Business Taxes In Bankruptcy
Income taxes that you incur personally as a result of operating a business are dischargeable in bankruptcy under the 3-2-240 rules. However, different rules apply to other business-related taxes:
Payroll Trust Fund Taxes. Trust fund taxes are not dischargeable in bankruptcy. Trust fund taxes include payroll taxes that employer withholds from an employee’s pay on behalf of the government. If you fail to withhold required taxes or withhold the taxes from an employee’s check but fail to pay the withheld funds to the taxing authority, the taxes are not dischargeable.
Employer’s Portion of the Payroll Tax. The employer’s part of the payroll tax is dischargeable in bankruptcy under rules similar to the 3-2-240 rules. The debtor must file for bankruptcy a minimum of three years from the date that the IRS 941 form was due and two years from the date the debtor filed the tax forms.
Sales Tax. Like other trust fund taxes, sales taxes are not dischargeable in bankruptcy in Pennsylvania.
Can A Tax Lien Be Removed Or Released In Bankruptcy
If the IRS places a tax lien before you file Chapter 7 bankruptcy, the tax lien generally stays. In most cases, the tax lien will still be present after the Chapter 7 bankruptcy, and you wont be able to sell your property until you pay the taxes associated with the lien.
In Chapter 13, once your payment plan is complete, the tax lien gets removed, but in most cases, it stays in place during your three or five-year repayment plan.
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Tax Debt Bankruptcy Discharge Test: No Fraud
The tax return also cannot have been fraudulent or filed in any other manner deemed by the IRS or Michigan Treasury to have been a willful attempt to evade or defeat the tax liability.
What is fraud? If that word has explicitly aimed at you by the IRS or if you have been criminal prosecuted for tax evasion, your tax debt is likely to be non-dischargeable in bankruptcy. However, there are other occasions less explicit to be found in existing case-law. Some examples include the understatement of income, extended failure to file tax returns, and failure to cooperate with the IRS.
Once again, it is crucial that an experienced bankruptcy attorney competent in tax liability discharge be retained if you should such debt obligations.
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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.
When Tax Debt Is Not Dischargeable: Chapter 13 Reorganization Plan Treatment
Even if your tax debt is not dischargeable, however, all is not lost.
A Chapter 13 bankruptcy is a form of bankruptcy in which some types of debt you may owe are treated in priority over other types of debt.
A non-dischargeable tax debt will be paid in a Chapter 13 payment plan in full before any garden-variety unsecured liabilitiescredit card, medical, other unsecured debtsare paid anything at all.
If you have only X amount of disposable income to stave your creditors off with each month, a Chapter 13 will allow you to dedicate that money to your priority tax debt so that you are able to pay it off without worrying about your other creditors, and then pay in part or full and discharge the unpaid balance of the unsecured debt at the end of the Chapter 13 process.
Further, any tax debt paid will be paid at 0% interest in the Chapter 13 Plan. That is an improvement of at least a couple of percent on what the IRS charges for its non-bankruptcy payment plan arrangements every time.
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Discharging A Tax Debt By Filing Chapter 7 Bankruptcy
If all of the following conditions are applicable, you might be able to successfully file Chapter 7 bankruptcy and eliminate federal income tax debts:
- The debts are solely related to income taxes: Any tax debts other than those that arise from income tax cannot be eliminated by filing for Chapter 7 bankruptcy.
- You did not fraudulently file or willfully evade paying your taxes: A fraudulent tax return or an attempt to evade your tax obligation will preclude you from discharging your tax liabilities through Chapter 7 bankruptcy.
- The tax debt must date back at least three years: The tax return in question must have been due at least three years before you filed for Chapter 7 bankruptcy.
- You have filed a federal tax return: With a few rare exceptions, you must have filed a federal tax return for your current tax liability at least three years before filing for bankruptcy.
- Your claim satisfies the 240-day Rule: The IRS must have assessed your income tax liability at least 240 days before you file for Chapter 7 bankruptcy. However, this time limit may vary if collection actions were suspended due to an offer in compromise.
State Taxes That Can Be Discharged In Bankruptcy
The state taxes that can be discharged most often are old state income taxes. They follow the same rules for dischargeability as federal income taxes, and it depends on when the return was due, when it was filed and when the tax was assessed. The rules for federal income tax discharge can be found in Does Bankruptcy Wipe Out Tax Debt? If the state income tax that you owe meets the rules for federal income tax discharge, then the state income tax can be discharged too.
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Whats Personal Liability For Debt
In a nut shell, personal liability is the right of your creditor to use the powers of the law to reach your wages and your assets to satisfy a debt.
When you get a bankruptcy discharge, that personal liability is erased. The discharged creditors cant reach assets that you acquire after the bankruptcy, nor the assets that you exempted in your bankruptcy case.
