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Can You File Bankruptcy On State Taxes

Discharging California Sales Tax And Other Taxes

Can I File Bankruptcy on Back Taxes?

Sales taxes and other taxes, such as those owed to the State Franchise Tax Board, or Board of Equalization or Employment Development Department may also be dealt with in a bankruptcy case.

In California, discharging sales tax liability requires the same elements listed above for income taxes. The additional issues with sales taxes is that the business that generated the liability must be closed so that no new sales tax liability can be assessed and the taxes must have been actually assessed against you as the responsible party more then 240 days before filing the bankruptcy case.

How To Get Your Tax Debts Cleared In Chapter 7

Lets walk through the rules to give you some guidance state and federal taxes will generally be subject to the same treatment. Weve framed the discussion in terms of hurdles. Each of the hurdles below must be cleared before your tax debt will be eligible for discharge.

Note: Filing a tax return extension or seeking an offer in compromise are considered tolling events, which can lengthen some of the discharge deadlines mentioned below. If you have questions, its always best to talk to an experienced bankruptcy attorney.

What If Im Not Required To File Tax Returns Can I File Bankruptcy


If you are not required to file tax returns by law, then you do not need to supply tax returns to the trustee. Some trustees will ask for an affidavit stating that you are not required to file tax returns. You may not need to file returns if your only income is from social security, for example.

You should be certain that this is the case, however. Sometimes clients tell us that theyre not required to file tax returns when, in reality, they are required to file returns. This could be a problem.

If you work with a tax professional, you should consult that professional to determine whether you are required to file. If you do not work with a tax professional, good news. Attorney Best is also a tax attorney. We can work with our clients to determine whether you are required to file tax returns. Moreover, if you are required to file, but havent done so, we can file them for you!

One of the reasons people hire our office to file their bankruptcy is that its one stop shopping for bankruptcy and tax. We are even able to perform a tax dischargeability analysis!

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Does Bankruptcy Clear State Tax Debt

State tax debts can sometimes be cleared by filing for bankruptcy. It depends on the type of tax debt that is owed. Many of the same rules apply to state income tax debt and tax debt owed to the Internal Revenue Service , but not all. In this article, you’ll learn about:

  • state rules for wiping out tax debt
  • state taxes that aren’t dischargeable in bankruptcy, and
  • paying off nondischargeable tax in Chapter 13 bankruptcy.

Be aware that tax liability resulting from business ownership, such as sales, withholding, and franchise tax, have specific rules that vary between states. Youll want to speak with an experienced attorney about your particular case.

Can A Tax Lien Be Removed Or Released In Bankruptcy

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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 Liens In Chapter 13 Bankruptcy

There are also several options that are available in a Chapter 13 bankruptcy to resolve tax liens on personal or real property.

If the taxes owed from the tax lien are not dischargeable and are priority debts, then you may simply wish to pay the owed amount as part of Chapter 13 bankruptcy. Chapter 13 bankruptcy allows you to set up a repayment plan in which you can pay off taxes through a repayment plan.

If you own minimal assets, then you can reduce the tax lien to the value of your assets at the time of filing. In a Chapter 13 bankruptcy the tax lien is treated as secured only to the extent that there is equity in assets that it attaches to at the time of filing. If your assets are only worth $7,000 and there is a tax lien for $50,000, then you would cram down the tax lien to $7,000. Only $7,000 would be treated as secured as part of your bankruptcy plan. The remainder of the taxes would be treated as either unsecured priority taxes that must be repaid in full or unsecured general claims that may be paid the same as other general claims. This process can substantially reduce the amount that is required to be paid to eliminate the tax lien.

If you have tax liens recorded against your personal or real property it is important that you consult with a tax attorney or bankruptcy lawyer who can give you strategies for reducing or eliminating the tax lien.

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.

Let’s Summarize…

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.

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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. You’ll choose the chapter that’s 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.

Individual Income Tax Liability Can Be Discharged In Bankruptcy Usually After 3 Years After The Return Was Due

Can I File Bankruptcy on Back Taxes?

Regular unpaid income tax debt, owing to either the IRS or the Illinois Department of Revenue, can be discharged if all of the following are true:

  • It has been at least 3 years since the tax return that caused the income tax liability was due .
  • The return actually must have been filed more than 2 years ago. This usually only applies if you filed your returns late.
  • There have been at least 240 days since an IRS adjustment or audit adjustment took place or there was an amended return. If you make an Offer in Compromise, this time frame is extended during the time that the OIC is under consideration plus 30 days. See 11 U.S.C. §507.
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    How A Chapter 13 Bankruptcy Can Help

    If your state tax obligation wont go away, Chapter 13 bankruptcy will let you spread the payments over three to five years. Youll have the added benefit of potentially paying less on other debt, such as credit card balances, leaving you a larger percentage of your income to pay off the tax.

    Understand, however, that tax debt can be complicated. Before you explore this route, youll want to get an assessment with a bankruptcy attorney. Getting legal help isn’t as expensive as you’d think, and most people believe hiring a bankruptcy lawyer is well worth the cost.

    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.

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    Can Chapter 13 Bankruptcy Help Get Rid Of Tax Debt

    This article has focused on the treatment of tax debts in Chapter 7 bankruptcy. In a Chapter 13 case, priority tax debts meaning tax debts that have been due for less than three years are paid in full, usually minus penalties, through the life of the Chapter 13 repayment plan. Non-priority tax debts, or tax debts that are dischargeable in Chapter 7, are paid exactly like credit card debt and medical bills according to the debtors disposable income, often at pennies on the dollar.

