The Return Was Filed At Least Two Years Ago
The tax debt must be related to a tax return that was filed at least two years before the taxpayer files for bankruptcy. The time is measured from the date the taxpayer actually filed the return. In most cases, this covers the same period of time as the due date rule, unless you missed the due date and filed the return late.
Tax debts that arise from unfiled tax returns are not dischargeable. This is an important distinction, because the IRS routinely assesses tax on unfiled returns. These tax liabilities can’t be discharged unless and until the taxpayer files a tax return for the year in question.
Most Taxes Can’t Be Eliminated In Bankruptcy But Some Can
Updated by Cara O’Neill, Attorney
If you’ve heard commercials offering the hope of eliminating tax debts in bankruptcy, be cautious. It’s not as simple as it sounds. Most tax debts can’t be wiped out in bankruptcyyou’ll continue to owe them at the end of a Chapter 7 bankruptcy case or have to repay them in full in a Chapter 13 bankruptcy repayment plan. In this article, learn:
- when you can discharge a tax debt
- what happens with federal liens, and
- how to manage tax debt using Chapter 13.
You’ll also learn the pros and cons of filing tax returns before or after bankruptcy.
If you’d like step-by-step guidance through the bankruptcy process, read What You Need to Know to File for Bankruptcy in 2021.
What Is Debt Discharge
Debt discharge is the cancellation of a debt due to bankruptcy. When a debt is discharged, the debtor is no longer liable for the debt and the lender is no longer allowed to make attempts to collect the debt. Debt discharge can result in taxable income to the debtor unless certain IRS conditions are met.
- A debt discharge occurs when a debtor qualifies through bankruptcy court.
- When debt is discharged, a lender can no longer make attempts to collect the debt and the debtor is no longer responsible for paying it back.
- Debt discharge often results in taxable income to the debtor unless certain IRS conditions are met.
- Not everyone qualifies for discharge of debt.
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Tax Returns And Chapter 13 Bankruptcy
You must be up to date on your tax returns before you file a Chapter 13 case, but the rules allow you a little wiggle room. You’ll provide copies of the returns for the previous four tax years to the Chapter 13 trustee before the 341 meeting of creditors . If you’re not required to file a return, your trustee might ask for a letter, an affidavit, or a certification explaining why. Sometimes local courts will impose additional rules for documents in their districts.
If you owe the IRS a return but don’t file it before your 341 meeting of creditors, things can happen to derail your case.
- A motion. The trustee will file a motion giving you a very brief period to provide your returns. If you miss the deadline, the court can automatically dismiss your case, leaving you no chance to plead your case to the judge.
- A substitute return. The IRS might file a “best estimate” claim based on your past income. The problem? IRS estimates are almost always higher than what you would owe after you file a proper return.
How Discharge Affects Your Belongings
Discharge from bankruptcy doesn’t mean you’ll get back any belongings, even if they haven’t been sold yet. It might take some time for the official receiver to deal with them.
If you come by any new assets after you’ve been discharged, these will usually remain yours and can’t be claimed by the trustee. An important exception to this rule is any payments you receive by claiming for payment protection insurance which was mis-sold before you become bankrupt.
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Qualifications For Discharging Income Tax Debt By Filing For Bankruptcy
Take advantage of your free consultation with Milwaukee area bankruptcy attorney Steven R. McDonald to learn about your best options for a fresh start.
If You File For Bankruptcy What Can You Keep
What property can you keep in a Chapter 7 bankruptcy? Some states let you choose between the state exemptions and the federal bankruptcy exemptions. Oklahoma does not. Instead, you must use the Oklahoma bankruptcy exemptions, which include but are not limited to:
1. equity in your home if it is your primary residence 2. up to $7,500 of equity in a car, motorcycle, truck, van, SUV, or other vehicle 3. food, most livestock for family use, and seed for growing crops for up to a year 4. up to $2,000 worth of firearms for personal use 5. health aids prescribed by a healthcare professional 6. furniture, household items, your personal computer, and up to $4,000 worth of clothing 7. personal injury and wrongful death awards up to $50,000 8. wedding and anniversary rings worth up to $3,000 9. most pensions and public benefits
A Chapter 13 bankruptcy helps you pay your unsecured debts but does not eliminate them. Under Chapter 13, you and your bankruptcy attorney will develop a plan for repaying your debts over three to five years. That plan must then be approved by the bankruptcy court.
When You Can Discharge Tax Debt
If you need to discharge tax debts, Chapter 7 bankruptcy will be the better optionbut only if the tax debt qualifies for discharge and you’re eligible for Chapter 7 bankruptcy. All of these conditions must be met before you can discharge federal income taxes in Chapter 7 bankruptcy:
- The taxes are income taxes. Taxes other than income, such as payroll taxes or fraud penalties, can never be eliminated in bankruptcy.
