Taxes – “trust fund” taxes are taxes such as FICA, Medicare, and income taxes that an employer must withhold from the pay of employees, and sales taxes paid by customers.
• Certain employment taxes, excise taxes, and custom duties, depending on specific time periods.
• Non-punitive tax penalties on non-dischargeable taxes if the transaction or event that sparked the penalty occurred less than three years before filing the bankruptcy petition.
• Erroneous tax refunds or credits relating to non-dischargeable taxes.

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