Bankruptcy And Tax Debt
Its more common than you think: simple income tax debt can drive Canadian consumers and small business owners into insolvency. Tax bills can be large and unexpected, and the Canada Revenue Agency can be ruthless. To top it off, CRA has powers of collection that are unavailable to other creditors.
When you are sure just how much income tax you really owe to CRA, and have considered less serious solutions , your final possibility is to resolve your income tax debts with bankruptcy.
Tax Liens & Bankruptcy
Tax debt and tax liens are different things. Tax debt is simply money that you owe either the State of Wisconsin or the IRS. A tax lien is a legal judgment secured against your property to satisfy a tax obligation that you owe the state or federal government. Should you qualify for Chapter 7 bankruptcy, and meet all of the above criteria, unfortunately bankruptcy will not eliminate prior tax liens.
Your obligation to pay off the debt will be discharged, but not eliminated. However, the IRS will no longer be able to go after your income or bank account.
However if a tax lien was filed before you filed for bankruptcy, the lien will remain on the property. If you ever want to sell your property, you will have to pay off the lien before you can do so.
Do you have other tax related, or bankruptcy questions? Let us know. Were happy to help.
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What About My Tax Refund
This question comes up quite a bit. If you anticipate a large refund, talk about this issue with your attorney. It may be a good idea to delay filing until after you receive your tax year refund for the past year. Technically, when consumers file for bankruptcy, all their non-exempt property goes to the trustee. That includes tax refunds. Since the policies vary depending on where you live, you may be able to use the wildcard exemption to exempt the tax return.
Owing past-due income taxes can be stressful. These bills are often so high that, even if you fall behind a little, you could end up owing a lot of money. Fortunately, if your debts meet certain requirements, filing Chapter 7 bankruptcy can erase past-due income tax debt in one fell swoop.
Have At Least 240 Days Passed Since The Date On Which The Irs Assessed The Tax Debt At Issue
11 U.S.C. § 507. Assessments can follow an audit, examination, or amended return. Beware the sleeping assessment. The IRS has three years to assess taxes and penalties, from the date the return was filed. That means taxes can be assessed upon filing, and then again up to three years later if there is an increase in tax or a penalty following an audit or examination. Thus, its often not as simple as waiting until 240 days have passed from assessment you dont want to file a bankruptcy only to find out in the middle of it that additional taxes have been assessed, because they wont be dischargeable. Beware that this 240-day period is extended by an offer in compromise plus 30 days. 11 U.S.C. §507.
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Second Step: Be Aware Of The Consequences Of Unpaid Income Taxes And Late Filed Returns
There are two certainties in life, death and taxes. Neither situation is something that one looks forward to and the CRA has extensive powers to enforce the filing of returns and the payment of taxes.
- Penalties and interest are charged on balances due on late filed tax returns. You should consult with your income tax preparer as to your due dates.
- In the event that returns are not filed, the CRA can make an arbitrary assessment for your income tax liability.
- The CRA can withhold child tax credits, Canada Pension Plan or Old Age Security benefits, GST credits and tax refunds until your debt is paid.
- The CRA can garnishee your bank account and paycheque directly from your employer. No court application is required and as such, your bank or employer need only be served with a Requirement to Pay notice by the CRA.
The CRA will typically not accept less than full payment from a taxpayer unless you engage the services of a Licensed Insolvency Trustee or are successful with a Taxpayer Relief application. From the CRA perspective, should they accept less than the full balance outstanding, they would be setting a precedent that would force them to accept lower amounts from all other taxpayers. As such, the obligation can only be reduced through a Licensed Insolvency Trustee or through the Taxpayer Relief provisions.
Chapter 13 Overview And Tax Debt
Federal income taxes also qualify for partial repayment in a Chapter 13 Bankruptcy if the required criteria are met, and Chapter 13 bankruptcy for property taxes may also be an effective option. What happens to liens in Chapter 13 bankruptcy depends on whether the lien existed before, or was placed after, the bankruptcy filing, as discussed further in the tax lien and bankruptcy section below.
