First, the good news: it is possible to discharge some tax debts in bankruptcy. That said, the process of discharging tax debts sets forth several requirements that must be met to qualify. The benefit to an eligible debtor can be substantial if the tax debt satisfies the rules that permit discharge, and each situation will require a detailed analysis of the facts in each case.
If a debtor’s case is filed under chapter 7 (most common for individuals) the following conditions must be met to obtain a discharge of tax debt:
1. Only income taxes owed to federal, state or local governments are eligible for discharge. Any other taxes such as payroll and property taxes or fraud penalties/fines cannot be eliminated through bankruptcy.
2. Any fraud or willful evasion will prevent a discharge. Filing a return with a false Social Security number or submitting a ‘zero return’ in which all numbers are entered incorrectly are examples of situations that will prevent discharge.
3. The tax debt must have become due at least three years before filing. Since taxes usually fall due on April 15, three years must be added to the due date to determine the earliest date when the case may be filed. For example, federal and state taxes for 2018 became due on April 15, 2019. If you owed taxes for that year and want to discharge them, the earliest possible filing date is April 15, 2022.
4. A tax return must have been filed at least two years before filing bankruptcy. This allows discharge to be granted even if the returns were filed late, so long as the forms were filed at least two years before filing for bankruptcy. In this situation, if someone intends to discharge an income tax obligation for 2018, (when the return was due on April 15, 2019) but did not file until July 15, 2020, the bankruptcy case cannot be filed until July 15, 2022, in order to satisfy both the two year filing requirement and the three year period from when the taxes were due.
5. The IRS must have assessed the income tax debt at least 240 days before the bankruptcy case is filed. Generally the date of assessment is on or near the date on which the return was filed so long as the IRS agrees as to the amount owed. This time limit can be extended if the IRS suspended collection activity because of an offer in compromise.
Clients sometimes have tax debts that have resulted in liens filed against their property by the IRS, Department of Revenue or both. Tax debt and tax liens are different things. Tax debt is simply money that is owed to the level of government that imposes the tax. A tax lien is a legal judgment secured against your property to satisfy a tax obligation owed to the federal or state government. Unfortunately, discharge of a tax debt does not automatically remove a tax lien if one has been filed against real property. If discharged, the underlying debt will disappear, however, the lien will remain in place. No more collection activity can be taken to collect the (now discharged) tax debt, but when the property is sold, the debt will have to be paid to transfer clear title. There are ways to resolve a tax lien that can be as simple as a direct negotiation with the IRS. This will be covered in a later article.
The rules regarding tax debts in a chapter 13 case differ significantly. In a chapter 13 case, the debtor commits to making monthly payments for a three to five year period. Dischargeable tax debts—those that meet the above criteria may be forgiven without any payment, depending on the amount of disposable income remaining after reasonable and necessary living expenses are deducted from your pay.
Other impacts of taxes in chapter 13 cases include the following: additional interest or penalties will not accrue while the plan is in place, a tax lien can be satisfied through a chapter 13 plan and the IRS must abide by the terms of the plan so long as all outstanding tax debt is included, and tax filings are current and up to date.
The decision whether to file bankruptcy and its impact on tax debt is complex and each case is unique because everyone’s situation differs. An attorney should be consulted to analyze your situation and to recommend an appropriate course of action. I would be honored to discuss your options to get you a fresh start. Please contact me, Ted Benchik, at 717-236-3010 ext. 126 or via email at firstname.lastname@example.org.