- You did not commit fraud or willful evasion. If you filed a fraudulent tax return or otherwise willfully attempted to evade paying taxes, such as using a false Social Security number on your tax return, bankruptcy can’t help.
- The debt is at least three years old. The tax return must have been originally due at least three years before filing for bankruptcy.
- You filed a tax return. You must have filed a tax return for the debt you wish to discharge at least two years before filing for bankruptcy. , you have not filed a “return” and cannot discharge the tax. In some courts, you can discharge tax debt that is the subject of a late return as long as you meet the other criteria.)
- You pass the “240-day rule.” The IRS must have assessed the income tax debt at least 240 days before you file your bankruptcy petition, or not at all.
Can I File Bankruptcy On Taxes
Yes. If you have income tax debt, you can declare bankruptcy on taxes owing. In Canada, tax debts are treated the same as any other type of unsecured debt, such as a credit card or a personal line of credit. If you successfully complete a bankruptcy, all tax debt will be cleared. However, filing for bankruptcy is often a last resort for getting out of debt and it may not be your only solution. A Licensed Insolvency Trustee can walk you through your options, so you can determine the best path to take.
What Happens If I Have Tax Debt That Cant Be Erased Yet
Plenty of taxpayers are in this boat, and they all have several legal options. An attorney can advise you on the best course of action, but ultimately, the decision is yours.
Pay in installments. Some people talk to the IRS about a payment plan. The IRS usually backs off once the taxpayer starts an installment agreement. After all, the IRS just wants the money. It doesn’t really want to garnish your wages. Keep in mind that installment agreements are only a good idea if you have the money. If thatâs not the case, you need another option.
Participate in the Offer in Compromise program. The IRS has many programs to help taxpayers pay their tax debt when they have little or no money. The main example is the Offer in Compromise program where taxpayers pay what they can, and the IRS forgives the rest. This program can be extremely complex, and few people qualify. Also, if the taxpayer has any assets whatsoever the IRS will force the taxpayer to sell them. Finally, while the taxpayer negotiates, the IRSâs harassing collections techniques continue.
Five Rules To Discharge Tax Debts
Dischargeable tax debts must meet five other criteria.
Tax debts are associated with a particular tax return and tax year, and bankruptcy law lays out specific criteria for how old a tax debt must be before it can be discharged.
Tax debt is dischargeable in Chapter 7 bankruptcies if it meets all five of these rules:
- The due date for filing the tax return in question was at least three years ago.
- The tax return was filed at least two years ago.
- The tax assessment is at least 240 days old.
- The tax return was not fraudulent.
- The taxpayer is not guilty of tax evasion.
Apply these criteria to each year’s tax debt to determine whether that year’s unpaid balance is dischargeable through bankruptcy. Some of your debts might be eligible, while others might not.
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The Different Chapters Of Bankruptcy
There are six numbered chapters of bankruptcy filings. Chapters 7, 11, 12, and 13 are applicable to individuals in different circumstances.
Bankruptcy chapters 9 and 15 aren’t applicable to tax debts.
Chapter 7 is sometimes called a “straight” bankruptcy, because it provides for the full discharge of allowable debts. The bankruptcy court effectively takes control of your assets and liquidates them as necessary to pay off as much of your debt as possible. You’re no longer responsible for those unpaid balances after your bankruptcy discharged if you don’t have sufficient assets to cover all your debts.
Chapter 13 bankruptcy involves a multiyear, court-approved payment plan to repay your debts to the greatest extent possible. The goal is to pay them off in full, but some balances that can’t be paid can be discharged.
Chapter 11 allows for debt reorganization and a repayment plan similar to a Chapter 13 filing, but it is generally used by incorporated businesses or individuals whose debt is in excess of the limits for a Chapter 13 filing. That limit is $394,725 as of 2020.
Chapter 12 is intended for family farmers and fishermen who are financially distressed by expenses related to their businesses. It’s intended to be a quicker method of filing and designing a repayment plan. There are also limits to how long creditors can collect on debts under this chapter.
Can I File Bankruptcy On Tax Debt
You may be able to file bankruptcy on some types of tax debt. For instance, you may be able to discharge income tax debt if certain conditions are met .
Note that you will need to pass the means test to qualify for a Chapter 7 bankruptcy in the first place. The means test compares your disposable income to the state median income for your household size. If your income is too high and you can’t pass the means test, you can file for Chapter 13 instead and develop a plan to repay your debts over the course of a few years.
