Bankruptcy – A “Fresh Start”

Bankruptcy laws give debtors a “fresh start” through the discharge of debts while still providing equitable treatment to creditors. Many people do not realize that income taxes owed by a debtor may be discharged through the bankruptcy process. However, the rules concerning bankruptcy and taxes are technical and can be quite complicated.

Chapter 7 and Chapter 13 Bankruptcy

The two main forms of bankruptcy used by individual debtors are Chapter 7 and Chapter 13. A Chapter 7 bankruptcy is a traditional liquidation process in which the debtor’s property is sold to pay creditors. Remaining debts are discharged and the debtor is free to begin a fresh start.

In a Chapter 13 bankruptcy, the debtor can keep his or her property, but is required to repay all or a portion of its debts over a three-to-five year period. At the end of the repayment period, any remaining debts are discharged. Whether you are eligible for a Chapter 7 or Chapter 13 bankruptcy, you may be able to discharge your income tax debts through bankruptcy.

How to Discharge Personal Income Tax Debts through Bankruptcy

Here is a high level overview of how to discharge taxes in bankruptcy. In order to discharge your personal income tax debt through bankruptcy, certain complicated timing requirements must be met. These rules depend on three factors: 1) when the tax return was due; 2) when the tax return was filed; and 3) when the tax was assessed.

First, the tax return must be due more than three years before the filing of the bankruptcy petition. This means that any income tax for which a tax return is due within three years before the bankruptcy filing will not be dischargeable. Next, the bankruptcy filing date must be two years after the filing date of the tax return. This rule looks at whether the debtor filed any tax returns late and within two years before the bankruptcy petition. Finally, the tax must be assessed at least 240 days before the filing of the bankruptcy petition. This rule relates to when the IRS “assessed” the debtor’s tax obligation. These rules are applied for each and every tax year. This means that certain taxes will be dischargeable now, but others will be dischargeable only if the bankruptcy date is delayed. Filing the bankruptcy petition at the right time can maximize the income tax discharge to the debtor.

Tax Liens are not Discharged

With a bankruptcy discharge of income tax debts, the debtor no longer has to pay those debts to the IRS. However, if the IRS placed a federal tax lien on the debtor’s property before the bankruptcy petition, that tax lien is not discharged through the bankruptcy. This essentially means that even though the IRS cannot recover tax debts from the debtor personally, it still may be able to seize and sell the encumbered property. Before attempting to discharge your income tax debt through bankruptcy, you should consult a knowledgeable tax attorney to make sure that you do not have a federal tax lien on your property.

How a Tax Attorney Can Help

Because the rules regarding the discharge of income tax debts are complex, debtors should seek out the advice of qualified and knowledgeable tax attorneys. These rules are time-sensitive and require planning to maximize the benefit to the debtor. Depending on how the rules are applied, the debtor must choose the best bankruptcy filing date in order to maximize the income tax debt that can be discharged. While this is certainly possible, discharging taxes in bankruptcy should never be attempted without the guidance of an experienced tax lawyer.

The Tax Lawyer - William D Hartsock offers free consultations with the full benefit and protections of attorney client privilege. Call for a free consultation today.

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