Tax Debt and Bankruptcy
Chapter 7 – wipe out IRS debt
Chapter 7 bankruptcy is the most common type of bankruptcy that we see. It is primarily used for those who have income tax debt but are unable to pay anything back. Chapter 7 can be a lifesaver for insolvency because it completely eliminates all dischargeable back tax debts. In layman’s terms, you pay nothing.
However, while Chapter 7 has the ability to hit the reset button on income tax debt, it doesn’t work with payroll taxes. Additionally, rules on previously unfiled returns are not uniform and newer liabilities are unable to be resolved. It’s definitely worthwhile to keep note of the disadvantages of Chapter 7 and to discuss them with proper counsel before you commit to declaring bankruptcy.
Chapter 9 – The rarest of the bunch
Chapter 9 bankruptcy is incredibly rare. Why? Primarily because Chapter 9 bankruptcy is for municipalities who owe back taxes — along with any other debts — that they can’t repay. While this probably doesn’t relate to any of our readers, take some comfort in the fact that Chapter 9 exists! If a municipality (who has the ability to collect taxes and foreclose on those who don’t pay) can get behind with the IRS, then maybe you — a regular taxpayer — shouldn’t feel so bad. After all, you don’t have the ability to force repayments from people who owe you money or to levy taxes when you are short of funds.
Chapter 11 – Reorganizations for IRS taxes
Chapter 11 bankruptcy is available to every business — whether organized as a corporation, partnership, or sole proprietorship — and, believe it or not, to individuals as well. Even though individuals are included, it is predominately used by corporate entities. Chapter 11 is more of a reorganization plan – some debts will be repaid, some won’t be. The entity’s affairs will be run by a bankruptcy trustee, who balances the competing interests of creditors, including the IRS. The advantage of a Chapter 11 bankruptcy — really the only advantage you ever see — is that there is no clear disadvantage once a business is insolvent.
Chapter 12 – For fishermen and farmers who get behind on their taxes
Chapter 12 bankruptcy is just like Chapter 13, which we will discuss below, except that it applies to fishermen and farmers (and apparently offers additional benefits).What makes fishermen and farmers so special? Well for one, they are special. Without fishermen you could not enjoy a tasty Captain’s Platter. And without farmers, you would spend your day in frustration, foraging for sparse calories, only to turn up at home empty-handed to a hungry, disappointed family.
But in all seriousness, the reason appears to be that historically, family farmers and fishermen are business owners that tend to be the first ones affected by economic downturns or acts of God; the law took note of that. Or, I could be making this all up. It’s your call.
Chapter 13 – Repayment plan for IRS problems
The IRS claims that for individuals, the most common type of bankruptcy is a Chapter 13 bankruptcy. Before you consider filing a Chapter 13, here are some things you should know:
- The statute of limitations on collections is tolled; if the plan fails, the IRS will have more time to collect the entire debt.
- You must file all required tax returns for tax periods ending within four years of your bankruptcy filing.
- During your bankruptcy, you must continue to file — or get an extension to file at a later date — all required returns.
- During your bankruptcy case, you should pay all current taxes as they come due.
- Failure to file returns and/or pay current taxes during your bankruptcy may result in your case being dismissed.
When Discharging a Tax Debt is Allowed
You can discharge (wipe out) debts for federal income taxes in Chapter 7 bankruptcy only if all of the following conditions are true, you must qualify and full financial audit is required:
The taxes are income taxes. Taxes other than income, such as payroll taxes or fraud penalties, can never be eliminated in bankruptcy.
You did not commit fraud or willful evasion. If you filed a fraudulent tax return or otherwise willfully attempted to evade paying taxes, such as using a false Social Security number on your tax return, bankruptcy can’t help.
The debt is at least three years old. To eliminate a tax debt, the tax return must have been originally due at least three years before you filed for bankruptcy.
You filed a tax return. You must have filed a tax return for the debt you wish to discharge at least two years before filing for bankruptcy. (In most courts, if you file a late return (meaning your extensions have expired and the IRS filed a substitute return on your behalf), you have not filed a “return” and cannot discharge the tax. In some courts, you can discharge tax debt that is the subject of a late return as long as you meet the other criteria.)
You pass the “240-day rule.” The income tax debt must have been assessed by the IRS at least 240 days before you file your bankruptcy petition, or must not have been assessed yet. (This time limit may be extended if the IRS suspended collection activity because of an offer in compromise or a previous bankruptcy filing.)
Federal Tax Lien Are Not Eligible To Be Discharged
If your taxes qualify for discharge in a Chapter 7 bankruptcy case, your victory may be bittersweet. This is because bankruptcy will not wipe out prior recorded tax liens. A Chapter 7 bankruptcy will wipe out your personal obligation to pay the debt, and prevent the IRS from going after your bank account or wages, but if the IRS recorded a tax lien on your property before you file for bankruptcy, the lien will remain on the property. In effect, this means you’ll have to pay off the tax lien in order to sell the property.
For More Information
To find out more about which debts you can eliminate in bankruptcy, feel free to contact us at 877-372-2520. Our Tax Resolution Experts will be happy to help you.
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