So, get a bankruptcy discharge that wipes out older taxes and the IRS cant garnish your future wages or levy your bank accounts. Further, the existing tax lien wont attach to assets you acquire in the future.
Options For Dealing With Non
In Chapter 13, claims for priority taxes and secured taxes must be paid in full however, secured claims are only paid in full up to the value of debtors assets. Your bankruptcy attorney can bring an application under Section 506 to determine what portion of the secured claim must be paid in full. The balance of the unsecured portion will be paid with the rest of the unsecured claims, often for a fraction of its full value.
In addition to eliminating the Chapter 13 super-discharge that existed under prior law, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 made other tax-related changes, particularly concerning Chapter 13. BAPCPA requires a Chapter 13 debtor to file tax returns for the four taxable years preceding the bankruptcy filing no later than the day before the first scheduled Section 341 Meeting of Creditors. A debtor who fails to file these required tax returns cannot have his Chapter 13 Plan confirmed by the Court, and his case is subject to dismissal.
Under BAPCPA, there are more instances where tax refunds can be intercepted by interested parties. The automatic stay created by the bankruptcy filing no longer prevents the interception of tax refunds for payment of a domestic support obligation , and it no longer prevents taxing authorities from exercising setoffs against tax refunds for prepetition tax periods to cover prepetition tax debt.
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If You Think Your Small Business May Fail Speak To Your Bankruptcy Attorney Well In Advance Of The Doors Closing
Because of the harsh penalty for failing to pay tax authorities certain taxes, small business owners should consult with a knowledgeable bankruptcy attorney before closing up shop. Winding up the company the right way can save you significant tax liability and penalties.
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New York State Tax Lien
- Non-dischargeable tax debt is collectible for 20 years, with the 20 year period being renewed whenever a payment is made.
- Tax lien is created by filing of NYS Tax Warrant, which attaches for 10 years to all personal property in any location, and to all real estate located in the County where it is filed.
- New York State exemptions limit the State Tax Departments ability to collect, protecting many assets from seizure, including: the 10% limit on salary garnishments the $50,000.00 homestead exemption for residences the protections afforded qualified pension plans, profit sharing plans, IRAs and most retirement plans.
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Important Note On Late
Filing a tax return late is a costly mistake, whether or not you file for bankruptcy. In bankruptcy, it can be catastrophic. Unfortunately, a some courts, including a federal appeals court, have held that a tax return filed even a day late is not a tax return under the statute allowing discharge of tax debts in bankruptcy. In other words, if your forms were filed late without an extension in any given tax year, you cannot discharge the taxes for that year.
To be sure, the courts’ interpretations of the statute are tortured and run counter to the Bankruptcy Code’s purpose. Hopefully, the U.S. Supreme Court will clarify this issue. However, until then, I advise clients that debts arising from late-filed forms may not be dischargeable. In the meantime, if you have unfiled tax returns, you should get them filed as soon as possible.
Quick Note:If you know you will be filing late, get an extension. Even if you cannot pay the amount due, at least file the forms. As discussed below, you can lose your ability to discharge taxes in bankruptcy and incur unnecessary penalties if you file late without an extension.
The Importance of Filing Tax Returns on time. There here is no upside to not filing your tax forms or filing them late. In my Philadelphia bankruptcy practice, I sometimes see clients whose taxes would have been dischargeable, if only they had filed their tax forms or filed them on time.
State Taxes That Cant Be Discharged
Some kinds of state taxes are never dischargeable. These include income taxes that are less than 3 years old. Most of the non-dischargeable state taxes come from owning a business. These are taxes such as sales tax and payroll taxes. If your business is a sole proprietorship, then you are automatically personally liable for sales and payroll taxes. If your business is a corporation, partnership or limited liability company, then you are only personally liable if the business does not pay, and the taxing authority has said that you, personally, owe the tax, known as a personal assessment.
Sales and payroll taxes are called trust fund taxes. It means that the business was supposed to collect those taxes and hold them in trust for the taxing authority until they are periodically paid over to the taxing authority. Taxing authorities tend to be very aggressive in trying to collect trust fund taxes. There is also usually a very long period of time, often 10 years or more, for the taxing authority to collect those taxes. The time period will depend on the state you live in. If you owe trust fund taxes, you should seek advice from an experienced attorney on how best to proceed.
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Tax Debt Discharge In Chapter : A Timeline
All these rules apply to the bankruptcy process as well. If you have past-due tax debt, things will be a little different.
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Filing: On your paperwork, you will list the tax debt as priority unsecured debt in Part 1 of Schedule E/F.
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Trustee meeting: At this meeting, the trustee will review your paperwork, confirm your identity, and ask questions about any red flags in the paperwork.