    While a Chapter 13 case is in effect, a court-ordered injunction called the automatic stay will prevent the IRS or the State of California from initiating collection efforts or tacking on additional fees. Also applicable during the shorter Chapter 7 period, the automatic stay acts as a protective bubble that shields debtors from phone calls, lawsuits, foreclosure, or any other collection attack.

    See also:Third Parties Trying to Take Advantage of Automatic Stay in Chapter 13 Bankruptcy

    The Tax Assessment Was At Least 240 Days Old

    What Are the Advantages and Disadvantages of Filing ...

    Again, this often covers the same ground as the first two rules. The IRS must assess the tax at least 240 days before the taxpayer files for bankruptcy. The IRS assessment can arise from a self-reported balance due , an IRS final determination in an audit, or an IRS proposed assessment that has become final.

    In other words, you reported what you owed, or the IRS has officially stated, “This is what you owe.”

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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 Irs Debt Be Discharged In Chapter 13

    Filing for Chapter 13 bankruptcy does not immediately discharge tax debt. First, you must determine if your income tax debt is a priority or nonpriority debt.

    Your tax debt is considered nonpriority when it meets the 5 qualifications listed above. Otherwise, it is considered priority and must be paid off over the duration of the 3-5 year repayment period.

    You will pay a percentage of your nonpriority tax debt over the course of the repayment period. When you complete the repayment period, the remainder of your nonpriority tax debt is discharged.

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    Dealing With Income Tax Debt Without Filing For Bankruptcy

    Statutes of Limitations on Collection of Income Taxes. Statutes of limitations on both the assessment and collection of federal, state, and local income taxes can significantly reduce taxpayer liability for back taxes. Statutes of limitations bar the taxing authority from either collecting old taxes or assessing new taxes after a certain amount of time has passed.

    Federal Statute of Limitations On Collection of Taxes. The Statute of Limitations on the collection of federal income taxes is ten years from the date the IRS assessed the taxes. After this period passes, the IRS cannot collect the remaining tax debt in most cases. IRC §6502. As noted above, tax liens usually expire with the ten-year statute of limitations on collection.

    There is no statute of limitations if the IRS has filed suit against the taxpayer and reduced the lien to judgment. Fortunately, the IRS rarely seeks a judgment. Filing an offer in compromise, filing an appeal, signing an IRS Form 900 waiver , and some other actions can toll the Statute of Limitations and allow the IRS more time to collect.

    Filing an offer in compromise, filing an appeal, signing an IRS Form 900 waiver , and some other actions can toll the Statute of Limitations and allow the IRS more time to collect.

    Can You File Bankruptcy On Taxes

    What do you do with your tax refund before filing bankruptcy and what can you spend it on?

    Yes, you can file bankruptcy to resolve back taxes, but not for all of your tax debts. Every chapter has a different set of requirements and processes. Chapter 7 is often a saving grace for anyone in over their head with insolvency because it completely eliminates all dischargeable back tax debts. This strategy is used for those who are unable to pay back income tax debt however, it is more difficult to get approved for than the other chapters of bankruptcy.

    While you can file Chapter 7 for income tax debt, the same strategy will not work for payroll taxes. In addition, rules on previously unfiled tax returns are not uniform and newer liabilities are unable to be resolved. Chapter 7 is not the only way to handle bankruptcy and taxes with IRS, and you should consider other chapters before filing. Learning more about the different chapters of bankruptcy will help you determine which type can help you in your circumstances.

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    Tax Liens And Bankruptcy

    Liens of any kind remain after a bankruptcy discharge is entered. Even if the underlying debt is discharged. However, the lien only remains against property that exists on the date the bankruptcy case is filed.

    For example, if you own real estate that is subject to a tax lien, you can discharge the tax debt, but the lien will remain against the property until it is sold or refinanced and the taxes paid.

    However, the lien cannot attach to any new assets acquired after filing the bankruptcy case. So there is a definite benefit to discharging tax debts even where there is a lien attached to property.

    Federal tax liens can attach to ANYTHING you own, including retirement accounts and right down to your socks and underwear. Often, this does not amount to much and it is possible to get the taxing agency to abate the tax and release the lien after a discharge if the value of property to which the lien has attached is of relatively insignificant value.

    This is something a good bankruptcy attorney can negotiate after your case is completed.

    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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    Debts That Are Not Dischargeable

    The biggest advantage of filing a Chapter 7 bankruptcy is the possibility of having some or all of your debts discharged. When a debt is discharged, it is cancelled by the Court and you do not have to repay it. However, not all debts are dischargeable. In general, the following kinds of debts cannot be discharged:

  • Child Support Obligations: Under federal law, both back child support and current child support obligations cannot be discharged in bankruptcy. Additionally, filing for Chapter 7 bankruptcy does not stop your ex-spouse from taking you to Chancery Court to recover child support owed. If you face a substantial back support debt, discuss with your attorney the options a Chapter 13 bankruptcy may offer in this matter. If you find that you are unable to pay your child support even after your other debts are cancelled in bankruptcy, you must ask the Chancery Court to reduce your child support.
  • Spousal Support Obligations: Like child support, spousal support that you have been ordered by a Court to pay cannot be discharged in bankruptcy.
  • Some Debts Owed to the Government Other than Tax Debts: For example, debts to the U.S. Department of Justice cannot be discharged in bankruptcy.
  • Criminal Restitution: If you have been convicted of a state or federal crime, you may have been ordered to pay the victim for your crime. The debt may take the form of a fine, replacement of property, or medical bills. Such debts cannot be discharged in bankruptcy.
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