The discharge of income tax debts in bankruptcy proceedings depends on different factors. Income tax debt can be wiped out in either chapter 7 or chapter 13 bankruptcy depending on whether the requirements for a discharge of the tax debts are met.
The difference between chapter 7 and chapter 13 is what the reasons for filing bankruptcy are. A chapter 7 bankruptcy wipes out all unsecured debts but does not modify secured loans such as your car loan. A chapter 13 bankruptcy case has the same effect as chapter 7 but in addition it prevents your mortgage company or your car creditor from repossession your property as long as you make your payments under the chapter 13 plan. A common misconception is that under Chapter 7 bankruptcy, the debtor’s assets are sold by the bankruptcy trustee and proceeds are distributed proportionately among creditors. That is wrong. In almost all cases a chapter 7 is filed because there are no assets the trustee can recover, if there are assets that are recoverable by the trustee, your bankruptcy attorney will either prepare you to make an offer to the trustee, offer the property to the trustee if you don’t want to keep it or file a chapter 13 instead of a chapter 7. Chapter 13 bankruptcy involves a repayment plan submitted to and approved by the bankruptcy court. Debtors who file for this type of bankruptcy are required to maintain a steady income. Income can include wages, pensions and federal benefits, such as Social Security. Monthly payments are made to the bankruptcy trustee, which is then disbursed to creditors. Repayment plans range from three to five years.
Although revised bankruptcy laws require that delinquent taxes be treated similarly to all other debts, not all tax debts can be discharged in bankruptcy. Under a Chapter 7 bankruptcy plan, five criteria must be met in order to successfully discharge federal and state income tax debts:
• The tax debt must be related to an income tax return that was due at least three years prior to the bankruptcy filing.
• The tax debt must be related to an income tax return that was filed at least two years prior to the bankruptcy filing.
• The tax debt must have been assessed by the IRS at least 240 days prior to the bankruptcy filing.
• The tax return does not contain fraudulent or misleading information.
• The taxpayer cannot be guilty of tax evasion.
If all the required criteria are met to the satisfaction of the bankruptcy court, most tax debt can be discharged under Chapter 7. Failure to satisfy any one of the criteria makes tax debts non-dischargeable in any type of bankruptcy. There are some exceptions pertaining to the discharge of tax debts. Tax debts that arise from unfiled tax returns cannot be discharged. The IRS routinely assesses taxes on unfiled returns. The only manner in which these tax debts are eligible for bankruptcy discharge is for the taxpayer to file a tax return for each year in question. Before a Chapter 7 discharge is granted, the debtor is not required to submit proof that all tax returns for the previous four years have been filed. The discharge includes all dischargeable debt which includes taxes if the requirements are met. It is a common misconception that the debtor has to proof or show any evidence in court. This is incorrect. In the event tax returns have not been filed for the specified years, the debtor still should file the tax returns, but the tax debt would not be dischargeable within the following years. In the case that tax debt cannot be discharged because not sufficient time has elapsed since filing of the tax return, your bankruptcy attorney will discuss the pros and cons of waiting with filing your bankruptcy or going ahead with filing knowing that some or all of the tax debt cannot be discharged. Sometimes, waiting with filing until after April 15th can include another tax year and discharge more income taxes.
Under a Chapter 13 plan, if the five criteria are satisfied, tax debts are treated as general unsecured debts. Payments for tax debts are made in the same manner as all general unsecured debtors. Under most Chapter 13 plans, the monthly amount paid to the IRS is significantly lower than if the debtor had entered into an IRS Installment Agreement. For example, if the plan proposed to pay unsecured creditors only 10 percent of the outstanding debts, the claim of the IRS for income tax debt will be paid at 10 percent. This includes penalties and late charges. Under a Chapter 13 bankruptcy plan, taxes debt is often completely taken care of. If tax debt is not dischargeable, it is paid as priority in full. If the tax debt is unsecured debt it is wiped out with all other unsecured debt.
If a debtor fails to comply with the terms established by the Chapter 13 repayment plan, all interest and penalties assessed by the IRS will be calculated retroactively, as if the bankruptcy had never occurred. The chapter 13 bankruptcy case is a good option to resolve any tax debt whether it is dischargeable or not.
Federal tax liens recorded against a debtor’s property cannot be discharged in bankruptcy court. A Chapter 7 bankruptcy discharge will not remove previously recorded tax liens. The personal obligation to pay the tax debt is removed and the IRS is prohibited from pursuing collection efforts, such as wage or bank account garnishments.
State income tax debts fall under the same general bankruptcy rules as federal tax debts. In order to obtain a discharge of state tax debts, the debtor must satisfy the same criteria that applies to the discharge of federal tax debts.
The rules stated above only deal with income taxes, other rules apply to other forms of tax debt.