Filing for bankruptcy can be a daunting process, but it’s an option some individuals consider to alleviate overwhelming debts. One of the most common misconceptions about bankruptcy is the notion that it’s impossible to discharge tax debts. The truth, however, is that under certain conditions, income tax debts can be discharged in bankruptcy. This article provides an overview of how and when this can happen.
1. Understanding Bankruptcy Basics
There are two primary types of personal bankruptcy in the U.S.: Chapter 7 and Chapter 13. Chapter 7 bankruptcy, often referred to as “liquidation,” allows eligible debtors to discharge certain unsecured debts. Chapter 13 bankruptcy, on the other hand, requires the debtor to enter a repayment plan to pay off a portion or all of their debts over a period of 3 to 5 years.
2. Criteria for Discharging Tax Debts
Not all tax debts can be discharged in bankruptcy. There are specific criteria that must be met:
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Age of the Debt: The tax debt must be related to a tax return that was due at least three years before the debtor files for bankruptcy. This includes any extensions that were granted.
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Filing Date: The relevant tax return must have been filed at least two years before filing for bankruptcy. If the IRS filed a substitute return on the debtor’s behalf, it might not count towards this criteria.
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Assessment Age: The income tax debt must have been assessed by the IRS at least 240 days prior to filing for bankruptcy. This period can be extended if certain events, like an offer in compromise or a previous bankruptcy filing, intervened.
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Non-Fraudulent Returns: The tax return in question must not be fraudulent. If the IRS determines that a return was filed fraudulently, the corresponding debt cannot be discharged.
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No Willful Evasion: The debtor must not be guilty of willfully trying to evade or defeat the tax.
3. Taxes That Can’t be Discharged
There are certain types of tax-related debts that can’t be discharged, regardless of the circumstances:
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Tax liens: If the IRS has placed a tax lien on the debtor’s property before the bankruptcy filing, the lien will remain on the property even after the bankruptcy case is closed. This means that if the debtor sells the property, the IRS can still collect the owed amount from the sale proceeds.
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Payroll Taxes or Fraud Penalties: Money a business owes for employee payroll taxes or penalties for tax fraud are non-dischargeable.
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Certain other tax debts: This includes debts for which no return was filed, or debts from late-filed returns where the return was due during the previous two years.
4. Bankruptcy Chapter Specifics
While Chapter 7 bankruptcy can result in the outright discharge of qualifying tax debts, Chapter 13 provides a repayment plan that may include some tax debts. Once the terms of the Chapter 13 repayment plan are met, any remaining eligible tax debts may be discharged.
5. Conclusion
While it is possible to discharge certain income tax debts in bankruptcy, it’s crucial for debtors to understand the specific criteria and exclusions. It’s always recommended to seek legal counsel from an attorney who specializes in bankruptcy and tax law to navigate these complexities effectively.