Taxes in Bankruptcy

I hear questions about discharging income taxes in bankruptcy all the time.  In Washington State, there is no personal income tax; so this discussion only involves federal income tax that is owed to the IRS.  Back taxes can be a huge burden, especially with penalties and interest.  You can use bankruptcy to take care of debts to the IRS.

I see two issues with taxes most frequently.  First if you lose your home to foreclosure, then you may end up under withholding on your payroll.   This is because many people set their withholding based on a mortgage interest deduction.  Once you lose your mortgage interest deduction, you may need to adjust you withholding; and if you don’t, you could end up owing extra taxes at the end of the year.   Second if you own your own business and you have a slow year, the taxes may be the last bill that you budget for.  That can mean that you end up with a tax bill at the end of the year.

There are two basic rules for discharging income taxes due to the IRS.

  1. If the return was due within the last three years; the tax cannot be discharged in bankruptcy.  The due date is the date that the tax return was last due.
  2. It’s not enough just to know when the tax return was due, but you also have to know when you filed the return.  For example, if you have back taxes from 2000 and you haven’t filed a return yet, they still can’t be discharged.  You have to wait two years after the return was filed to get the discharge.   Additionally, you cannot discharge any tax that was assessed less than 240 days before you filed bankruptcy.

Bankruptcy Strategy Tip: Most people’s tax returns are due on April 15; but you can get an extension to October 15.  If you file for an extension the period is 3 years from October 15.  Make sure to let your bankruptcy lawyer know if you got extensions on your taxes; because that may change your filing strategy.

What If I Can’t Discharge My Taxes?

You can use a chapter 13 bankruptcy to discharge your tax debt.  If you have non-dischargeable tax debts, then you can use a chapter 13 bankruptcy to payoff your taxes.  A chapter 13 bankruptcy allows you to payoff your taxes over 5 years.   This is because a tax debt is not a normal debt.  A tax debt is classified as a priority unsecured debt.  This means when you file a chapter 13 plan, the tax debt gets paid before the general unsecured debts like credit cards, medical bills, and store credit.

What Are The Benefits of A Chapter 13 Tax Case?

  • Have you ever tried to negotiate a payment plan with the IRS?  It’s tough.  If you do it on your own, it can take hours and hours of filing out paperwork, calling the IRS, waiting on hold, and getting contradictory information.  A chapter 13 plan is simple.  You take the total amount due to the IRS and divide it by the number of months in the plan and that’s your payment.  That’s it.  The IRS has to take the payment.
  • Penalties and interest stop accruing as soon as you file your bankruptcy.
  • You could get rid of all of your other unsecured debts for as little as zero cents on the dollar.
  • What if my tax debt is too big to payoff in a chapter 13?  This is rare, but you can still file a chapter 11 bankruptcy.

 

If you have any questions about your tax debts and bankruptcy, please call David Fuller at (253) 520-2972 or (206) 789-8751.

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