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Discharge: The court has the power to discharge both secured and unsecured debts. If your debts meet all requirements, you should receive a notification of a discharge within about 60 days.
In special circumstances, you’ll have to meet additional qualifications to discharge some types of debt. This may be true in cases involving tax liens. It’s also true in student loan cases. If you want to discharge student loan debt, you must convince the court that there is an undue hardship preventing you from repaying the loan.
What Makes A Chapter 12 Bankruptcy Different Than A Chapter 7 Or Chapter 13
In a Chapter 12 bankruptcy, usually, the debtor is a family farmer or fisherman. To qualify as a family fisherman, at least half of their income from the previous year must be from fishing. To qualify as a farmer, at least half of a taxpayers income for the last three years must come from farming activities. In a chapter 12 bankruptcy, taxes are priority liabilities, and the taxpayer must pay them first.
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When Tax Liens Are Not Paid Through Bankruptcy
Unfortunately, tax liens usually are not paid in Chapter 7 cases. Most Chapter 7 cases are “no asset” cases. In a no asset case, creditors receive nothing because there is no property that the trustee can sell for the benefit of the bankruptcy estate after taking into account secured claims and exemptions. Ordinarily, trustees will not attempt to sell property if all of the proceeds would have to be paid to secured creditors or the debtor.
Example. Let’s take the example of a house worth $200,000, with a $150,000 mortgage, a $25,000 federal tax lien, and a $100,000 homestead exemption. In most cases, the trustee would not try to sell the house, because there would be no proceeds available to pay other creditors after taking into account the mortgage, tax lien, and homestead exemption.
In this situation, the tax lien would still remain on your property after your Chapter 7 case is over. In order to get rid of the lien, you could sell the property and pay the IRS from the proceeds. Or, you could attempt to work out a payment plan with the IRS to pay the balance due and have the tax lien released. Simply filing Chapter 7, however, would not make the lien disappear.
Tax Debt & Michigan Bankruptcy: The Bottom Line
The bottom line is that, if you are considering filing for bankruptcy and are holding any income tax debt, you need to retain an experienced bankruptcy attorney to assist you.
It is highly unlikely that a lay person will perform this analysis properly, and a mistake in timing your bankruptcy filing by even a day can cost you your tax debt dischargeability.
The Law Offices of Walter A. Metzen & Associates offers free consultations for those interested in the bankruptcy process and is experienced in determining and advising as to the best treatment of income tax debt within the bankruptcy process.
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What Bankruptcy Can Do
Bankruptcy allows people struggling with debt to wipe out certain obligations and get a fresh start. The two primary bankruptcy types filedChapter 7 and Chapter 13 bankruptcyeach offer different benefits and, in some cases, treat debt and property differently, too. Youll choose the chapter thats right for you depending on your income, property, and goals.
Here are some of the things you can expect regardless of whether you file for Chapter 7 or 13.
Automatic Stay In Bankruptcy
When you file bankruptcy, the bankruptcy court grants you an automatic stay against all collection actions by private creditors. The automatic stay applies to all current and future collection actions for debts you owed at the time you filed the bankruptcy case. This means if a private creditor is currently garnishing your wages, or offsetting your taxes, the garnishment and tax offset must stop once you file for bankruptcy. The automatic stay prohibits creditors from starting any new collection actions against you. The automatic stay typically lasts until the court discharges your bankruptcy. Creditors cannot collect on debts discharged in bankruptcy.
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Interest And Penalties On Taxes In Bankruptcy
For the most part, interest and penalties are treated the same in Chapter 7 and 13. However, there are some differences concerning priority debts, which we will discuss.
Discharging penalties on back taxes. Tax penalties more than three years old are dischargeable in both Chapter 7 and Chapter 13 bankruptcy unless the IRS or other taxing agency has secured the debt by filing a tax lien.
Discharging interest on back taxes. In both Chapter 7 and Chapter 13, if the taxes are dischargeable, the interest is also dischargeable.
Penalties and interest on priority tax debts in Chapter 7. In Chapter 7, penalties and interest on priority tax debts are not dischargeable.
Penalties and interest on priority tax debts in Chapter 13. All pre-petition penalties and post-petition interest are discharged in Chapter 13 if the debtor completes the Chapter 13 plan. Therefore, if you have significant penalties on priority tax debt, filing under Chapter 13 may be a better option, particularly if you cannot wait for the taxes to qualify under the 3-2-240 rules.
Penalties and interest on secured tax debts. Interest and penalties on secured tax debt are not dischargeable up to the value of the security interest in the debtor’s property.
Post-petition interest on secured debts. Taxing agencies may be entitled to post-petition interest on secured tax debts, which the debtor must pay as part of the plan in a Chapter 13 case.
