Tax Discharge in Bankruptcy
Filing for bankruptcy is sometimes the best way to get your finances under control and get a fresh start. However, declaring bankruptcy is not right for everyone. It’s important to understand how bankruptcy can affect different types of debts, such as tax debts.
If you are behind on medical bills, car payments, or other debt obligations, you may not have the resources to pay taxes. All your debt can continue to pile up and eventually become overwhelming. Thankfully, certain tax debts may be reduced or even eliminated by filing for bankruptcy. An experienced bankruptcy tax lawyer can help you determine whether bankruptcy makes sense for your financial situation and whether any of your tax liabilities may be dischargeable.
At Amourgis & Associates, Attorneys at Law, our Ohio bankruptcy attorneys are committed to helping consumers overcome financial setbacks and achieve their long-term economic goals. Contact us today for a free consultation with our skilled team.
Does Bankruptcy Discharge Tax Debt?
The rules and restrictions surrounding dischargeable tax debt in bankruptcy can be confusing. But filing for bankruptcy can enable you to eliminate some of your tax debts. Additionally, as soon as you declare bankruptcy, the Internal Revenue Service (IRS) and other agencies are barred from continuing their collection activities while your bankruptcy case is ongoing.
It’s important to understand that not all types of tax debt are dischargeable. The types of tax debt you may be able to discharge will depend on the type of bankruptcy case you plan to file. For example, you will still owe most types of tax debt after a Chapter 7 liquidation bankruptcy plan is completed. Under a Chapter 13 plan, you will likely need to repay most tax debts as part of your three- to five-year repayment plan.
However, it may be possible to discharge some federal, state, and local-level income tax debts in an Ohio bankruptcy case. Although there are differences between the types of debt you may be able to discharge in Chapter 7 or 13 bankruptcy cases, you may be able to discharge interest and certain penalties associated with dischargeable tax debts.
When You Can Discharge Tax Debt
In most cases, Chapter 7 bankruptcy is the ideal option if you wish to discharge tax debts. This is because during Chapter 13 bankruptcy, you will most likely be required to repay your tax debts as part of your court-approved repayment plan. Chapter 7 liquidation bankruptcy, on the other hand, wipes out most types of debt after filers sell off their non-exempt assets.
To discharge tax debts in Chapter 7 bankruptcy, you must meet the five following criteria:
- Your tax debt is from federal, state, or local income taxes. Debt from non-income taxes such as payroll taxes, capital gains taxes, sales taxes, and fraud penalties cannot be eliminated by declaring bankruptcy.
- You did not file a fraudulent tax return or willfully avoid paying your taxes. If you included information on your tax return in an attempt to defraud the IRS or commit intentional tax evasion, your associated debts are not eligible for discharge through bankruptcy. Forgetting to file a return or being unable to pay your tax debts is usually not considered willful tax evasion.
- Your tax debts are at least three years old. Your tax debt must be from a tax return that was initially due three or more years before the date you file for bankruptcy.
- You filed your tax return at least two years ago. You filed a tax return for the tax debt you want to discharge two years before the date you file for bankruptcy. In most cases, if you file a late return after the usual tax deadline and any applicable extensions have expired, the associated tax debt is not dischargeable through bankruptcy.
- The IRS assessed your tax debts at least 240 days ago. The IRS assessed your income tax debt at least 240 days before the date you file for bankruptcy. If the IRS suspends its collection activities because of an offer in compromise (OIC) or an earlier bankruptcy case, the 240-day time limit may be extended.
Non-Dischargeable Tax Debts
Many debts, including some tax debts, can be discharged through Chapter 7 bankruptcy or paid off over time through Chapter 13 bankruptcy. However, certain tax debts are given special priority and are not eligible for discharge, even with a successful bankruptcy case.
Tax debts are considered priority non-dischargeable debts if:
- The debt is from any type of non-income tax due.
- The debt is less than three years old.
- The tax return for the debt is less than two years old.
- The IRS assessed the tax debt less than 240 days ago.
In bankruptcy cases, priority debts are treated differently. A priority debt must be paid off before other obligations, such as credit card debts or medical debts. Filers are also responsible for any priority debt obligations that remain after their bankruptcy case is completed.
Your income tax debt will also be considered non-dischargeable if you failed to file a timely tax return, filed a fraudulent tax return, or made willful attempts to avoid paying the taxes you owed.
Bankruptcy and Federal Tax Liens
In some cases, the IRS may file a tax lien if you are past due on your federal income taxes. A lien is a claim filed against your property or assets that allows the IRS to seize those assets if you fail to pay the taxes you owe. This could include garnishing your wages, seizing real estate in your name, or even taking control of your bank accounts.
Your ability to discharge a federal tax lien through bankruptcy depends on the type of bankruptcy you file. For example:
- Chapter 7 bankruptcy ─ While Chapter 7 bankruptcy can stop the IRS from collecting what you owe directly from your bank accounts or wages, it will not eliminate a federal tax lien. If the IRS filed a lien on your property before you declared bankruptcy, the lien will still be on the property after the bankruptcy case has concluded.
In some cases, the IRS may agree to release certain liens in Chapter 7 if the value is low enough. It may also be possible to reduce the value of a lien based on the amount of equity you have in your personal assets.
- Chapter 13 bankruptcy ─Under Chapter 13 bankruptcy, you can remove a federal tax lien by paying off your debt obligations over the course of your three- or five-year repayment plan. You may not be required to pay the full amount you owe for a federal tax lien in Chapter 13 if the value of your assets is less than the cost of the lien. As long as you keep up with your court-ordered repayment plan, your federal tax lien can be wiped out at the end of a Chapter 13 bankruptcy case.
Should I File for Bankruptcy Before or After Filing My Tax Return?
You must have filed all past tax returns to be eligible to file for bankruptcy. However, the timing of any tax returns you file before your bankruptcy case can have an impact on any money you expect to collect in refunds.
If you file your taxes well before you file for bankruptcy, you are more likely to retain the full amount of any refund money you receive. After all, if you use your refund for things like household expenses, bills, or other necessities, the IRS cannot force you to forfeit money you have already spent.
If you receive money from a tax refund after you have already declared bankruptcy, some or all of that money may be lost to your creditors.
If you fail to file your return at all before you file for bankruptcy, your case may be dismissed, or you could be on the hook for estimated tax obligations as calculated by the IRS. In most cases, IRS estimates are much higher than any amount you would owe if you filed a return yourself.
Contact a Bankruptcy Attorney Today
The bankruptcy attorneys of Amourgis & Associates, Attorneys at Law, fight for individuals and families who are overwhelmed by debt. With years of experience and considerable resources at our disposal, we can help you develop a solid debt relief plan and get back on your feet.
To learn more about how our team can help you plan for your future, contact us today to get started with a free, confidential case review.