Perhaps you have heard the many TV or radio ads promising that bankruptcy can eliminate your tax debts. However, wiping out your tax debt in bankruptcy is not nearly as simple or easy as the advertisements might suggest — in fact, most tax debts are not eliminated in such cases. If you file a bankruptcy under Chapter 7, you may still have to pay the tax debt even after your bankruptcy is successfully discharged. In a Chapter 13 bankruptcy the tax debt will be fully paid through a debt repayment plan.
Any tax liens filed before a Chapter 7 bankruptcy is initiated will remain attached to all real estate and personal property owned by the taxpayer. Generally speaking, the taxpayer must pay the value of the tax lien in order to get a release of the lien. However, the IRS cannot levy your wages or bank account to satisfy a tax lien that was filed prior to the bankruptcy. Also, while your bankruptcy is pending, the IRS is forbidden from levying your bank accounts or seizing your property.
TAX DEBTS THAT CAN BE DISCHARGED IN BANKRUPTCY
There are very specific rules that must be followed in order for a tax debt to be eliminated in bankruptcy and they are as follows:
- Generally income taxes are the only type of tax debt that can be discharged in bankruptcy.
- The tax debt must originate from a tax return that was due at least three years before the bankruptcy petition is filed.
- The actual tax return must be filed at least two years before filing for bankruptcy.
- The taxing authority must assess the tax debt 240 days (approximately 8 months) before the bankruptcy petition is filed. Moreover, this time limit can be extended if the taxpayer submitted an offer in compromise with the taxing authority or the taxpayer had a previously filed bankruptcy.
- The tax return cannot be deemed fraudulent or frivolous by the taxing authority. The taxpayer also cannot be held guilty of intentional act of evading tax laws.
TAX DEBTS THAT ARE NOT DISCHARGEABLE IN BANKRUPTCY:
- Taxes that a third party is required to pay or withhold are not dischargeable in bankruptcy. This is often called “trust-fund” taxes because the taxing authority trusts the taxpayer to collect the tax from a third party and pay it to them. Trust fund taxes include the taxes withheld from an employee’s check. This category also includes sales and use taxes because the taxpayer is required to charge sales tax to their customers and pay said amounts to the taxing authority.
- Property taxes payable within one year of the bankruptcy petition being filed, cannot be discharged in bankruptcy.
It is the rare case that bankruptcy will wipe out an entire tax liability. However, even if you have the rare bankruptcy case, any tax liens file by the IRS prior to the bankruptcy will survive after the bankruptcy and will continue to impact your property interests. If you wanted to sell your house after your bankruptcy, the tax lien would have to be satisfied in the order of its legal priority, even though your Chapter 7 bankruptcy was successfully discharged. Bankruptcy is not generally a lasting and permanent resolution to your tax liability.