You might have heard that bankruptcy does not help with taxes, and especially not with business taxes. That’s not true. This is an area with many myths and misconceptions. Let’s clear some of them up right now.
Myth: Bankruptcy does not write off some debts, and taxes are one of the categories of debts that it does not write off.
Truth: The first part of this is true: certain select kinds of debts are not written off, or “discharged,” when you file a bankruptcy. And SOME taxes can’t be discharged, but others CAN. The question of whether taxes can or can’t be discharged gets complicated because sometimes that depends on the facts. We’ll dig into this a little bit below. But very important: even those taxes that can’t be discharged can often be handled much more favorably in a bankruptcy case. We’ll also show you how below.
Myth: Bankruptcy does not help with employee withholding taxes, the “trust fund” taxes you were supposed to pay to the IRS or the Oregon Department of Revenue after withholding them from your employee’s wages.
Truth: No kind of bankruptcy will discharge this category of taxes. Admittedly this type of tax is treated quite strictly. After all this is money that, in a sense, was the employees’, for you to hold in trust until paying it over to the taxing authorities on behalf of the employees. But a Chapter 13 case will give you years to pay off those trust fund taxes, WHILE keeping the tax authorities off your back, usually stopping the interest and penalties from accruing, AND often letting you pay less to your other creditors so that you can focus on paying off this one. These are HUGE advantages.
Myth: Business taxes can’t be discharged (written-off).
Truth: Depends what you mean by “business taxes.” If you ran a business as a sole proprietorship (or in a partnership) then the business would not separately pay income taxes—the income would flow through to you as personal income (after deducting the business expenses). This “business” income tax would or would not be able to be discharged just like any other personal income tax. If you owed for a number of years of unpaid income taxes, a bankruptcy may well be able to discharge a substantial amount of those taxes. That depends on a series of factors, including whether you’ve filed the tax return for that particular tax, if so how long ago the tax return was filed, when the tax was originally due, whether you tried to get a tax compromise, and whether you tried to evade the taxes. And similar to what we stated above, if some of your tax debt is not dischargeable and you file a Chapter 13 case, your Plan will usually give you years to pay off those “nondischargeable” “priority” taxes, WHILE protecting you and your assets from the tax authorities, usually stopping the interest and penalties from accruing, AND often letting you pay less (and sometimes nothing) to your other creditors so that you can focus on paying these taxes. Then when you finish your case and are out of the protection of the bankruptcy court, you will no longer owe any taxes.
CAUTION: This discussion assumes that you own or owned the business as a sole proprietorship or a partnership. It’s a bit more complicated and some of these answers are different if your business was formed as a corporation or LLC.