If you’ve been caught in a money crunch for a while, you may have neglected to pay your taxes in favor of keeping a roof over your family’s heads, eating, and keeping on such luxuries as heat. You are wondering if you can wipe out your unpaid taxes by filing a bankruptcy, and you may even see advertisements suggesting that you can. Sadly, however, since this is money owed to the government, whether federal, state, or local, eliminating them in bankruptcy is not always an option. Most tax debts cannot be discharged in bankruptcy. You’ll likely continue to owe them after Chapter 7, or you’ll have to repay the full amount in or after Chapter 13. There are some instances, however, where bankruptcy can either eliminate the tax debt completely or assist you in getting it paid down. In any case, the advantage that bankruptcy can offer you is eliminating other debts so as to leave you with more money to dedicate towards resolving the tax arrearage.
If you are looking to wipe out your unpaid taxes, you can do that in Chapter 7 so long as you are eligible to file under this chapter (your gross income is below the IRS median income standards for your state) and the tax debts qualify for discharge. To qualify for discharge, all the following factors must be true:
The taxes must be income taxes. (Payroll taxes, sales taxes, property taxes, and fraud penalties cannot be eliminated.)
You did not commit fraud or willful evasion. (You did not file a falsified tax return or otherwise intentionally attempt to avoid paying your taxes.)
The tax obligation must be at least 3 years old. (The taxes must have been due at least three years before you file the bankruptcy, including extensions. For example, if the taxes due were disclosed in a 2011 income tax return for which extensions expired on October 15, 2012, the tax return due date will be satisfied if the bankruptcy is filed after October 15, 2015.)
You filed the tax return for these taxes at least 2 years before filing the bankruptcy. (Keep in mind that a late return may not qualify as a return by the court. To qualify as a “return,” your tax filing must: 1) indicate clearly that it is a return; 2) be executed under penalty of perjury; 3) contain sufficient data to allow calculation of the tax; and 4) represent an honest and reasonable attempt to satisfy the requirements of tax law.)
You pass the “240-day rule”. (If the IRS has assessed the income tax obligation, it must have done so at least 240 days before you file the bankruptcy.)
There remains another factor that we have to consider in analyzing whether Chapter 7 will eliminate your income taxes: whether the taxing authority has recorded a tax lien against your property. A bankruptcy cannot wipe out previously recorded tax liens. While it will eliminate your personal obligation to pay the taxes and prevent the taxing authority from going after your bank account or wages, the tax lien will remain on the property. You will have to pay off the tax lien when you sell that property.
Treatment of tax arrearages is much different in a Chapter 13 bankruptcy. How much of the tax debt you pay during the Plan depends upon whether the tax debt is classified as a priority claim or whether it is a nonpriority, unsecured claim. Priority claims are paid in full through the Plan. You generally pay only a portion of your nonpriority, unsecured tax debts through the Plan, with the unpaid balance surviving the bankruptcy when the Plan is completed.
Priority debts include tax liens that encumber your property, recent property taxes, taxes that, as an employer, you must withhold from your employees’ pay, sales taxes, and erroneous tax refunds. You pay off these taxes in full through the life of the Plan, which will likely result in your payments to the unsecured creditors being less than if these priority debts didn’t exist. This protects you from having to sell assets in order to pay the tax debt back right away. Further, the IRS cannot object to your payment Plan once it is approved by the bankruptcy court. You are often paying the taxes through the Plan at 0% interest over the life of the Plan, which is a much better deal than the IRS will offer.
Income taxes are nonpriority, unsecured debts, so long as you did not commit fraud or willful evasion. In a Chapter 13 Plan, the nonpriority tax debt is lumped in with your other unsecured debt (medical bills, credit cards, etc.) and is paid at the Plan percentage for such debts after all priority and secured claims are paid. Although you cannot fully discharge this debt at the close of the bankruptcy, a portion of your monthly Plan payments will go toward bringing down the balance owed. In most cases, no future penalties can be assessed during the Plan.
Therefore, while bankruptcy cannot simply wipe most unpaid taxes out completely, both Chapter 7 and Chapter 13 have some advantages to offer in helping you deal with getting those taxes paid. As always, you are best advised to contact a bankruptcy professional to see what is available to you under your particular circumstances.
If you have more questions about if filing for bankruptcy can help with back taxes, contact an experienced attorney at Horwitz & Horwitz.