Bankruptcy law can write off some taxes, but also gives you other powerful tools for attacking your income tax debts.
The General Rules
- Personal income taxes CAN be discharged (permanently written off), by meeting a number of conditions, most of which are based on the precise timing and nature of your tax debts.
- Each tax year for which you owe income taxes needs to be analyzed very carefully to determine how it would be treated in a Chapter 7 “straight bankruptcy” and in a Chapter 13 “adjustment of debts.” For each year the tax amount, the penalties, and the current interest may be treated differently. Whether the IRS or Oregon Department of Revenue (ODR) has imposed a tax lien or “distraint warrant” can also make a huge difference.
- Only certain income taxes can be discharged, not real property taxes (unless you are surrendering the property), withholding taxes, nor most other kinds of taxes.
- Even if a tax debt cannot be discharged outright, bankruptcy can still often provide substantial help, turning an impossible situation into a very manageable one.
- The moment your bankruptcy case is filed, the IRS and the ODR (and any other taxing authorities) must stop almost all of their collection activities against you. Federal law protects you from garnishment of your paycheck and bank accounts, from the recording of tax liens on your home and everything else you own, and the rest of their aggressive behavior.
Chapter 7 Bankruptcy
A Chapter 7 can help you with income taxes three ways: 1) by discharging certain older taxes, 2) discharging your other debts so that you can pay or settle your non-dischargeable taxes, and 3) in the occasional case when your Chapter 7 trustee liquidates your non-exempt assets and pays some of your tax debts through the proceeds.
1. Dischargeable Taxes:
Income taxes can be discharged if they meet 4 conditions, but the first two are usually the only relevant ones:
- The tax return for the tax was due more than 3 years before the date your bankruptcy case is filed, plus any time for any tax-filing extensions.
- The tax return for the tax was filed more than 2 years before your bankruptcy filing.
- The tax was assessed more than 240 days before your bankruptcy filing. The date of “assessment” is the date the IRS/ODR officially determines the amount of the tax. Since this is usually shortly after you send in the tax return, usually this 240-day condition is met long before the above 2-year condition. This means that this condition is not a practical concern for most people. It becomes relevant when there’s a delay in assessment for some reason, such as a dispute about the amount of the tax.
- The tax was not based on a “fraudulent return,” and you did not “willfully attempt in any manner to evade” the tax.
See our recent blog post for a more detailed discussion about this: “Discharging Income Taxes through Chapter 7 Bankruptcy.”
2. Discharging Your Other Debts So You Can Pay or Settle Your Taxes:
If you were to file a Chapter 7 case, it may clear enough room in your budget so that you could then afford to make monthly payments to the IRS/ODR to pay off your taxes over time, or instead to settle for less than what you owe.
- Look at your budget very carefully, find out from your attorney what tax debt(s) you will continue to owe and what monthly payment amount the IRS/ODR would likely accept in your circumstances.
- You also need to be realistic about whether your income and expenses are steady enough that you will be able to make those tax payments consistently until the tax would be completely paid off.
- The IRS/ODR will continue adding interest and penalties throughout the time you are making installment payments. So consider how much the accruing interest and penalties will add to the amount you must pay before it would be paid off.
- If there is absolutely no room in your budget even after filing Chapter 7 to pay anything towards your tax debt, you may instead try to settle your taxes for less than you owe. The IRS may allow a taxpayer to settle a tax debt through an Offer in Compromise, and the ODR through an Application for Settlement Offer. Talk to your attorney or a qualified tax accountant about whether you are a good candidate for tax settlement.
See our recent blog post for a more detailed discussion about this: “Regular Chapter 7 Bankruptcy Can Be Your Tax Debt Solution.”
3. The Chapter 7 Trustee Paying Your Taxes Out of Your Non-Exempt Assets:
In the relatively uncommon situation in which everything that you own is NOT covered by property exemptions, so that you have to surrender some non-exempt asset(s) to the trustee, your non-dischargeable income taxes may be paid out of the proceeds of the trustee’s liquidation of those assets.
- Most Chapter 7 cases are “no-asset” cases, meaning that the trustee determines that all of your assets are exempt from his or her power to collect and sell them. In that case the trustee would have no funds with which to pay any of your debts, including any of your taxes.
- But if the trustee is entitled to take any of your assets, he or she may then have some funds with which to pay your non-dischargeable tax debts.
- The Chapter 7 trustee is required by law to pay out the proceeds of sale of your non-exempt assets to your creditors in a very specific order. Certain special kinds of debts called “priority” debts are paid in full before anything goes to your “general unsecured” debts. Income taxes which cannot be discharged are “priority” debts, meaning that they would be paid by the trustee before anything would go to your “general unsecured” debts.
- So, if you don’t have any debts which are higher on the priority list than your income taxes, then the money that the trustee is distributing to your creditors (after the trustee’s own fees) will go to your taxes until paid in full, or as much money as is available.
- If you DO have a debt or two that are ahead of income taxes on the priority list, then those would be paid in full first, and then whatever is left would be paid to your taxes. The main kind of debt which comes ahead of income taxes is accrued child and spousal support.
See our recent blog post for a more detailed discussion about this: “How to Pay Some or All of Your Income Tax Debt through Your Chapter 7 Trustee.”
That covers Chapter 7. Please be sure to visit our website again in a week for a review of the advantages of Chapter 13 in dealing with income tax debts. In many situations Chapter 13 helps with taxes even more than Chapter 7 does.