Are Taxes Dischargeable in Bankruptcy?
One of the most prevalent misconceptions that people have about bankruptcy is that you cannot discharge tax debts under a Chapter 7 discharge. Chapter 7, the ‘liquidation’ bankruptcy, is the most common bankruptcy chapter and the one people most often assume when thinking of bankruptcy. You can, in fact, discharge income tax debts if they meet all of the criteria outlined below.
- The tax debt is income-based. Income taxes are the only type of tax debt dischargeable under Chapter 7. In order for taxes to be dischargeable, the tax debt must be for federal or state income taxes or taxes on gross receipts.
- The tax debt is at least three years old. To eliminate tax through Chapter 7, the tax debt must be from a tax that was due at least three years ago. This date includes all valid extensions. For instance, if taxes were disclosed in a 2015 tax return for which extensions to file the return expired on October 15, 2016, the due date test will be satisfied only if the bankruptcy petition is filed after October 15, 2019.
- The tax return was filed at least 2 years ago. If you wish to discharge tax ability, you must have filed your return at least two years before filing your Chapter 7. In most courts, a late return (when the IRS filed a substitute return on your behalf after all of your extensions expired) does not “count” as a return and thus the tax debt is deemed to be nondischargeable. In some courts, however, you can discharge tax debt even if you file a late return, assuming you meet the other criteria outlined here. In general, San Diego bankruptcy tend to allow debtors to discharge tax returns filed after all extensions expired, if they meet all other criteria.
- The “240-Day Rule”. To discharge tax debt, the taxing authority must have assessed the tax (entered the liability on the taxing authority’s records) against you at least 240 days before you filed bankruptcy. This time limit may be extended if there was an offer in compromise between the taxing authority and you, or if you had previously filed for bankruptcy.
- No fraud or willful evasion. You cannot receive a discharge of tax debt if you have been deemed guilty of any intentional act of evading any tax law. if you file a joint return, the taxing authority must prove that both you and your spouse committed an act of fraud related to the applicable return or willfully attempted to evade the tax in order to deny a discharge of the tax debt.
To put all of this is a nutshell, if your tax debt is income-related, from 3 or more years ago, and you filed your return(s) relatively timely without any major incidents or problems, your tax debt is likely dischargeable under Chapter 7.
The following tax related debts are not dischargeable under Chapter 7:
- Tax Liens. If you have tax liens, also known as secured taxes, a Chapter 7 discharge will not remove the liens from your property. A discharge under Chapter 7 will wipe out your personal obligations related to the debt, and will prevent the taxing authority from going after your bank account or wages; however, the lien(s) will still be attached to your affected property. This rule only applies to liens recorded against your property before you file for bankruptcy. In other words, while you may be not be personally liable for the tax debt, you will have to pay the lien from any profits left over when you sell the property.
That being said, if the lien is based on a dischargeable debt, the debt itself is subject to discharge as outlined above, there may be options to remove the debt.
- Recent Property Taxes. If a property tax is incurred before you file for bankruptcy, the tax is nondischargeable. However, this only applies to property taxes last payable within one year of your bankruptcy filing. You can discharge your personal liability for property taxes that were payable (without penalty) more than one year before your bankruptcy filing. Keep in mind, though, that many counties attach a lien to your property upon assessment or one year afterwards. If you have a lien against your property for the property tax, that lien will remain after your Chapter 7 discharge (although your personal liability will be removed).
- Third Party “Trust Fund” Taxes. The so called “trust fund” taxes, that is, taxes that a third party is required to collect or withhold, such as FICA, Medicare, and income taxes that an employer must withhold from the pay of employees, and sales taxes paid by the debtor’s customers that the debtor is required to send to a governmental unit, are not discharged under Chapter 7.
- Non-punitive Tax Penalties. Non-punitive tax penalties on nondischargeable taxes are not dischargeable in a Chapter 7 bankruptcy if the transaction or event that sparked the penalty occurred less than three years before filing the bankruptcy petition.
- Erroneous Tax Refunds. If the IRS made a mistake and erroneously issued you a refund or credit related to nondischargeable taxes, you cannot discharge the IRS’ error.