How Bankruptcy Affects Tax Obligations

Our capitalist system encourages individuals to take risks. Some prove productive; unfortunately, for those that fail, many times the individual is left with tax debt. This can include income taxes owed to the IRS or a state taxing agency, and payroll taxes. While bankruptcy discharges many debts that a business or consumer may have incurred, the rules regarding tax debts are very tricky.

In chapter 7 bankruptcy, some of the common rules that generally apply to discharging income tax debts are:

The tax debt must be for a tax year for which a tax return is due more than 3 years prior to filing the bankruptcy petition. For example, tax returns are usually due on April 15 for the previous calendar year. If an extension is obtained, the due date for the return could be as late as October 15 for the previous calendar year. If you want to discharge taxes for a particular calendar year, the bankruptcy petition must be filed more than 3 years after the due date for the return for that calendar year;
The tax debt must have been assessed more than 240 days before the bankruptcy petition is filed; and
A tax return must have actually been filed by the taxpayer for that calendar year more than 2 years before the bankruptcy petition is filed.

These same rules generally apply in chapter 13 bankruptcy to determine how much tax debt must be paid in full pursuant to a plan and how much can be discharged.

Payroll taxes are treated differently. Generally an individual cannot discharge trust fund taxes in either chapter 7 or 13. There is a potential exception in chapter 13. Trust fund taxes are those that are required to be withheld from an employees pay check.

If you’re facing tax debts, bankruptcy may be a viable option to give you a fresh start. Given how complex this area is, the first step is to meet with an attorney, ideally an attorney that practices almost exclusively as a bankruptcy lawyer. Indeed, the rules above are simply guideposts and there are many other factors that may affect the dischargeability of your tax debt.

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Disclaimer

The information in this blog post (“post”) is provided for general informational purposes only, and may not reflect the current law in your jurisdiction. No information contained in this post should be construed as legal advice from Reid & Hellyer, APC or the individual author, nor is it intended to be a substitute for legal counsel on any subject matter. No reader of this post should act or refrain from acting on the basis of any information included in, or accessible through, this Post without seeking the appropriate legal or other professional advice on the particular facts and circumstances at issue from a lawyer licensed in the recipient’s state, country or other appropriate licensing jurisdiction.