DISCHARGING TAXES IN BANKRUPTCY
By Attorney Donald A. Hayes
A question often asked is: can I discharge taxes in bankruptcy? The answer may surprise you, but yes you can discharge some taxes in bankruptcy depending on the type of taxes owed and other circumstances. Chapters 7 and 13 offer different forms of relief from taxes. The following is an analysis of discharging personal income taxes. The subject of discharging payroll and sales taxes is too complicated to discuss here and will be explored in a future article.
In order to get a discharge of personal liability for tax obligations in a Chapter 7 Bankruptcy case: (1) the income tax must have been due at least three years before the bankruptcy was filed; (2) the tax must have been assessed at last 240 days prior to the filing of the bankruptcy; (3) in the case of late filed returns, the tax returns must have been filed at least two years prior to the bankruptcy filing; (4) the tax return was not fraudulent and the taxpayer did not attempt to evade the tax owed.
Also, if the tax agency has recorded a Notice of Tax Lien with the County recorders Office then the tax debt will be considered a secured debt. In this instance, although the personal liability of the tax debt may be discharged in the bankruptcy, the lien still remains attached to the debtors real property. The tax agency cannot now attempt to enforce the tax debt against you personally, however their lien will have to be repaid when the property is sold.
More taxes are dischargeable in a Chapter 13 case than in a Chapter 7 case. A debtor can discharge taxes even if the tax return was never filed, or even if the debtor was engaged in fraudulent or evasive conduct. For example, say you owe $100,000 in taxes for which tax returns were never filed in the past. The IRS has assessed you with a tax liability of $100,000 and has recorded a Tax Lien. Say for example, you file a Chapter 13 and list your assets as a house with no equity, personal property worth $5,000, a car worth $5,000, and a 401K retirement plan with a present value of $10,000. The IRS would have a secured tax lien up to the net value of all your property, or $20,000. You would also owe them $80,000 as an unsecured tax obligation. By filing a Chapter 13, all interest and penalties associated with the unpaid taxes are halted upon the filing of the case. You would offer to repay monthly, up to five years, the amount of the secured claim of $20,000 with interest. Interest must be paid on the secured claim only. You could then offer to pay nothing toward the unsecured balance of $80,000! The amount you must pay toward the unsecured amount is dependent on your income and budget so what you propose may vary. At the conclusion of your case the entire $100,000 obligation you owed for taxes would be discharged forever and the lien would be extinguished!
This result would work the same if instead, you had filed your taxes on time and the taxes were otherwise dischargeable taxes under the three year/two year rule outlined above for Chapter 7 cases. However if the filed tax returns were within the three year/two year window, they would be considered priority taxes in either a Chapter 7 or a Chapter 13 case, and would have to be repaid in full.