In a Chapter 13 filing, the bankruptcy trustee will help you restructure your debts and enter into a repayment plan. Tax debt will be listed in the plan as a nonpriority debt, meaning the tax debts will be treated like credit cards and the trustee will determine a reasonable amount that you are able to repay over three to five years.
If the necessary criteria are not met in regard to the tax debts for example, if you are not current on your tax filings with the IRS the tax debt will remain a priority debt under the Chapter 13 plan. This means that while the debt can still be paid through a payment plan, it will have to be paid in full.
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Tax Obligations In Bankruptcy
Felicity is a 37 year old unemployed woman from Dandenong in Victoria. She is currently single and has no children.
For 8 years she was a sole trader running a small business as a pastry chef. Felicity struggled to stay on top of her bookkeeping and bills. As a result, personal and business debts built up until Felicity had no choice but to close the business.
Felicity ended up filing for bankruptcy. At the time she had not lodged a tax return for the past 4 financial years.
Felicity listed the Australian Taxation Office as a creditor on her bankruptcy form. She did not know how much she owed because of her unfiled tax returns. She estimated on her form that it would be about $150,000.
AFSA contacted Felicity to talk about her bankruptcy. AFSA explained that Felicity still needed to lodge her overdue and future tax returns in the normal way. AFSA does not do this for her and bankruptcy does not remove this obligation.
AFSA explained that most ATO debts are covered by bankruptcy. This means they do not have to be repaid . The ATO would still be a creditor in the bankruptcy, which meant that if any money became available to pay creditors, the ATO would get a share.
However, any tax refund Felicity is entitled to during her bankruptcy may be kept by the ATO. The ATO would use this money to pay off some of her tax debt. This would reduce the ATOs claim against Felicitys bankrupt estate.
Tax Debt Not Covered By Bankruptcy
Can bankruptcy remove tax debt? Often, this is the case. However, not every tax debt can be discharged in bankruptcy. Examples of debts that cannot be discharged include payroll taxes, employment taxes, trust fund taxes, sales tax, and any penalties connected to these non-dischargeable types of taxes.
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Which Tax Debts Get Discharged
Debtors can discharge some tax debt in bankruptcy, but not all. Taxes must meet the following criteria before being forgiven:
- The taxes are on wage-related income or gross receipts .
- The income taxes were due at least three years before you filed the bankruptcy.
- You filed your tax return at least two years before you filed the bankruptcy case. If you did not file a return, if you filed the return late, or if the IRS filed a substitute return for you, some bankruptcy courts have held that those taxes will never qualify for a discharge.
- IRS tax assessmentthe process of entering the tax on the books as a tax liabilityoccurred at least 240 days before filing for bankruptcy. This period could be lengthened if you had pending an offer in compromise or if you filed a prior bankruptcy case.
- You didn’t commit fraud or willfully try to evade paying your taxes for the tax year in question.
If you meet all of these factors, the chances are that your tax debt will be dischargeable. If not, your tax obligation won’t go away in a bankruptcy case.
Back Owed Income Taxes And Chapter 13 Bankruptcy
When you file for Chapter 13 bankruptcy, only some of your back taxes may be discharged and most have to be repaid over the next three to five years. You will be set up with a repayment plan that usually runs three years, unless you are making less than the state median income, in which case it will be about five years.
Income taxes must meet all of the following requirements if they are to be discharged when filing a Chapter 13 bankruptcy:
- You do not have secured debts of more than $1.01 million
- You do not have unsecured debts of more than $337K
- Your tax returns were field at least 4 years before filing for bankruptcy
- Youre not including business taxes in the filing
- You are disclosing all of your assets, liabilities and income and are not guilty of any fraudulent activities
- You are still paying all taxes with a lien filed against them
- You are submitting a Statement of Financial Affairs
- You agree to pay court filing fees and taxes from the previous year
- You have completed credit counseling with a Federal government agency
- You have completed a comprehensive budget analysis
- You are able to pay at least $100 a month for the next 5 years
- You agree to submit a payment plan proposal to the court for review
As you can see, its not very easy to have your income taxes discharged when you are filing bankruptcy.
