Can You Wipe Out Your Tax Debts in Bankruptcy?
The answer is “Maybe.” I know. Not the resounding “Yes you absolutely can!” you were hoping for, but still better than a resounding “NO!”. In bankruptcy, some tax debts can be discharged by filing either a Chapter 7 or Chapter 13 bankruptcy. To be dischargeable in bankruptcy, your income taxes must meet the following conditions:
1. Owed more than 3 years ago;
2. Assessed more than 240 days ago; and
3. The original return was timely and not fraudulent.
If your tax debts fall outside these factors, they will survive bankruptcy, and you will be personally liable for them.
What Can a Chapter 13 do for my Tax Debts?
Chapter 13 allows debtors to pay their back-taxes over a five year period of time. The IRS is a creditor just like any other, and while they cannot be forced to take pennies on the dollar as other secured creditors (the IRS is known as a “priority” unsecured creditor), having that breathing room to pay off your tax debts over time can be a huge help to your immediate financial position. Additionally, if your taxes are too high to even pay off over the 5-year period, it is possible to obtain an “offer in compromise” from the IRS, where Uncle Sam will consider certain living standards compared against an evaluation of collectability and likely liability on your taxes.
Since the taxing authority’s only recourse is against the property, there really is nothing to worry about regarding your personal liability in bankruptcy. I often get this question when people decide to surrender their houses back to the bank with property taxes owed. Property taxes follow the property, and the taxing authority’s recourse is always to put a tax lien on the property. Once you surrender a home, the property taxes are the lender’s problem.
Payroll and Trust Taxes
Shareholders of a corporation are generally not liable for the taxes owed by the company, with payroll, or trustfund taxes. Wages withheld from an employee’s paycheck are held in trust to be turned over to the IRS. If these funds are not turned over, any signatory on the corporate bank accounts (including the bookkeeper) can be held liable for the amount due. Equity owners, officers, and directors with any amount of control over corporate bank accounts can file a Chapter 13 to pay these taxes over time,as they are not dischargeable in bankruptcy no matter how old they are.
Tax Liens and Bankruptcy
If you file a Chapter 7, the tax lien will still survive the bankruptcy; however, if, pursuant to the section mentioned above, your personal liability on the underlying taxes is dischargeable, then the lien will only attach to any available equity in property you have as of the filing of the bankruptcy petition. Essentially, the lien will not attach to assets you acquire after the filing of your bankruptcy petition, and any equity you may have in pre-petition property can simply be paid back to the IRS. For more information about tax liens and how bankruptcy can help, please visit my blog post on the topic: What You Need To Know About Tax Liens and Bankruptcy.