Eliminating Taxes in Bankruptcy

    tax help orlandoMost people think you can’t eliminate taxes in a bankruptcy proceeding. This is not true. The treatment of tax debts is is one of the more complicated areas of federal bankruptcy law, but the Bankruptcy Code offers substantial tax relief to tax debtors who meet certain requirements. Whether your bankruptcy will relieve you from your tax debts will depend on several factors including the nature of the tax liability and the type of bankruptcy proceeding you are in.

    Type of Tax:

    Income TaxesFederal income taxes may be discharged in bankruptcy provided they meet the discharge rules explained below under the heading “The Bankruptcy Discharge Rules.”

    Trust Fund Taxes: Trust Fund taxes are those taxes withheld from employee pay checks for social security and medicare (“employment tax”). The amount withheld includes the employer’s share and the employee’s share of employment tax. A business owner and other responsible persons may be personally liable for the Trust Fund taxes if he or she oversaw the collection and accounting of the tax and made decisions about which creditors the business paid.  Trust Fund taxes are not dischargeable in bankruptcy. State sales tax collections are deemed to be held in trust and also cannot be discharged.

    Other Taxes: Excise taxes such as estate and gift taxes, sales taxes and fuel taxes are not dischargeable.

    Secured Tax Debts: In the course of its collection efforts the IRS has to power to file a tax lien to perfect its tax claim against individuals. A federal tax lien applies to all of the taxpayer’s personal property wherever it is located even if the personal property is outside Florida. The tax lien encumbers the debtor’s real property only in the county or counties where the IRS files its tax lien. Florida’s homestead exemption does not apply to tax liens.

    A federal tax lien once filed makes the IRS debt a secured claim in bankruptcy and ineligible for discharge. Tax debt which is not secured by a tax lien on property is treated as a “priority debt” which means that like other priority debts it is paid in full before money is available to pay general unsecured bankruptcy creditors.

    The Bankruptcy Discharge Rules

    All tax debts are eligible for discharge as described above (e.g., income taxes, etc.) except the following:

    1. Taxes for which a tax return was due to be filed within three years (plus extensions) prior to the date of filing bankruptcy. For example, the tax return for 2009 income taxes was due to be filed on April 15, 2010, (plus any extensions) , and therefore, these income taxes cannot not be discharged by filing bankruptcy filed on or before April 15, 2013 (plus the time of extensions); OR
    2. Taxes assessed by the IRS within 240 days before the filing of bankruptcy. Assessment date is the date that tax liability is entered on IRS records; OR
    3. Taxes not yet assess but still assessable; OR
    4. Taxes for which a tax return was filed late and filed within two years prior to filing bankruptcy.; OR
    5. Taxes of a debtor who committed fraud related to a tax return or willfully attempted to evade or defeat taxes sought to be discharged.
    6. Taxes assessed pursuant to a Substitute Tax Return (i.e. a return the IRS filed on behalf of the taxpayer) cannot be discharged.

    A tax debt that does not fail any one of the above five tests will be eliminated in a Chapter 7 or a Chapter 13 bankruptcy. In other words, these taxes are dischargeable.

    The dischargeability test is somewhat different in a Chapter 13 banrkuptcy. A Chapter 13 bankruptcy a debtor can discharge:

    1. Taxes for which tax returns were filed late but within the two years preceding the bankruptcy, provided tax assessments have either not been made or have been made more than 240 days prior to the bankruptcy filing; AND
    2. Taxes related to fraudulent returns or taxes the debtor willfully attempted to evade or defeat.

    Discharge of Interest and Penalties: If the income tax is dischargeable then so is the interest related to the income tax. Regarding penalties, however, the general rule is that if the event that gave rise to the penalty occurred more than 3 years before the bankruptcy petition was filed, the penaltyis dischargeable.

    Chapter 7 Bankruptcy Tax Relief

    Chapter 7 bankruptcy will eliminate all dischargeable income tax debts but will not avoid recorded tax liens.

    Chapter 13 Bankruptcy Tax Relief

    Chapter 13 bankruptcy involves a payment plan approved by the bankruptcy court under which a debtor pays some of his debts and discharges other debts.

    There are two basic tax discharge rules in a Chapter 13 bankruptcy:

    1. Taxes not dischargeable in Chapter 13 are considered “priority debts” and they must be paid in full during the Chapter 13 plan. The amount of the priority tax debt includes interest and penalties assessed up to the bankruptcy filing date, but the assessment of interest and penalties stops once the bankruptcy petition is filed.
    2. Dischargeable tax debts will be paid in part during the bankruptcy plan, and the unpaid balance is wiped out upon successful completion of the plan.

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