Discharging Tax Debt in Bankruptcy

   Despite what you may have heard, you can discharge some income tax debts in your bankruptcy case.  Not every type of tax can be discharged and the timing of your filing can impact how your tax debt is treated.  Here are answers to many of the questions we face:

1. What kind of taxes are dischargeable in bankruptcy?

Answer: Income taxes can be dischargeable.  If you have payroll tax debt (941 liability) or other “trust fund” tax debt, those taxes are not dischargeable in bankruptcy.

2. When is my income tax debt dischargeable?

Answer: Income tax debt is dischargeable if it meets certain requirements.  First, the tax debt must be “stale.”  Stale tax debt is defined as tax debt that came due more than three years ago. 

Example:  2000 taxes came due on April 15, 2001.  Your 2000 tax debt became stale on April 16, 2004.  If you filed an extension to September 15, 2001, then your 2000 tax debt became due on September 16, 2004.

3. What if I did not file my tax returns on time?

Answer: In addition to being stale (due more than 3 years prior to filing), your returns must have been filed no less than 2 years prior to filing.

Example: Tom filed his 2000 tax return late - on February 17, 2005.  His tax debt does not become stale until February 18, 2007.  The taxes came due more than 3 years ago, but he has to wait 2 years after he actually files.

4. What if there is a tax lien?

Answer: A tax lien is a secured debt - meaning that all of your real and personal property (with limited exceptions) can be seized by the IRS to satisfy the lien.  Tax liens cannot be wiped out in a bankruptcy.

In a Chapter 13, the secured tax lien can result in a huge problem because your Chapter 13 plan has to pay the secured portion of your tax debt at 100%.  In a Chapter 7, the lien is not erased by your Chapter 7 discharge.  However, if the lien secures stale tax debt, you may be able to negotiate a settlement on the lien after your bankruptcy case is over.

Clark & Washington is not a tax problem resolution law firm and we will defer to your accountant or tax preparer.  If you have significant tax debt you should coordinate your bankruptcy filing with the advice of your tax preparer.