Taxes in Bankruptcy

Taxes in Bankruptcy

Are you one of the many individuals in Alabama who owe back taxes to the IRS? Income taxes can be discharged under certain conditions but must meet a 5-part test to qualify for discharge in a bankruptcy case. If they do not meet this 5-prong test, then they are generally considered priority taxes that cannot be discharged in a Chapter 7 bankruptcy or must be paid in full in your Chapter 13 bankruptcy case. To make sure that you don’t end up in a situation like this, it may be in your best interest to hire an accountant who will be able to help you organize your taxes so you never have to face the possibility of going bankrupt. In order to discharge taxes in a Chapter 7 or Chapter 13 bankruptcy, your taxes must meet a five-prong test, one that can help you navigate. If one of these prongs is not met, then your income taxes cannot be discharged and will be treated as a priority debt in your bankruptcy.

1. 1. Taxes must have been due 3 years ag—the due date for taxes is generally April 15 of each year unless you have filed an extension. In order for your income taxes to meet this requirement, you must count back to see whether the taxes were due more than 3 years ago. For example, if you are filing for bankruptcy on March 10, 2015, then taxes that meet this standard would be 2010 taxes since they were due April 15th of 2011 (unless you filed an extension), but 2011 taxes would not qualify since they would fall short of being due 3 years ago since they would have been due April 15th, 2012. 2.
      1. ⁣⁣ xes must have been filed on time or at least 2 years ago. ⁣ ou must have filed the taxes that you are trying to discharge more than 2 years ago from the date of your bankruptcy filing. If you have not filed your tax returns, then the taxes that are due on the return cannot be discharged in bankruptcy. If your taxes were assessed on the basis of a substituted tax return that the IRS uses to obtain an educated guess on your tax liability, then your taxes may not be dischargeable.
         When are taxes deemed filed?
         • When you mailed them
         • ⁣ f they are late, then it is the date the IRS received them.
         • Substituted Tax Returns
           • Not Signed by the Debtor—Not Filed
             The tax court has ruled that substituted tax returns that were filed by the IRS but not signed by the debtor were not considered returns under the Bankruptcy Code Section 523(a)(1)(B). According to the tax courts, the unsigned substitute for a tax return did not meet the definition of a return and therefore could not be discharged in bankruptcy. The question that courts have struggled with is whether you can discharge taxes that have been filed after a substitute for a tax return has been filed.
           • Signed by the Debtor-Filed
             1. The bankruptcy code includes a return prepared by the government and signed by the taxpayer.
             2. Taxes must have been assessed more than 240 days ago. The taxes must have been assessed more than 240 days before the filing of your bankruptcy case. Offers in compromise or audits of your taxes affect when your taxes were assessed. Important issues to be aware of:
                The date that your taxes are assessed is not the date of filing. Generally this is the date the IRS officer signs a summary record of assessment. It is a good idea to obtain a record of assessment to determine when your taxes were assessed or a certificate of assessment. The assessment period is extended during the time an offer in compromise is pending plus 30 days. Amended tax returns where a deficiency is assessed will alter the date that your taxes were assessed. Time is tolled during the time a prior bankruptcy was pending.
             There was no willful intent to evade taxes or fraud involve—the taxes that you owe must not have resulted from an intent to evade taxes, such as filing inaccurate tax returns in which you count additional dependents that you know you cannot count as dependents or underreporting your income.
             Failing to pay taxes while engaging in “unnecessary and unreasonable expenditures” evidences an intent to evade taxes. Engaging in lavish purchases or transferring assets while failing to pay your tax obligations indicates an intent to evade taxes. Failing to pay taxes has not been found alone to indicate intent to evade taxes.
             3. Unsecured Taxes- If there is a valid tax lien that has been filed by the IRS, then the tax lien will remain after bankruptcy. Although your personal tax liability will be discharged in bankruptcy, the tax lien will remain on your property. The tax lien attaches to exempt property in the bankruptcy. You can reduce the value of the tax lien as part of your bankruptcy since the value of the tax lien is reduced to whatever the value of your property is at the time of filing.
                Chapter 7 Bankruptcy—If your total assets at the time of filing are $10,000 and a tax lien was recorded for $50,000, then the bankruptcy reduces the tax lien to $10,000 (the value of your assets at the time of filing).
                • Chapter 13 Bankruptcy- If your total assets are worth $10,000 at the time of filing and there is a recorded tax lien for $60,000, then $10,000 would be treated as secured tax debt as part of the bankruptcy, and the remaining portion should be treated as unsecured tax debt.

