Bankruptcy and Taxes

Bankruptcy is intended to give you a fresh start- all of your credit card debt, medical bills, deficiency judgments and unsecured debt become nothing more than a bad memory. But what about your nasty tax liabilities? Will they follow you forever? This is a question my clients frequently ask.

Well, it depends.

In general, if returns were properly filed (even though the taxes were not paid) income taxes more than three years old can be discharged in bankruptcy. Pay attention: only income taxes are dischargeable; other taxes, such as payroll taxes or fraud penalties cannot be discharged. Penalties on taxes that are dischargeable are also discharged.

Here are the specifics- all of the following rules must be met:

  1. The due date for your tax return(s) must be at least three years (including extensions) before you filed for bankruptcy;
  2. You filed the return(s) to which the tax relates more than two years before your bankruptcy petition (the actual filing date controls);
  3. The tax was assessed is at least 240 days before the bankruptcy was filed;
  4. Your tax return was not fraudulent and there was no attempt at tax evasion. If you filed a fraudulent tax return or used a false Social Security number your taxes will not be discharged;
  5. The tax was not assessable at the time of the filing of the bankruptcy petition. Taxes are usually assessed after a taxpayer is given notice of an alleged deficiency and the taxpayer has had an opportunity to challenge the deficiency;
  6. The tax was unsecured

If your taxes are dischargeable, they will be eliminated in a Chapter 7 bankruptcy. In Chapter 13 and 11 cases you will establish a payment plan of up to five years, after which remaining tax debts can be discharged.

A final (if unhappy) note: If the IRS recorded a tax lien on your property before you file for bankruptcy, the lien will remain on the property even though the tax liability is discharged. The lien will have to be paid when the property is sold.

Handling tax liabilities in bankruptcy can be complex and you will need the advice and help of a competent bankruptcy attorney to protect your rights. A more in depth essay on Bankruptcy and Taxes is available at Bankruptcy Q & A.