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Discharge Tax Debts in Bankruptcy

Many clients are dealing with significant tax debts. Filing bankruptcy may help resolve these debts.

Chapter 7 and Tax Debts

Certain tax debts may be discharged in a chapter 7. At a minimum, the applicable tax return must have been due at least three years before the date you file bankruptcy. For example, 2014 taxes were due by April 15, 2015. Therefore, 2014 tax debts may be eligible for discharge after April 15, 2018. There is an exception to this rule. If for any reason the IRS reassess the taxes for a certain year, you must wait at least 240 days after the assessment before the debt can be discharged in bankruptcy. If the tax return was filed late pursuant to an extension, the eligibility date starts from the extension date. If the tax return was late filed without an extension, the tax debt may not be discharged.  However, the IRS does not currently follow the strict letter of the law when it comes to late filed returns. It is common for the IRS to classify these debts as unsecured non-priority which means they can be discharged. If a tax payer did not file a tax return, the IRS will eventually file a substitute for return. The resulting tax debt will not be discharged and there are no exceptions. If a tax debt can be discharged it is classified as a non-priority unsecured tax liability. If a tax debt cannot be discharged, it is classified as unsecured priority tax liability. If the trustee opens a bankruptcy estate to liquidate non-exempt assets, the priority tax debts will be paid before other unsecured creditors.

Chapter 13 and Tax Debts

The same rules apply to chapter 13 as concerns the classification of priority and non-priority tax debts. The difference is that a chapter 13 is a repayment plan. Debtors rarely pay their unsecured debts (e.g. credit cards, medical, loans, etc) in full through a chapter 13. Instead they pay a fraction of the total liabilities and the remaining balances are discharged upon the completion of plan payments. Unlike non-priority unsecured debts, priority tax debts must be paid in full through a chapter 13 plan. Non-priority tax debts are treated the same as other unsecured debts. In some cases, the treatment of priority tax debts is beneficial to the debtor. Some debtors have just enough disposable income to pay-off their priority tax debts leaving very little to pay unsecured creditors. Since the unsecured debts will be discharged at the end of the plan, it is better to minimize the amount the debtor pays these creditors. If the debtor’s priority tax debts are too high, this could prevent the debtor from affording the resulting chapter 13 plan payments. The duration of a chapter 13 plan cannot exceed five years. Therefore, some debtors must wait to file bankruptcy until certain priority tax debts reach non-priority status.

The rules regarding secured tax debts are complex. You should consult with an attorney regarding how your tax debts can be resolved through bankruptcy.

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