How to Handle Tax Debts in Bankruptcy

Table Of Contents

What Tax Debts Are Dischargeable in Bankruptcy?

Tax debts dischargeable in bankruptcy are generally older income tax debts that meet specific criteria. The tax debt is for income taxes. The tax debt is at least three years old from the original due date of the tax return, including extensions. The tax return for the tax debt is filed at least two years before the bankruptcy petition date.
The tax authority assesses the tax debt at least 240 days before the bankruptcy petition date. No fraud or tax evasion exists with the tax debt. The tax authority does not place a tax lien on the tax debt. Meeting these conditions allows discharge of the tax debt in a Chapter 7 bankruptcy.

How Does Tax Debt Discharge Work?

Tax debt discharge works by eliminating a qualifying tax debt through the bankruptcy process. A debtor files a bankruptcy petition. The bankruptcy court reviews the debtor's financial situation. The bankruptcy court determines if the tax debt meets the discharge criteria.
The bankruptcy court issues an order of discharge for qualifying tax debts. This order legally releases the debtor from personal liability for the tax debt. The tax authority cannot pursue collection actions for the discharged tax debt. The discharge applies only to the debtor's personal liability.

What is the Three-Year Rule for Tax Debts?

The three-year rule for tax debts states the tax return was due at least three years before the bankruptcy filing date. This rule applies to income tax debts. The three-year period includes valid extensions for filing the tax return.
The tax debt must satisfy this three-year rule for potential discharge in Chapter 7 bankruptcy. Other rules also apply to the tax debt. The tax debt must meet all criteria for discharge. The three-year rule is a fundamental requirement for tax debt dischargeability.

What is the Two-Year Rule for Tax Debts?

The Two-Year Rule for Tax Debts means a tax return was filed within two years of the bankruptcy petition. The Two-Year Rule applies to tax returns filed on time. A late-filed tax return starts the two-year period from the actual filing date.
The tax debt must satisfy this two-year rule for discharge. The debtor must demonstrate compliance with this filing timeframe. The bankruptcy court examines the tax return filing dates. This rule prevents debtors from filing tax returns immediately before bankruptcy to discharge new tax debts.

What is the 240-Day Rule for Tax Debts?

The 240-day rule for tax debts is a period before bankruptcy filing. The tax authority assesses a tax debt. The 240-day rule allows the tax authority time to process the tax assessment. An assessment is the official recording of a tax liability.
The 240-day period extends under certain circumstances. An offer in compromise pauses the 240-day clock. A previous bankruptcy filing also pauses the 240-day clock. The 240-day rule determines tax debt dischargeability.

What If a Tax Lien Exists on Tax Debts?

What if a tax lien exists on tax debts? A tax lien generally remains enforceable even if the underlying personal liability for the tax debt is discharged. A tax lien is a legal claim against a debtor's property. The tax lien secures the tax debt. The tax lien attaches to all the debtor's property.
The discharge in Chapter 7 bankruptcy eliminates the debtor's personal obligation to pay the tax debt. The tax lien, however, survives the bankruptcy. The tax authority can still pursue collection against the property subject to the tax lien. The property remains encumbered by the tax lien.

FAQS

What types of taxes are never dischargeable in bankruptcy?

Types of taxes never dischargeable in bankruptcy include payroll taxes, sales taxes, and trust fund taxes. Property taxes are also generally not dischargeable. These tax debts remain obligations after a bankruptcy filing.

How do unfiled tax returns affect dischargeability?

Unfiled tax returns prevent the discharge of the related tax debts. The tax return must be filed for the tax debt to be considered for discharge. Filing the tax return starts the clock for the two-year rule.

Can tax penalties be discharged in bankruptcy?

Tax penalties can be discharged in bankruptcy if the underlying tax debt is also dischargeable. Penalties related to non-dischargeable tax debts are generally not dischargeable. The penalty must meet the same criteria as the tax debt.

Does bankruptcy affect future tax obligations?

Bankruptcy does not affect future tax obligations. Bankruptcy addresses past tax debts. New tax debts incurred after the bankruptcy filing remain the debtor's responsibility. The debtor must continue to file tax returns.

When should I consult a professional about tax debts in bankruptcy?

You should consult a professional about tax debts in bankruptcy as soon as you consider bankruptcy. A professional assesses your specific tax situation. A professional determines the dischargeability of your tax debts.

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