Bankruptcy and Unpaid Taxes: A Guide

Struggling with unpaid taxes can feel like you’re trapped in quicksand, the harder you try to free yourself, the deeper you sink. When these issues snowball into a potential bankruptcy situation, it’s easy to feel overwhelmed. But here’s some hope – navigating through bankruptcy and unpaid taxes isn’t as daunting as it seems. We’re here to light up a path that, for many, seems hidden in shadows.

The thought of filing for bankruptcy brings up images of endless paperwork and complex legal jargon that few understand fully. Add unresolved tax debts into the mix, and suddenly, you’re not just facing one giant but two.

Yet, understanding your options can turn the tide in your favor significantly.

Understanding Bankruptcy and Unpaid Taxes

If you’re drowning in bankruptcy and unpaid taxes, I get it. It’s overwhelming.

But you’ve got options. Getting a good grip on those options can be the magic trick you need to dust yourself off and stand tall again.

Types of Bankruptcy

First things first: what kind of bankruptcy are we talking about here?

There are different types, usually referred to by their chapter in the U.S. Bankruptcy Code:

• Chapter 7: Liquidation
• Chapter 9: Municipalities
• Chapter 11: Reorganization
• Chapter 12: Family Farmers & Fishermen
• Chapter 13: Repayment Plan
• Chapter 15: Used in Foreign Cases

For individuals, Chapter 7 and Chapter 13 are most common. But which is right for you? It depends on your specific situation.

Tax Debt Discharge Requirements

Now let’s talk about those unpaid taxes. Can bankruptcy make them disappear? Maybe.

To discharge tax debt, some requirements must be met:

1. The taxes must be income taxes. Other kinds, like payroll taxes or fraud penalties, can’t be discharged.
2. The tax return must have been originally due at least 3 years before filing for bankruptcy.
3. The tax return must have been filed at least 2 years before the bankruptcy.
4. The tax assessment must be at least 240 days old.
5. You must not have committed willful evasion or tax fraud.

If you check all those boxes, your income tax debt may be wiped out in bankruptcy. But there’s a catch…

Tax Liens in Bankruptcy

Even if your tax debt is discharged, tax liens can still haunt you. A Chapter 7 filing won’t remove a tax lien.

With a Chapter 13, you may have options to avoid or “strip off” certain tax liens if there’s no equity securing the lien.

But in general, if the IRS or state filed a tax lien on your property before the bankruptcy, you’re stuck with it.

The moral of the story? Bankruptcy can erase tax debts, but it’s tricky. Liens often stick around. And the rules for discharging tax debt are very specific.

So before you file, make sure you understand your tax liability and what bankruptcy can (and can’t) do about it.

How Bankruptcy Affects Tax Debt

So you’re considering bankruptcy. But what happens to your tax debt?

The answer depends on what type of bankruptcy you file and what kind of tax debt you have.

Chapter 7 Bankruptcy and Tax Debt

In a Chapter 7 bankruptcy, your tax debts may be discharged – poof, gone. – if they meet certain criteria.

Basically, the tax debts need to be at least 3 years old, and the related tax returns filed at least 2 years before the bankruptcy. You also can’t have any tax fraud or evasion on your record.

If your tax debts qualify, then your personal liability for them is erased in a successful bankruptcy filing. But there’s a big “but” here…

Any tax liens recorded before the bankruptcy are still valid. The bankruptcy estate may pay off some of the tax debt. But the remaining lien stays attached to your property, even after bankruptcy.

Chapter 13 Bankruptcy and Tax Debt

In a Chapter 13 bankruptcy, your tax debts are categorized as priority, secured or unsecured. How much you pay depends on the category.

Priority tax debts, like recent income taxes, must be paid in full through your repayment plan. Secured tax debts, like those with liens, must be paid at least the value of the asset securing the debt.

Unsecured tax debts are trickier. They may be discharged if they meet the same criteria as in a Chapter 7 bankruptcy. Otherwise, they’re lumped in with your other unsecured debts and paid a percentage.

One silver lining in Chapter 13 is that you may be able to “strip off” certain tax liens if there’s no equity securing the lien. But this is a complex process that requires a separate court motion.

Automatic Stay on Tax Collection

Regardless of the type, filing for bankruptcy triggers an automatic stay on all collection activities – including those by the IRS or state tax agencies.

The automatic stay prevents the IRS from starting or continuing any collection actions, like garnishing your wages or filing a tax lien. This is like a superhero shield that lets you catch your breath and relax a little.

