Income
Taxes and Bankruptcy.
It is a common misunderstanding
that bankruptcy cannot eliminate any tax liability. Although
treatment of tax liability is one of the most complicated aspects
of consumer bankruptcy law, the Bankruptcy Code does offer many
debtors substantial income tax relief. Whether or not your bankruptcy
filing relieves your tax debt depends on several factors including
the nature and the status of tax liability and the type of bankruptcy
proceeding.
Type of
Tax
Only individuals,
not businesses, can discharge (wipe out) certain taxes through
bankruptcy. The only tax eligible for discharge is federal income
tax. Bankruptcy offers no relief from taxes for which the debtor/taxpayer
was responsible for collecting from others such as FICA withheld
from employees. Bankruptcy also will not relieve liability for
excise taxes such as estate and gift tax, sales tax, or fuel
taxes.
Secured
Tax Debts
In the course of its
collection efforts, the IRS has the power to file a tax lien
to perfect its tax claim against individuals. A tax lien, once
filed, becomes a secured lien on all of the taxpayer’s
property. If a tax lien is in place prior to your filing bankruptcy,
the IRS’s secured tax lien has priority over the bankruptcy
filing, and bankruptcy cannot dislodge the lien from the your
property. Even property which would otherwise be exempt in a
bankruptcy, such as homestead, cannot be sold or transferred
without payment of the IRS tax lien. In this instance, bankruptcy
provides no tax relief.
Tax Relief
in a Chapter 7 Bankruptcy
Chapter 7 Bankruptcy
will eliminate all income taxes except the following tax liability:
a. Taxes for which a tax return was due to be filed within three
years (plus extensions) prior to the date of filing bankruptcy.
For example, the tax return for 2003 income taxes was due to
be filed on April 15, 2004 (plus any extensions), and therefore,
these income taxes cannot be discharged by filing bankruptcy
on or before April 15, 2007 (plus the time of extensions); OR
b. Taxes assessed by the IRS within 240 days before the filing
of bankruptcy. Assessment date is the date that tax liability
is entered on IRS records; OR
c. Taxes not yet assessed but still assessable; OR
d. Taxes for which a tax return was filed late and filed within
two years prior to filing bankruptcy; OR
e. Taxes of a debtor who committed fraud related to a
tax return or willfully attempted to evade or defeat taxes sought
to be discharged.
Income taxes that do not fail any of the above five tests may
be wiped out in a Chapter 7 Bankruptcy.
Tax Relief
in a Chapter 13 Bankruptcy
Taxes which are non-dischargeable
in Chapter 13 are considered priority debts and must be paid
in full during the Chapter 13 plan without interest.
Other
Points to Remember
Dischargeable taxes
are eliminated in Chapter 7 and are treated as general, unsecured
creditors in Chapter 13.
Secured tax liens cannot be discharged in Chapter 7. The secured
portion of tax liability must be paid during a Chapter 13, in
full and with interest, but without further penalty.
