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Resolving Tax Debt In Bankruptcy

Many clients believe that tax debt cannot be discharged in bankruptcy. Not so!  Under the right conditions and we solid legal advice, it is possible to wipe out some tax debt through a bankruptcy case.

Chapter 7 bankruptcy permits tax debt to be wiped out under certain conditions.  If any one of the qualifications below are not met, or off by a day or two, the taxes will still be due at the end of the bankruptcy proceedings. Chapter 13 bankruptcy allows tax debt to be paid off over a period of 3 to 5 years.  The following explains the process of qualifying for tax relief through bankruptcy:

Discharging Taxes in Chapter 7 Bankruptcy

  • Solely Income Taxes – Only income taxes can be discharged in bankruptcy as opposed to payroll taxes, and other types of taxes.
  • Taxes Must Be At Least 3 Years Old – In other words, the tax debts and their respective returns must be at least three years before filing for bankruptcy. This is often called the 3 year rule. Understand that this includes filing extensions as well. So if you received a 6 month extension, then it would be 3 years from the extension date (typically October 15th, October 17th in 2011).
  • Tax Returns Filed 2 Years Before Bankruptcy Filing – What this basically means is that any IRS taxes you want discharged must have been filed 2 years before you filed for bankruptcy. Therefore, a taxpayer cannot file unfiled tax returns today from 3 years ago and then file for Chapter 7. Substitute tax returns do not count.
  • Taxes Were Assessed At Least 240 Days Ago – The IRS needs to have assessed your taxes at least 240 days before you file a petition. Taxes can be assessed more than once in a year. An assessment is when the IRS reviews unpaid taxes, and makes any changes (adding to the balance for example) to the tax return and taxes owed. Therefore, any taxes that don’t meet this 240 day rule cannot be discharged.
  • No Fraudulent Tax Activities or Evasion – If you are convicted of tax evasion or fraudulent tax activities, you can kiss qualifying to have your taxes discharged goodbye.

Again, realize in addition to these conditions, you must prove to the court that your last 4 years of tax returns have been filed and you must have a copy of your most recent return. Also, take note that tax liens will not be removed with a Chapter 7 bankruptcy, and must be negotiated separate from a bankruptcy case.

Repaying Taxes in Chapter 13 Bankruptcy

Many clients do not qualify for a Chapter 7 bankruptcy and, therefore, need an alternate solution for their tax liability.  A Chapter 13 bankruptcy can be an excellent option for many families.  The IRS will discharge very little or none of your IRS taxes through a Chapter 13 bankruptcy but instead provide a payment plan to pay off the taxes through the bankruptcy case. Here are some important things to know:

  • Proof You Can Pay – You will need to show that you can pay at least $100 dollars a month or more, and show that you have the disposable income to meet the monthly minimum payment on a payment plan.
  • Must be Eligible for the Chapter 13 Case – Regardless of your tax debt, you must meet the eligibility requirements of a Chapter 13 bankruptcy case. Chapter 13 qualification is determined based on your income, and the total amount of your secured and unsecured debts.  A bankruptcy attorney from our staff can help you evaluate your eligibility.
  • Credit Counseling by US Gov Agency – Before you can file for Chapter 13, you will need to complete a credit counseling course with a US government agency.
  • Individuals (or sole proprietor) not Businesses – Only individual taxpayers can apply for Chapter 13.


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