I regularly get questions about the dischargeability of taxes in a personal bankruptcy. This area of the law is not simple, as there are numerous exceptions for every rule.
You may be surprised to learn that you can eliminate some tax debts in your Chapter 7 or Chapter 13 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.
You should not be surprised to learn that the rules which permit tax discharge are very specific. The rules relating to discharge of state and federal income tax debt are complex and confusing.
The Bankruptcy Code only allows for discharge of income tax debts. If you own or owned a small business and you owe 941 (trust fund) taxes, those taxes are not dischargeable.
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, the only type of tax debt that can be discharged is 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). If you have personal liability for other types of taxes such as sales tax or payroll tax, those debts cannot be discharged in bankruptcy, although you may be able to use Chapter 13 to pay these “trust fund” taxes in full, over time.
- 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. Assuming that you have income tax debt, it can only be discharged if it is “stale.” The IRS and Bankruptcy Code define stale tax as:
- First, the due date for your income tax must be more than three years ago. Remember that the due date for income taxes is April 15 (or perhaps a few days later if April 15 falls on a weekend or if the IRS extended the date due to a natural disaster). If you requested an extension, then the due date may be September 15 or some other date. Here’s an example: Tom filed his 2005 income tax return on April 10, 2006 and he owes $10,000. The earliest this tax debt could become dischargeable would be April 16, 2009. If Tom requested an extension until September 15, 2006, then the earliest his tax debt could become dischargeable is September 16, 2009.
- Second, your tax return must have been filed more than 2 years ago. This rule applies if you filed an old return late. Here’s an example: Sally filed her 2001 income tax return on October 23, 2007. The earliest her tax debt could be dischargeable is October 24, 2009. In this case, her tax debt came due more than 3 years ago and her return was filed more than 2 years previously.
- Third, your income taxes must have been assessed more than 240 days ago. A tax assessment is essentially a tax bill. When you file your tax return, the IRS staff reviews your calculations and issues an assessment. In order to be dischargeable that assessment must have been made more than 240 days previously. Generally the only way to find out when your tax assessment was issued is to get a tax transcript or to confirm a date with an IRS employee. At Ginsberg Law Offices, we can find the date of assessment by having you sign a limited IRS power of attorney, then we submit that power of attorney along with a request for a tax transcript to the “tax practitioner’s hotline.”
- Fourth, your tax return itself must not be fraudulent.
- Fifth, your tax return must not reflect an attempt to engage in tax evasion.
If you meet these five criteria, your tax debt may be dischargeable.
No Missing Tax Returns
No missing tax returns. You need to be up to date with your tax filings. Chapter 7 and Chapter 13 trustees in the Northern District of Georgia will not hold your 341 meeting of creditors hearing if you have missing tax returns from the last four years. I suspect that Chapter 7 and Chapter 13 trustees in various districts throughout the country have their own standards about how many years of tax returns they will require, but the point here is that bankruptcy trustees want to know if you have non-dischargeable tax liability because it affects the administration of your case.
Tax Liens Create Additional Problems
We sometimes meet with clients who have dischargeable tax debt but the IRS or State of Georgia has filed a tax lien. 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 are a problem because these liens cannot be eliminated in a bankruptcy, nor can you file a motion to avoid a tax lien. Therefore you may have a situation where your underlying tax debt is dischargeable but a valid tax lien remains.
In such a case, Chapter 7 would wipe out the underlying tax debt but the lien would remain – you or your attorney would need to negotiate a settlement of the tax lien with the IRS and/or Georgia.
In a Chapter 13, the IRS or Georgia would likely file a secured claim for the amount of the tax lien. Since there is no way to get rid of the tax lien, this secured claim would have to be paid in the Chapter 13. Needless to say, you have many more options with regard to your tax debt if no tax lien has been filed.
So, if you have a situation where you have income tax debt subject to a tax lien and the tax debt itself is “stale” and dischargeable, then, in theory at least, you can go to the IRS or state tax authority following discharge and negotiate a settlement of the tax lien that arises from newly discharged tax debt.
I can tell you from personal experience that the IRS has little interest in formalizing this type of agreement and it can be very frustrating and time consuming to obtain documentation regarding any settlement of a tax lien. Instead, the IRS will advise you to check your tax transcript periodically to confirm that the lien has been adjusted, and they will advise you that there will not be any attempts at collection on the tax lien “at this time.” Not a very reassuring position, to be sure.
State tax departments of revenue (i.e., the Georgia Department of Revenue) has been reluctant to accept the notion that the discharge of stale tax debt should have any bearing on the validity or collectability of its tax lien. In other words, Georgia takes the position that its tax lien remains in full force regardless of any discharge of underlying tax debt.
Ask Your Lawyer if He/She Understands Tax Discharge Issues
The concepts that determine whether your income tax debt is dischargeable are not complicated. The key is to obtain the correct information from the IRS and/or Georgia or other States. You do not want to file a Chapter 7 only to discover that if you had waited 3 weeks, you could have discharged $15,000 of stale tax debt. Similarly, you do not want to file a Chapter 13 only to discover that a previously unknown tax lien makes your plan payment unaffordable.
In my 20+ years of practice, I have represented debtors who were seeking to discharge tax debts. In one case, I filed a Chapter 13 the day before a tax lien was filed, which ended up saving my clients over $150,000. If you are a CPA, a tax preparer, or a taxpayer with questions about tax debt discharge and the treatment of tax debts in bankruptcy, I encourage you to call or email.
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: