It is a common
misunderstanding
that bankruptcy
cannot eliminate
any income tax
liability.
Although
treatment of
income 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 taxes
eligible for
discharge are
income taxes.
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.
