Bankruptcy and Tax Debt

Understanding Bankruptcy and Its Impact on Tax Debt

When facing overwhelming financial difficulties, many people turn to bankruptcy as a potential solution to eliminate or restructure their debts. However, not all debts are treated equally in the eyes of bankruptcy law, especially when it comes to tax debts. One of the most common questions people ask is whether filing for bankruptcy can eliminate tax debts. The answer is nuanced, depending heavily on the type of bankruptcy filed and the specific nature of the tax obligations.

Types of Bankruptcy: Chapter 7 vs. Chapter 13

In the United States, individuals typically file for one of two types of bankruptcy: Chapter 7 or Chapter 13. Each has different procedures and implications for resolving debts, including tax debts.

Chapter 7 Bankruptcy

• Liquidation Bankruptcy: Often referred to as "liquidation bankruptcy," Chapter 7 involves the sale of a debtor's non-exempt assets by a trustee to pay off creditors. In many cases, debtors are left with very few assets and thus can discharge most types of unsecured debt.

• Impact on Tax Debt: Certain tax debts can be discharged in Chapter 7 bankruptcy, but specific criteria must be met:

  1. Income Taxes Only: The debt must be due to federal or state income tax. Other types of taxes are non-dischargeable.
  2. Age of Debt: The tax debt must be at least three years old.
  3. Filing Compliance: The tax return for the debt in question must have been filed at least two years before the bankruptcy filing.
  4. Tax Assessment Timing: The IRS must have assessed the tax debt at least 240 days before the bankruptcy filing.
  5. Non-Fraudulent: There should be no evidence of tax evasion or fraudulent activity related to the tax return.

Chapter 13 Bankruptcy

• Reorganization Bankruptcy: Known as "reorganization bankruptcy," Chapter 13 involves creating a repayment plan to pay back debts over time, typically three to five years. This allows debtors to keep their assets while making manageable payments based on their income.

• Impact on Tax Debt: While Chapter 13 doesn't typically discharge tax debts as comprehensively as Chapter 7, it allows for:

  1. Restructuring: Tax debts can be restructured into the repayment plan, often allowing more time and flexibility for repayment.
  2. Interest and Penalties: Potential reduction in penalties and halting of additional interest accumulation during the repayment period.

When Tax Debt is Non-Dischargeable

Not all tax debts can be eliminated through bankruptcy. The following types are generally non-dischargeable:

• Recent Tax Debts: Taxes for which returns were due within the past three years.
• Property Taxes: Typically non-dischargeable unless they are one year past due, and even then, liens may remain.
• Trust Fund Taxes: Taxes collected or withheld, such as payroll taxes, cannot be eliminated.
• Fraudulent Returns or Evasion: If the debtor filed fraudulent returns or attempted to evade taxes, these debts cannot be discharged.

Special Considerations

Collection Activities

Even if certain tax debts are not dischargeable, filing for bankruptcy typically results in an automatic stay, temporarily halting collections activities by the IRS and other creditors. This can provide important relief and space for financial reorganization or negotiation.

Bankruptcy Code and Tax Code

Navigating the intersection of the bankruptcy code and tax code can be complex. Each individual case may have unique factors affecting how tax obligations are handled. Consulting a bankruptcy attorney or a tax professional experienced in this area is essential for personalized guidance.

Differentiating Between Tax Types

The distinction between different types of taxes matters significantly in bankruptcy proceedings. For example, while income taxes older than three years may be dischargeable under specific conditions, payroll and trust fund taxes collected on behalf of employees are strictly non-dischargeable.

Table: Eligibility for Tax Debt Discharge

Frequently Asked Questions

Can filing for bankruptcy stop an IRS levy?

Yes, once you file for bankruptcy, an automatic stay goes into effect, stopping most collection activities, including an IRS levy. However, this is typically temporary, and understanding the nature of your tax debt is crucial for long-term resolution.

Will bankruptcy eliminate state tax debts?

Similar to federal taxes, if state taxes meet specific criteria, they may be discharged in a Chapter 7 bankruptcy. In Chapter 13, state tax debts can be reorganized within your repayment plan.

How does bankruptcy affect ongoing tax obligations?

Filing for bankruptcy does not eliminate your obligation to file your tax returns on time in the future. It's crucial to maintain compliance with tax filings to avoid new tax debts.

What is the role of a bankruptcy attorney?

A bankruptcy attorney helps you navigate the legal complexities of filing for bankruptcy, determining which, if any, tax obligations may be dischargeable, and forming a strategy for managing any non-dischargeable debts.

Additional Resources

For those exploring the impact of bankruptcy on tax debts further, reputable resources include:

• IRS: Declaring Bankruptcy and Paying Tax Debts
• United States Courts: Bankruptcy Basics

Moving Forward

Understanding the implications of bankruptcy on tax debt requires careful consideration of various factors and professional advice. If you're struggling with tax debts, consulting with professionals who specialize in bankruptcy law and tax code will be instrumental in guiding you through this challenging process.

For more articles and information on financial management and debt solutions, feel free to explore additional content on our website.