Bankruptcy Analysis and Discharge of Taxes

As bankruptcy attorneys, we are routinely asked if an Internal Revenue Service tax liability can be dismissed in a bankruptcy. It is often misunderstood whether a bankruptcy will discharge taxes or not.

The truth is that a tax liability can often be discharged. There is a set of complex rules that decide whether the tax liability is dischargeable. Read on to learn about just a few of those rules.

Call or email us for a Bankruptcy Analysis to learn more about the solutions our tax attorneys can offer and how Martelle Law can assist you.

Bankruptcy Analysis

If the obligation is due fewer than three years from the date the return was due, it is considered a priority tax and could not be discharged. Many liabilities that are three years or older from the due date of the return may result in a bankruptcy discharge of the taxes because they are not considered a priority tax.

The tax return must also have been filed at least two years before the bankruptcy.

Keep in mind that if you are in business, any withholding taxes due from payroll for your employees will not result in a discharge of them in bankruptcy.

If the state or IRS filed liens against your property, the tax still might be discharged if the tax is older than three years. However, the lien itself will create a new challenge. Even though the obligation has now been discharged in bankruptcy, the lien itself will survive through the bankruptcy. The lien will remain attached to the taxpayer’s assets at the full value of the taxpayer’s property for the duration of the bankruptcy. Even after the bankruptcy has been discharged, the state or IRS could still seek to get the amount due from the taxpayer’s assets.

TAXES IN A CHAPTER 7 BANKRUPTCY

In order for a liability due to the IRS to be considered for a bankruptcy discharge in a Chapter 7 bankruptcy, the tax liability needs to meet the following bankruptcy code requirements:

1. The liability is due a minimum of three years prior to the bankruptcy filing.
   

   Example: The taxes filed for the year 1999 become due April 15, 2000. They are then eligible for discharge on April 16, 2003.

   Note: Be aware that there can be no extension requests to file a return whether this return was completed by a representative or by the individual themselves. However, if the request for extension had been made, then the three years will be extended to the actual date the extension came due.

2. The returns must be filed a minimum of two years prior to the filing for bankruptcy.
   

   A. A return needed to have been actually filed.

   B. If the IRS had filed a Substitute for Return (SFR), that return will not qualify for having filed a return for bankruptcy purposes. The taxpayer is the one who actually has to file a return.

3. The liability assessment must be made a minimum of 240 days before filing. The return cannot be fraudulent.Note: If for some reason these taxes cannot be discharged, then a bankruptcy along with an Offer in Compromise could provide the relief needed for those dealing with both IRS tax problems and debt.

TAXES IN CHAPTER 13 BANKRUPTCY

Chapter 13 offers more flexibility than a Chapter 7.

1. Penalties can be abated and interest can be frozen in Chapter 13.
2. Priority taxes (those that are three years old or less) can be paid interest-free in a Chapter 13.
3. Penalties will frequently be discharged.

A debtor is allowed to pay off any IRS liability that has an IRS lien attached to it during the life of the Chapter 13 plan. This obligation can be reduced to the actual value of the taxpayer’s assets. The balance can be then discharged if the taxes are more than three years old, even if a lien had been filed.

BUSINESSES

The majority of rules that apply to individuals seeking a bankruptcy discharge also apply to businesses seeking the same type of discharge. IRS tax liabilities are frequently an obstacle to business owners who have neglected to pay their employment tax liabilities. Remember that payroll liabilities (or the taxes withheld from employee wages) cannot be discharged in bankruptcy.

Employment liabilities can be paid in both Chapter 11 and 13 plans. In a Chapter 13 plan, the penalties are frequently discharged and the interest may be stopped. The portion of the liabilities that are non-dischargeable can be arranged to be paid during a three- to five-year period in a Chapter 13 and potentially up to a six-year period in a Chapter 11.

Filing a petition with the bankruptcy court can temporarily halt collection efforts. Often, this allows for the time needed for a business to reorganize its liabilities; debts that are due; any liabilities due to the IRS; the move helps the business to survive during the process.

Because of the many rules and exceptions involved in filing for a bankruptcy discharge of your taxes, it is important to receive a thorough bankruptcy analysis to help avoid any pitfalls.

DISCLAIMER

The information provided in this article about bankruptcy discharge is based upon the wide-ranging principles of law. These principles might not necessarily relate to all situations. Nothing in this article constitutes any form of legal advice and no dependence should be placed on the legal principles mentioned in this article. It is important to contact an attorney in order to receive professional legal advice for your specific situation.