But be warned: if you had a prior bankruptcy case dismissed within the past year, the automatic stay may be limited to 30 days or not apply at all. And the IRS can still audit you, demand tax returns, or assess tax, interest or penalties during the bankruptcy case.

The automatic stay also doesn’t stop the clock on the time limit for the IRS to collect taxes from you. That clock keeps ticking, and it’s generally 10 years from the tax assessment date.

Once your bankruptcy case is over, the IRS can resume collection activities on any tax debts that weren’t discharged or paid through your bankruptcy plan.

The key takeaway? Bankruptcy can provide relief from tax debts, but it’s not a magic wand. Liens, priority debts, and non-dischargeable taxes can still haunt you after bankruptcy.

Consult with a bankruptcy attorney or tax professional to understand your options and make a plan for your tax debts before filing for bankruptcy.

Discharging Tax Debt in Bankruptcy

Wouldn’t it be nice if bankruptcy could just wipe out all your tax debts? Unfortunately, it’s not that simple.

Discharging tax debt in bankruptcy is possible, but it’s not automatic. There are strict rules about what kinds of tax debts can be erased.

Requirements for Discharging Tax Debt

To be discharged in bankruptcy, a tax debt must meet these criteria:

1. The debt is for income taxes. Other types of taxes, like payroll or fraud penalties, can’t be discharged.
2. The tax return was due at least 3 years before you filed for bankruptcy.
3. You filed the tax return at least 2 years before filing for bankruptcy.
4. The IRS assessed the tax at least 240 days before your bankruptcy filing.
5. You didn’t file a fraudulent return or willfully attempt to evade paying taxes.

If your tax debt checks all those boxes, it may be wiped out in a Chapter 7 or Chapter 13 bankruptcy. But even then, there are exceptions.

Non-Dischargeable Tax Debts

Some kinds of tax debts can never be discharged in bankruptcy, no matter how old they are:

• Tax liens. If the IRS recorded a tax lien before you filed for bankruptcy, the lien stays attached to your property.
• Taxes you never filed returns for. The 3-year and 2-year rules for discharge only start when you file the return.
• Trust fund taxes, like payroll taxes you withheld from employee paychecks but didn’t pay to the IRS.
• Certain employment taxes and excise taxes.
• Property taxes that come due after you file your bankruptcy petition.

These non-dischargeable taxes will stick around, even if your other tax debts are wiped out in bankruptcy.

Fraudulent Tax Returns

Thinking about fudging the numbers on your tax return? Think again.

If you file a fraudulent tax return or willfully try to evade paying taxes, that tax debt is not dischargeable in bankruptcy.

That’s right, even if the debt meets all the other criteria for discharge, it won’t be wiped out if there’s fraud involved. The bankruptcy code doesn’t let you off the hook for tax debts obtained through fraud.

Signs of tax fraud could include underreporting your income, overstating your deductions, hiding assets, or just not filing your returns at all.

The IRS can object to the discharge of a tax debt in bankruptcy if they suspect fraud. And you better believe they’re going to take a close look.

Honesty is always the best policy when it comes to your taxes and bankruptcy. Trying to cheat the system will only come back to bite you.

So what’s the bottom line on discharging tax debts in bankruptcy?

Most income taxes can be wiped out if they’re old enough and you filed the returns on time. But there are a lot of exceptions and special rules.

If you’re struggling with tax debt, talk to a bankruptcy attorney or tax resolution specialist. They can help you figure out what bankruptcy can and can’t do for your specific tax situation.

Tax Liens and Bankruptcy

Effect of Bankruptcy on Tax Liens

Here’s the deal with tax liens and bankruptcy: they don’t just disappear. If the IRS slapped a federal tax lien on your property before you filed for bankruptcy, that lien is sticking around. Even if your personal liability for the tax debt gets wiped out in the bankruptcy. The bankruptcy discharge eliminates your obligation to pay the tax debt. But the lien? It stays put, ready to be enforced against your assets after the bankruptcy. The IRS can still foreclose on that lien if you don’t pay up.

Avoiding Tax Liens in Bankruptcy

But wait, there’s a glimmer of hope. In a Chapter 13 bankruptcy, you might be able to avoid or “strip off” certain tax liens. This is possible if there’s no equity in the property the lien is attached to. You’d file a motion to avoid the lien because it impairs your exempt property. Here’s how it works: If the value of your assets is less than the total of your senior liens plus your exemption amount, a junior tax lien could get the boot. It’s treated as an unsecured debt in your Chapter 13 plan.