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You Can’t Discharge A Federal Tax Lien
If your taxes qualify for discharge in a Chapter 7 bankruptcy case, your victory may be bittersweet. Why? Bankruptcy won’t wipe out prior recorded tax liens. Chapter 7 bankruptcy will wipe out your personal obligation to pay the qualifying tax and prevent the IRS from going after your bank account or wages. But if the IRS recorded a tax lien on your property before the bankruptcy filing, the lien will remain on the property. You’ll have to pay off the tax lien before selling and transferring the property’s title to a new owner.
What About Tax Liens
A tax lien is a secured claim against all of a debtors property obtained by the IRS or State taxing authority. Bankruptcy does not itself remove a tax lien in other words, after discharge, the tax lien will remain as a lien on your property. Sometimes after a bankruptcy is discharged, the tax authority will voluntarily release a tax lien if it is apparent that the debtor has no nonexempt property to secure the lien.
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Taxes In Bankruptcy In More Detail
1) Priority Status Of Taxes
Certain debts are given priority status in bankruptcy . These debts are typically unsecured debts but do not receive the same treatment in bankruptcy as credit cards, personal loans, and medical bills. The typical priority debts are taxes owed to the government, child support, alimony, and student loans.
TAXES. Taxes have to meet specific requirements in order to be discharged through your bankruptcy. These requirements include:
the type of tax debt and
the age of the tax debt.
If the requirements are not met, then the taxes will have to be paid through your Chapter 13 bankruptcy payment or you will have to enter into a repayment plan with the government following your Chapter 7.
Lets look at the most common types of tax debts and how they are treated in a Chapter 13.
2) Income Taxes
3) Payroll Taxes
4) Property Taxes
If you owe taxes and feel that bankruptcy may be an option you need to explore, then fill out our online intake formto get your free evaluation from me. Completing the intake form does not obligate you to anything. Rather, I will respond quickly with my analysis and help you determine whether or not bankruptcy is an option for you to consider.
The sooner you start the process, the more control youll have over the outcome in your situation. Theres no cost and no obligation to fill out the iBankruptcy intake form and have me review your information. Dont put it off any longer.
Debts That Cannot Be Discharged In Bankruptcy
Some debts cannot be discharged in bankruptcy. There is a common myth that if you declare bankruptcy, all of your debts magically go away. Not only is this inaccurate, but bankruptcy also may not be your best option for debt relief. Before deciding on how to deal with creditors and unpaid bills, its essential to understand what debts you can include in bankruptcy, and which ones arent. Knowing this will help you settle on a debt recovery solution thats right for you.
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Taxes In A Chapter 7 Bankruptcy
Chapter 7 bankruptcy clears away unsecured debts in a relatively simple, 4-6 month process. Because of the immense benefits that Chapter 7 bankruptcy provides, there are strict eligibility requirements. There are mandatory waiting periods, and limits to how much equity the debtor can hold in assets called exemptions. There are also strict income limits to qualify for Chapter 7 bankruptcy. The first way to qualify is by making less than your states median income. In Arizona, the current median monthly income for a household of one is $4,653.25. For a family of two, this increases to $5,831.25. This increases to $6,296.67, $7,142.83, $7,892.83, and so on, for each additional family member. Your income will be combined with your spouses and averaged over the past 6 months for bankruptcy qualification purposes.
If your income exceeds the state median income, you may still qualify for Chapter 7 bankruptcy using your disposable monthly income. If your disposable monthly income is negative, or falls within a certain threshold, you can still file Chapter 7. You must first find your average monthly income, based on the past 6 months, to determine disposable monthly income. Next, deduct certain mandatory expenses, like taxes, child support, student loans, etc. If the number you are left with meets your states requirements, you will be eligible for Chapter 7 bankruptcy.
Initiation Of The Bankruptcy Process
- Where debts of an individual, excluding debts secured by the individual’s principal residence, are not more than $250,000, an insolvent debtor may file a Consumer Proposal with his creditors.
- For debt greater than this amount, a Division I Proposal can be filed.
- Prior to filing a Proposal under Division I, the insolvent individual may file a notice of intention to stay the creditors so that a Division I proposal can be filed with the Office of the Superintendent of Bankruptcy prior to the expiration of 30 days of the filing of the Notice of Intention
- Filing a Proposal under Division I is a serious decision, because an insolvent person will be placed into bankruptcy if the proposal is voted down by the creditors or not approved by the Court.
- If the Consumer Proposal is not accepted by the creditors or the consumer proposal is not a viable option, an insolvent person may either voluntarily assign himself into bankruptcy or be involuntarily petitioned into bankruptcy by his creditors
- The legal proceedings and creditor’s attempts to enforce the debts are stayed, no person is allowed to initiate or to continue existing legal actions against the bankrupt nor to enforce existing court orders
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