Discharging Tax Debt in Bankruptcy

In addition to debts such as a mortgage, line of credit and credit cards, many bankruptcy debtors are also behind on their tax obligations. The question often comes up: Can taxes be discharged in bankruptcy?

The answer to that question can be complicated. For instance, some tax debts can be discharged while other tax debts cannot. If you run a business, for example, and owe sales tax, that sales tax can never be discharged in bankruptcy. On the other hand, ordinary income tax can be, depending on various factors.

If you owe the IRS (or your State) for income tax, you may be able to discharge that debt in bankruptcy. First, you must understand how taxes are treated in your bankruptcy. There are essentially three types of debts for bankruptcy purposes: secured debt (such as your mortgage and car loan,) unsecured debt (such as credit cards and medical bills,) and priority debt (such as taxes.) If you are filing a Chapter 7 these different types usually do not make a big difference (but they still must be scheduled correctly on Schedules D, F and E, respectively.) In a Chapter 13, however, the type of debt can make a big difference. Since you are paying back at least some of your debts in a Chapter 13, the amount of each type of debt can determine how much you would have to pay into your Chapter 13 Plan.

Putting aside scheduling and treatment of debts, the conditions for discharging income tax debts are as follows:
1. The debt has to be for an income tax that was due at least 3 years prior to the filing of your bankruptcy petition. As an example, if you file your bankruptcy on May 1, 2012 then any taxes you owe for 2008 (which were due on April 15, 2009) may be discharged, but taxes for 2009-2012 cannot be discharged; and
2. You must have filed your income tax return at least two years prior to the filing of your bankruptcy petition. Taking the above example, if you filed your tax return on time (on or prior to April 15, 2009) and file your bankruptcy on May 1, 2012, then you have satisfied this 2-year rule. But let’s assume that you did not file your 2008 income tax return on time. Instead, you filed it late — let’s say on November 1, 2011. In that case, you must wait until November 2, 2013 (two years since the filing of the return) to file your bankruptcy if you want that tax debt to be discharged, even though it was due more than 3 years prior.

Things get more complicated if you owe for multiple years, some of which meet the above two requirements and some which do not. These are complex issues which can easily get confusing and not handled properly without the right guidance. The bankruptcy forms may seem simple and straight forward, but they are not. If you are contemplating filing for bankruptcy, call us for a free consultation.

Is Chapter 7 Right for You?

It is not uncommon for a new client to come into my office and tell me, “I need to file for a Chapter 7.” My first question to such a statement is always “Why?” The response varies, but has a common theme: “Because I can’t pay my bills.”

Not being able to pay your bills is, of course, a factor in making the difficult decision of filing for bankruptcy. Once making that decision, however, the next decision is whether to file for Chapter 7 or Chapter 13 (other chapters also exist, but they are not relevant to most consumers). While this decision may be made for you — based on, for example, the amount of debt you have — often you will qualify for both chapters. In that case, you must decide which will be more beneficial to you.

The major and most basic difference between these two varieties of bankruptcy protection available to most consumers is that, in a Chapter 7, you effectively “raise your hands and quit,” informing your creditors that you simply have nothing left. If you do not own a house or other property, and your income is just enough to make ends meet but not enough to save each month, then a Chapter 7 will probably be the right choice for you.

In a Chapter 13, on the other hand, you essentially tell your creditors that, while you do have some limited means to pay, you cannot pay all of them everything you owe. In filing a bankruptcy under Chapter 13, you propose a payment Plan, under which you promise to pay a certain amount each month to the Chapter 13 Trustee (assigned by the court and an employee of the Department of Justice), who then will distribute these funds to creditors. You will do so for 3 to 5 years and each of your creditors will get a portion of its debt paid off. At the conclusion of the Plan, any remaining
debts are wiped out.

So which chapter is right for you? While you should not decide the answer to this questions without speaking to a qualified bankruptcy attorney, the simple answer is that if you have no assets and
little income, you would probably end up in a Chapter 7. On the other hand, if you have assets, or your income is above the qualifying maximum income for a Chapter 7, a Chapter 13 may be right for
you.