Stripping Tax Liens in Chapter 13

Chapter 13 has another trick up its sleeve for tax liens. You can “strip down” the lien to the value of the equity securing it. Let’s say a tax lien is partially secured and partially unsecured based on the value of your assets. In this case, the lien can be split in two. The secured portion gets paid through your Chapter 13 plan, usually with interest. And the unsecured portion? It’s lumped in with your other general unsecured debts. If the underlying tax meets the discharge criteria, that unsecured portion could be discharged when you complete your plan payments. So while tax liens can survive bankruptcy, there are some strategies to minimize their impact in a Chapter 13.

Filing Bankruptcy and Tax Returns

Before you can even think about filing for bankruptcy, you’ve got some homework to do. And by homework, I mean tax returns. You must show proof that you filed your federal and state tax returns for the 4 years prior to your bankruptcy case. This is non-negotiable if you want to proceed with the bankruptcy and get a discharge. The trustee and your creditors have the right to scrutinize these returns. If you’ve got missing returns, you can file them during your bankruptcy case. But dragging your feet on this could get your case dismissed or your discharge denied.

Post-Bankruptcy Tax Return Filing

Just because you filed for bankruptcy doesn’t mean you’re off the hook for filing future tax returns. Especially in a Chapter 13 case. While your case is pending, you must file all required returns for tax periods that end during that time. Failing to file your post-petition returns in a timely manner could lead to your Chapter 13 case getting dismissed. Or even converted to a Chapter 7. The taxing authorities can file a claim for any unpaid post-petition taxes. So it’s crucial to stay on top of your filing obligations, even in the midst of a bankruptcy.

Amending Tax Returns in Bankruptcy

Sometimes, in the course of a bankruptcy, you might realize you need to amend previously filed tax returns. This often happens because of unreported income or overstated deductions. Amending the returns can increase your tax liabilities and throw a wrench in your bankruptcy case. You have a duty to let the trustee know about this ASAP. You might need to modify your Chapter 13 plan. Tax authorities might just go back to the drawing board and update their claims. Or you might have to file the claims for them. The moral of the story? When you’re filing for bankruptcy, it’s a smart move to go back and take another look at your past returns. If amendments are needed, get them done sooner rather than later to avoid complications in your case.

Bankruptcy Alternatives for Tax Debt

Offer in Compromise

An offer in compromise (OIC) is like striking a deal with the IRS. You offer to settle your tax debt for less than the full amount you owe. When the IRS takes a look at your situation, they’ll weigh things like how much you can afford to pay, what you’re earning, your bills and expenses, and what you’ve got in assets. If you qualify based on doubt as to collectibility, doubt as to liability, or effective tax administration, an OIC could be a viable alternative to bankruptcy.

Currently Not Collectible Status

If your financial situation is dire and you can’t afford to pay anything to the IRS, they might report your account as currently not collectible (CNC). CNC status means the IRS hits pause on collection actions against you. But the tax debt itself doesn’t go away. Penalties and interest keep accruing. If you don’t qualify for an offer in compromise or an installment agreement, being placed in CNC status can be a lifeline. This approach offers a sigh of relief, steering clear from the daunting shadows of bankruptcy.

Installment Agreements

An installment agreement is a payment plan with the IRS. It allows you to pay off your tax debt in smaller, more manageable monthly chunks. Installment agreements can be a smart alternative to bankruptcy if you have enough income to make the monthly payments and can pay off the debt within the time limits. The IRS has different types of installment agreements, like guaranteed, streamlined, partial-pay, and non-streamlined. The one that’s right for you will depend on how much you owe and your financial situation. Installment agreements do mean staying in debt longer. And they often come with setup fees, processing fees, and accruing penalties and interest. But they also mean avoiding the credit impact and public record of a bankruptcy filing. So if you’re considering bankruptcy because of tax debt, it’s worth exploring an installment agreement as a possible alternative. It could be the solution that gets you back on track without the baggage of a bankruptcy on your record.

Conclusion

In wrapping things up about bankruptcy and unpaid taxes, remember this is more than just about clearing debts or avoiding penalties; it’s about reclaiming peace of mind. Through thoughtful planning and taking informed actions – from recognizing when professional help is needed to exploring various debt relief options – navigating this challenging journey becomes possible.

Surely enough, confronting such challenges head-on may seem intimidating at first glance but consider this an opportunity for growth rather than despair—a fresh start awaits on the other side of resolution!

To those standing at this crossroads today—know that while the road might be tough, finding clarity amid chaos is within reach.
You are not alone in this fight against financial woes; resources abound, a brighter tomorrow begins with decisions made today.

Schedule your free bankruptcy consultation at The Law Office of William Waldner.