We may be able to wipe out some or all of your back taxes
Many people believe they are stuck with their tax debts forever. However, there are many circumstances where a bankruptcy case actually can erase some of your tax debts, including penalties, if certain conditions are met.
To qualify for Chapter 7 bankruptcy, all of the following conditions in regard to your income taxes must be met:
- 3 Year Rule – Your income tax debt from a tax return is from at least three years prior to filing for bankruptcy. For example, 2009 taxes became due on April 15, 2010. This means 2009 taxes become dischargeable on April 16, 2013. If the debtor filed an extension to file the 2009 tax return, the taxes become dischargeable October 16, 2013.
- Two Year Rule – Your income tax return was filed at least two years prior to when you filed for bankruptcy.
- 240 Day Rule – The IRS assessed your income tax debt at least 240 days prior to filing for bankruptcy. The date may be pushed back based on whether IRS chose to suspend collection activity. This all revolves around audits, so if the IRS has not audited any of your returns, you don’t have to worry about this part.
These conditions only apply to income taxes; not property taxes, payroll taxes, etc. In addition, as with all areas of bankruptcy, you cannot discharge debts that are based on fraud: If you have willfully committed tax evasion or fraud, such as changing your name, social security number, or repeatedly failing to pay taxes, these debts are not discharged.
If there was a state or federal tax lien on your property prior to filing for bankruptcy, it will not be discharged. You will have to pay it off in order to sell the property. Filing for Chapter 7 bankruptcy will eliminate personal responsibility from paying off the rest of your debt and prohibit the IRS from garnishing wages, but has no effect on any prior federal tax liens.
The above rules apply in a Chapter 13 bankruptcy, except that federal or state tax liens can be partially or completely removed depending on your circumstances. The amount of tax debt that you pay back depends on whether it is a secured claim (a tax lien), a priority claim (does not pass the above test) or non-priority unsecured claim (passes the above test).
In a Chapter 13, you will pay most of your secured and all of your priority/non-discharged taxes through the repayment plan over the course of a three to five year period. The good news is that often some or possibly even all of the dischargeable taxes may not need to be paid as part of the payment plan, in addition to any tax penalties that you have incurred. Non-priority unsecured tax debt is paid together with any other unsecured debt you have through your Chapter 13 repayment plan at the same percentage. This means that if you are paying credit cards, medical bills, etc. at 0%, 5% or 50%, the taxes are paid in that same percentage, which often results in our clients saving a lot of money on their tax debts.