You might be surprised to learn that income tax debt can be discharged in bankruptcy.  There are a number of rules associated with discharging tax debt but in our Atlanta area practice we regularly eliminate stale tax debt for the benefit of our clients.

Interestingly, it is much easier to discharge tax debt than it is to discharge student loan debt.   We discuss your options regarding student loan debt and bankruptcy elsewhere on this web site but the Bankruptcy Code’s harsher treatment of student loan debt is an example of how banking industry special interests have been able to influence lawmakers.

In any case,the rules relating to discharge of state and federal income tax debt are complex and confusing.   The main principles to remember:

  • you cannot discharge tax debt if you have not filed tax returns for the year in question
  • your tax debt must have come due at least 3 years ago to possible be eligible for discharge.

Entire books have been written about this subject and when we represent a client with tax debt, we can advise you about tax discharge issues related to your particular situation.  If the tax debt in question is large, we may recommend that you obtain a tax transcript from the IRS – we would have you sign a limited IRS or State of Georgia power of attorney and obtain a transcript on your behalf, or we may refer you to a tax lawyer for a formal opinion about dischargeability.  In other cases, we will advise you of the likely outcome and proceed accordingly.

Discharging Tax Debt in Bankruptcy – the Rules

Here are the basic rules associated with discharging income tax debt in Chapter 7 or Chapter 13:

First, you can only discharge income tax debt.  If you own a business and owe Section 941 trust fund withholding tax debt you cannot discharge that debt in bankruptcy.  Section 941 trust fund tax debt refers to funds that an employer withholds from an employee’s paycheck to pay the employee’s (and the employer’s portion) federal income tax, Social Security tax and Medicare taxes.   Trust fund liability cannot be discharged because it belongs to someone else (the employee).

You may be able to repay your 941 liability in a Chapter 13 if you pay these obligations at 100%.  You cannot wipe out or reduce any 941 liability in Chapter 7 or Chapter 13.</p>

Second, you can only discharge income tax debt if you have filed a tax return.  If you did not file a tax return for a particular year or years, you cannot discharge that tax debt.  And “substitute returns” filed by the IRS on your behalf do not count – you must have signed and filed an income tax return yourself. Third, you can only discharge “stale” income tax debt.   The IRS and Bankruptcy Code define stale tax as:

  • tax debt arising from income tax returns that came due more than 3 years previously; and
  • if the tax return came due more than 3 years previously but the return was filed late – the late return must have been filed at least 2 years prior to the bankruptcy filing; and
  • the income tax must have been assessed more than 240 days ago

Fourth, you cannot discharge income taxes if your tax returns are fraudulent and/or designed to wrongfully evade taxation

Tax Liens in Bankruptcy

A tax issue that arises frequently in bankruptcy cases has to do with tax liens.  As you may know, the IRS or State of Georgia can file a tax lien against everything that you own if you owe past due taxes.  A tax lien is, therefore, a secured debt.  Tax liens cannot be eliminated in bankruptcy, nor can you file a motion to avoid a tax lien. If you schedule a tax lien that is associated with otherwise dischargeable tax debt as part of your Chapter 7, the lien will survive the bankruptcy but the value of the lien will be limited to the value of property that you own as of the date of the commencement of your case If you schedule a tax lien as part of  your Chapter 13 case, the IRS will file a claim that may include priority (non-dischargeable) claim, a secured claim (the tax lien) and/or an unsecured (dischargeable tax debt) claim.  The Chapter 13 trustee will treat the claim as filed unless you object.

Additional Resources About Discharging Tax Debt in Bankruptcy

If you have significant tax debt, and  you want to research the question of dischargeability, here are several resources that generally contain accurate information:

Bankruptcy Law Network  (search for “tax discharge” or “discharge of tax debts”)

Moran Law Group  – tax information page

About 

Jonathan Ginsberg represents honest, hardworking men and women in the Atlanta area who need bankruptcy protection. Call him at 770-393-4985 for a confidential discussion.

    Find more about me on:

  • facebook
  • googleplus
  • linkedin
  • twitter
  • youtube