If you owe back taxes to the Internal Revenue Service (IRS) or the Texas Department of Revenue, it is fair to ask whether it might be possible to discharge a tax debt in Chapter 7 bankruptcy. While bankruptcy may help you erase (discharge) back taxes, interest, and penalties, there are several things you should know about tax forgiveness and bankruptcy regardless of your financial situation.
When the IRS takes possession of your financial assets or property to repay a tax debt, they’re enacting a ‘tax levy’. This can include garnishing your wages, withdrawing money from your bank account, and/or seizing your property. In certain circumstances filing for bankruptcy can halt a tax levy and erase (discharge) a tax debt. In facing the IRS, I can serve you in leveling the playing field and holding onto your assets to secure a fresh start.
It’s important to understand two things:
- Tax debts with respect to Chapter 7 Bankruptcy & Chapter 13 Bankruptcy are treated differently.
- Tax debt is classified as either secured, priority or unsecured debt.
Secured tax debt means the taxing service has a lien on your property that survives the bankruptcy.
Priority tax debt means the debt is nondischargeable in a chapter 7 or a Chapter 13 bankruptcy. A Chapter 13 will stop the penalties from accruing but not the interest. and is payable over a 3 to 5 year plan.
Unsecured tax debt means the debt can be discharged in a chapter 7 bankruptcy and you have zero liability left after the discharge. In a chapter 13 (depending on your disposable income, ) you would pay anywhere from 1% to 100% of the debt through the repayment plan.
Discharging Personal Tax Debt
For personal taxes, discharging tax debt with Chapter 7 Bankruptcy depends on several factors:
- Taxes have to be more than 3 years old, and the returns filed on time (or with an approved extension)
- The taxes must have been assessed more than 240 days before filing bankruptcy
- The tax return was filed at least two years before filing for bankruptcy.
- These deadlines may be extend if the IRS suspended collections due to an Offer and Compromise or a previous bankruptcy.
Even in cases wherein a tax debt turns out to be non-dischargeable in Chapter 7, obtaining tax relief may be possible by filing Chapter 13 bankruptcy. An advantage in doing so may be the ability to suspend tax penalties against you. Having said that, a limitation to a Chapter 13 is all of the tax debt is required to be paid over the course of the payment plan established with the bankruptcy court. Your decision on whether to pursue a Chapter 13 bankruptcy may depend on the overall size of your tax debt.
Bankruptcy filing will put into effect an automatic stay that stops all creditors from continuing their collection efforts, the Internal Revenue Service (IRS) included. If you're facing a tax levy and the IRS is attempting to seize your assets, filing for bankruptcy will instantly stop that attempt.
It’s only partly true that federal income tax cannot be discharged when filing for bankruptcy. For clarity, tax debt incurred within 3 years of a filing bankruptcy cannot be discharged, but older tax debts can possibly be entirely eliminated.
If you owe the IRS on federal tax returns that were due to be filed more than 3 years prior to your bankruptcy filing, Chapter 7 bankruptcy and Chapter 13 bankruptcy both offer the potential to erase (discharge) tax debt along with interest and penalties subject only to the value of a tax lien if filed.
Discharging Tax Debt in Bankruptcy Requires:
- The taxes are income-based. The taxes must be for federal or state income taxes or taxes on gross receipts.
- The federal return was due at minimum 3 years ago including all valid extensions. This is 3 years prior to your bankruptcy filing.
- You filed the federal return at minimum two years ago (2 years prior to your bankruptcy filing).
- The taxes were assessed at minimum 240 days ago. (240 days prior to your bankruptcy filing). It’s possible to get an extension on this time limit if you had previously filed for bankruptcy or there was an offer in compromise between you and the taxing authority.
- No fraud, willful evasion, and you cannot be guilty of any intentional act of tax law evasion. If you file jointly with a spouse, it must be proven that you both committed an act of fraud related to the applicable return or willfully attempted tax evasion, in order for the bankruptcy court to deny the discharge of the tax debt
Tax Liens ?
If you’re facing a tax lien and consequently file a chapter 7 bankruptcy, the tax lien won’t be discharged and would only apply and be enforceable onto the property you own till the date of the bankruptcy filing and not applied to property acquired afterward. This all can get somewhat complicated but there are some types of tax debt that may not be dischargeable. Those include the following:
- Tax liens attached to personal property;
- Property taxes that were to be paid within 1 year of the bankruptcy filing;
- Withheld or collected taxes by a third party;
- Various employment taxes (custom duties, excise taxes, and more).;
- Non-punitive in nature tax penalties
- Erroneously paid to you tax refunds
For owners or operators of a business, several types of priority tax debt that may not be discharged, include:
- Trust fund taxes (FICA, Medicare, etc.) and or income taxes you withheld from paychecks
- Collected sales tax from clients or customers; and
- Other miscellaneous taxes and non-dischargeable funds related to your business
Thus, a Chapter 7 bankruptcy discharge erases your personal obligation to pay the tax and stops the taxing authority from attaching to your wages and or bank account. While you would not be personally liable for the tax debt, stay mindful your property will remain subjected to the amount of the tax lien.