Discharging Taxes in Bankruptcy

      
DISCLAIMER

Information in this article is based on general principles of law.  They may
not apply to particular situations.  Nothing in this article constitutes legal
advice and no reliance should be placed on the legal principles set forth in
this article.  Please contact an attorney for specific advice relating to
particular situations.

One of the most frequently asked questions of me as a bankruptcy attorney is whether IRS liabilities can be discharged in bankruptcy.  A popular misconception is that taxes are not dischargeable in bankruptcy.

In fact, they are often dischargeable.  There are complicated rules that govern the dischargeability of tax liabilities.  Generally, obligations that are less than three years old since assessment are apriority  and may not be discharged.  Many  that are over three years old from the date of assessment are not a priority and may be discharged in a bankruptcy action.  Payroll withholding taxes are not dischargeable; however many times penalties are.

If the Internal Revenue Service or the State has filed a lien, the liability is still usually dischargeable if it is over three years old.  The lien creates another problem, however.  While the obligation is discharged, the lien survives bankruptcy and remains attached to the debtor’s assets, to the extent of the value of the debtor’s property at the time of the bankruptcy.  The IRS or the State may seek to recover that amount from the assets of the debtor, even after the discharge in bankruptcy.

TAXES IN CHAPTER 7 BANKRUPTCY

For a IRS liability to be dischargeable in Chapter 7 of the Bankruptcy Code, it must meet the following criteria:

1) It must have become due at least 3 years before filing bankruptcy;

1. For example, taxes for the year 2000 became due on April 15, 2001.They become dischargeable on April 16, 2004.
2. Beware that no request for an extension of time to file the return was made by the individual or his representative.  The 3 year period is extended if a request for an extension was made.

2) The return must have been filed at least 2 years before filing;

1. There must have been a return actually filed.
2. A Substitute for Return filed by the IRS does not qualify as a return for purposes of this section.  The person must have actually filed a return.

3) The liability must have been assessed at least 240 days prior to filing; and,

4)  The return must not have been fraudulent.

If the taxes are not dischargeable, many times an Offer in Compromise combined with a bankruptcy may provide the best relief for a person with both debt and IRS problems.

TAXES IN CHAPTER 13 BANKRUPTCY
         
There is much more flexibility in Chapter 13 than in Chapter 7. 

1) In many cases, Chapter 13 can be filed on fraudulent returns. 

2) Chapter 13 allows interest to be frozen and penalties abated. 

3) Priority taxes (those less than three years old) may be paid through Chapter 13 without interest!

4) Penalties are usually discharged, even on liabilities less than 3 years old.

Chapter 13 allows debtors to pay the IRS liability that have a lien filed during the life of the Chapter 13 plan.  These obligations can be reduced to the value of the debtor’s assets.  The balance is dischargeable if they are over three years old, even though a lien has been filed.

BUSINESSES

Most of the same rules apply for businesses as for individuals.  IRS liabilities are often a considerable challenge to business owners who have not paid employment liabilities.  It should be noted that the trust fund portion of employment liabilities, that is taxes that are withheld from employee’s wages are not dischargeable in bankruptcy.  They may, however, be paid through a Chapter 11 or Chapter 13 Plan. They receive favorable terms in Chapter 13.  Penalties are usually discharged.  Interest is stopped, except as to the value of the property of the debtor.   The non-dischargeable portion of the  liability can be paid over a period of between 3-5 years in Chapter 13 and up to 6 years in Chapter 11.

Many times filing a petition for relief in the Bankruptcy Court will enable a business to survive and successfully reorganize its debts and IRS liabilities.

There are many exceptions to the discharge rules in Bankruptcy.  A careful analysis is necessary to avoid pitfalls.

ABOUT MARTIN MARTELLE

Martin J. Martelle is an attorney who specializes in dealing with the IRS  in resolving tax problems and in discharging taxes in bankruptcy.

Contributed by Martelle Law Office
82 E. State St., Suite F
Eagle, Idaho  83616
(208) 938-8500
www.martellelaw.com