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Has The Taxpayer Refrained From Any Willful Attempt To Evade Or Defeat The Tax Debt At Issue
Likewise, willful attempts to evade or defeat a tax liability bars the discharge of the tax debt. 11 U.S.C. § 523.
The devil is always in the details this is a broad overview of a complex area of law. If you need help working through whether a bankruptcy would alleviate a tax problem, or have questions regarding tax debt within a bankruptcy, contact the experienced bankruptcy attorneys at Essex Richards today.
Heather Culp is an attorney with Essex Richards in Charlotte.
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Examples Of Taxes That Cannot Be Discharged
While income tax debts and older real estate tax debts may be able to be discharged, that doesnt apply to other types of tax debts. The debts that cannot be discharged during bankruptcy include the following:
- Tax Liens While the requirement to pay a tax may be removed through bankruptcy, tax liens will remain. However, this applies only to liens on your property prior to you filing for bankruptcy. Even though you may not be personally required to pay the tax debt, youll still have to pay to discharge the lien from the net proceeds when you sell your property, subject to the applicable staute of limitations on liens.
- Third-Party Trust Taxes Taxes like Medicare, FICA, and income taxes withheld by an employer and held in trust for others are not able to be discharged. This also applies to sales taxes paid by customers that must be paid to a government unit.
- Specific Employment Taxes Generally, employment taxes, customs duties, and excise taxes cannot be discharged depending on the time frame.
The Law Office Of Seth Kretzer Can Help You Handle Debt During Bankruptcy
When you are trying to figure out how to issues related to your IRS tax debts, you will need a lawyer with specific experience on bankruptcy in Texas and who has the right knowledge and resources to help you.
Contact us online today to schedule a free consultation and discuss the details surrounding your tax debt and bankruptcy case.
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.
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Tax Debt In Chapter 13 Bankruptcy
If you file for Chapter 13 bankruptcy where the court trustee arranges a partial repayment plan, then your tax debt will be included in the plan. If it meets the five criteria listed above, then it will be deemed a nonpriority debt.
This means it will get treated like credit cards and other debts that are generally easy to discharge. Instead of paying off the full amount, the court will determine how much you can reasonably afford to repay. You will repay some of the debt you or the IRS or your state tax office in your payment plan. Then the remaining balances will be discharged.
If your tax debt does not meet those five, then it may be deemed a priority debt. You will still be able to pay it off under your repayment plan. However, it must be repaid in full.
What Are The Requirements For Tax Discharge
There are a number of pre-requisites that have to be met before you can solve your bankruptcy tax debt. In order to be cleared of all income tax debt , the following minimum requirements have to be met:
- 3 years need to have passed since your returns were last due to be filedthis includes any extensions that you may have received.
- The returns were filed in a timely manner or its been at least 2 years since the returns were filed.
- There was no fraud or attempts to avoid and evade paying the IRS .
- The taxes havent been assessed in the last 240 days.
Sometimes, there are occasional exceptions and ways to get around the above requirements. You shouldnt give up on filing for bankruptcy to absolve yourself of tax debt until you have a qualified professional take a look at your files first. Even if you cant completely get rid of your tax debt through bankruptcy, you may be able to get a partial tax bankruptcy discharge for some of itand set up a payment plan for the rest.
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Tax Returns And Chapter 7 Bankruptcy
When you file for Chapter 7 bankruptcy, the trustee assigned to oversee your case will ask for your most recently filed tax return. That doesn’t necessarily have to be the tax return for the last tax year, but if it isn’t the most recent return, the trustee will ask for a written explanation.
The trustee will compare the income you report on your return to the amount listed in your bankruptcy paperwork. If you show that you’re due a refund, the trustee will also want to check that you have the right to protect it and that you’ve claimed the proper exemption amount. If not, you’d be required to turn the refund over to the trustee, who would, in turn, distribute it to your creditors.
Many people plan to use the return for necessary itemssuch as living expensesbefore filing a bankruptcy case. If you choose this approach, it’s a good idea to keep records of your expenditures.