Eliminating Tax Debts in Bankruptcy

SOME TAX DEBTS MAY BE ELIMINATED IN BANKRUPTCY

Unfortunately, most tax debts survive a bankruptcy discharge. You will continue to owe them at the end of a Chapter 7 bankruptcy case, or you’ll have to repay them in full in a Chapter 13 bankruptcy repayment plan.

If you need to discharge tax debts, Chapter 7 bankruptcy will probably be the better option if your debts qualify for discharge (see below) and you are eligible for Chapter 7 bankruptcy:

Does My Tax Debt Qualify For Discharge?

You can discharge federal income tax debts in Chapter 7 bankruptcy if all of the following conditions are true:

  • The taxes are income taxes. Taxes other than income, such as payroll taxes or fraud penalties, cannot be eliminated in bankruptcy.
  • You did not commit fraud or willful evasion. Tax debts arising from false or fraudulent tax returns, or where the taxpayer willfully attempted to evade paying taxes, will not be dischargeable in bankruptcy.
  • he debt is at least three years old. The tax obligation must have arisen for a tax year for which the return was due at least three years ago. Assume you are filing for bankruptcy in 2011. You have a tax debt that arose in tax year 2007. The return for 2007 was due April 15, 2008. 2008 is three years prior to 2011. These taxes may be dischargeable if all of the other requirements are met.
  • You filed a tax return. You must have filed a tax return for the debt you wish to discharge at least two years before filing for bankruptcy.
  • You pass the “240-day rule.” The income tax debt must have been assessed by the IRS at least 240 days before you file your bankruptcy petition, or must not have been assessed yet. (This time limit may be extended if the IRS suspended collection activity because of an offer in compromise or a previous bankruptcy filing.)

What Is The Effect Of A Federal Tax Lien?

Bankruptcy will not wipe out prior recorded tax liens, as these liens essentially turn the IRS a secured creditor. Federal income tax liens also apply to “after-acquired” property, that is, property or money you acquire after the lien arose, and after your discharge, until the statute of limitations runs on collection for the underlying debt. Your Chapter 7 discharge prevents the IRS from continuing efforts to enforce the tax lien – such as by levying your bank account or garnishing your wages.

One major advantage to filing for bankruptcy, however, is that when the IRS files its claim the penalty portion of the debt becomes “unsecured” and can be eliminated with other unsecured debts.

Do Interest And Penalties Continue To Accrue On My Tax Debt While I’m In Bankruptcy?

No. Penalties and interest do not continue to accrue once you file for bankruptcy.

Reprinted in part with permission from the publisher, Nolo, Copyright 2009, http://www.nolo.com