Interest on Taxes Are Dischargeable The general rule for interest on taxes is that they are dischargeable if the initial tax meets the requirements to be discharged. If your income taxes meet the requirements to be discharged, then any interest that has accumulated will also be subject to discharge. Penalties on Taxes May Be Dischargeable Penalties may be dischargeable even if your tax does not meet the standard to be discharged in bankruptcy. The general rule is that if the event that gave rise to the tax penalty occurred more than 3 years before the filing of your bankruptcy case, then the penalty can be discharged in bankruptcy. Penalties that were imposed as a result of actual pecuniary loss incurred. Nondischargeable Taxes

1. 1. • • Employee Taxes—Taxes that are collected by the employer to pay the employee portion of taxes are not dischargeable. Sales Taxes—Generally, in most taxes, these are considered trust fund taxes that are not dischargeable in bankruptcy. In California they are dischargeable because they don’t fall into this category, and therefore you can discharge them as part of your bankruptcy.

Taxes in Bankruptcy Frequently Asked Questions

The following frequently asked questions explain how bankruptcy may affect federal and state tax debts. Every case is different, so consult an experienced bankruptcy attorney about your specific circumstances.

Can income taxes be discharged in bankruptcy?

Some income tax debts may be discharged when the Bankruptcy Code's timing and filing requirements are satisfied.

What is the three-year rule for discharging income taxes?

Generally, the tax return must have been due more than three years before the bankruptcy filing date, including applicable extensions.

What is the two-year tax return filing rule?

In most cases, the tax return must have been filed at least two years before filing bankruptcy.

What is the 240-day assessment rule?

Generally, the taxing authority must have assessed the tax at least 240 days before the bankruptcy filing, subject to certain exceptions.

Can an offer in compromise affect the 240-day period?

Yes. A pending offer in compromise may extend or suspend the applicable time period.

Can a prior bankruptcy affect the tax discharge deadlines?

Yes. A prior bankruptcy may toll certain discharge timing requirements.

Are taxes dischargeable if the return was never filed?

Generally, taxes for which a required return was never filed are not dischargeable.

Can taxes based on a substitute return be discharged?

A substitute return prepared by the taxing authority may not qualify for discharge under bankruptcy law.

Can taxes involving fraud be discharged?

Taxes associated with fraudulent returns are generally not dischargeable.

Can taxes be discharged if the debtor willfully evaded payment?

Taxes may remain non-dischargeable if the debtor willfully attempted to evade or defeat payment.

Does simply failing to pay taxes prove tax evasion?

No. Courts consider the debtor's overall conduct and circumstances.

What are priority tax debts?

Priority tax debts receive special treatment under bankruptcy law and are generally not discharged in Chapter 7.

How are priority taxes treated in Chapter 13?

Priority tax debts generally must be paid through the Chapter 13 repayment plan.

Can Chapter 7 discharge older income taxes?

Yes. Older income taxes may qualify for discharge when all legal requirements are met.

Can Chapter 13 help with tax debt?

Yes. Chapter 13 may allow repayment of priority and secured tax debts through a court-approved plan.

Are payroll taxes dischargeable?

Trust fund and payroll taxes are generally not dischargeable.

Are sales taxes dischargeable?

Many sales taxes are treated as trust fund taxes and generally are not dischargeable.

Are property taxes dischargeable in bankruptcy?

Property tax treatment depends on the timing of the tax, liens, and applicable bankruptcy law.

Does bankruptcy remove an IRS tax lien?

A bankruptcy discharge may eliminate personal liability, but a valid tax lien may remain attached to property.

Can a tax lien be reduced in bankruptcy?

Depending on the bankruptcy chapter and property value, certain lien issues may be addressed.

Is interest on dischargeable taxes also dischargeable?

Interest associated with dischargeable taxes is generally treated the same as the underlying tax.

Can tax penalties be discharged?

Some tax penalties may be dischargeable depending on their nature and age.

Does the automatic stay stop IRS collection?

Filing bankruptcy generally stops many IRS and state tax collection activities through the automatic stay.

What documents should I bring to a tax bankruptcy consultation?

Bring tax returns, IRS notices, assessment records, lien notices, levy documents, payment agreements, and financial records.

Does Ferguson & Ferguson offer free consultations about taxes in bankruptcy?

Yes. Ferguson & Ferguson offers free bankruptcy consultations through its Huntsville and Decatur offices.

Free Consultations

Discharging taxes in bankruptcy can be tricky and requires careful examination of your income taxes and the circumstances surrounding their filing and assessment. If you owe income taxes, we will review your facts to determine if we can discharge your taxes in a Chapter 7 bankruptcy or have you pay less than 100% in a Chapter 13 bankruptcy. The law firm of Ferguson & Ferguson can help. Call 256-534-3435. Huntsville Office Location: 303 Williams Avenue SW Suite 321 Huntsville, AL 35801 Decatur Office Location: 211 Oak Street NE Decatur, AL 35601