Income Tax Debt and Bankruptcy

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Do you owe income tax debt to the IRS?

Income tax debt is a very specific and troublesome sort of debt to have, but even tax debt can be treated in bankruptcy to aid a person suffering from this burden. Generally speaking, most tax debts can’t be wiped out in bankruptcy — you’ll continue to owe them at the end of a Chapter 7 bankruptcy, or you’ll have to repay them in full in a Chapter 13 bankruptcy repayment plan. But there are situations when tax debt will qualify for discharge. Here are some general rules concerning dischargeability of tax debt:

When You Can Discharge an Income Tax Debt

You can discharge (wipe out) debts for income taxes in Chapter 7 bankruptcy only if all of the following conditions are true:

* The taxes are income taxes. Taxes other than income, such as payroll taxes or fraud penalties, can never be eliminated in bankruptcy.

* You did not commit fraud or willful evasion. If you filed a fraudulent tax return or otherwise willfully attempted to evade paying taxes, such as using a false Social Security number on your tax return, bankruptcy can’t help.

* The debt is at least three years old. To eliminate a tax debt, the tax return must have been originally due at least three years before you filed for bankruptcy.

* You filed a timely tax return. You must have filed a tax return for the debt you wish to discharge at least two years before filing for bankruptcy. But procrastinators beware: if you filed a late return (meaning your extensions have expired and the IRS (Internal Revenue Service) or Department of Revenue filed a substitute return on your behalf), you have not filed a “return” and cannot discharge the tax.

* You pass the “240-day rule.” The income tax debt must have been assessed by the IRS or DOR (Department of Revenue) at least 240 days before you file your bankruptcy petition, or must not have been assessed yet. (This time limit may be extended if the IRS or DOR suspended collection activity because of an offer in compromise or a previous bankruptcy filing.)

You Can’t Discharge a Tax Lien

If your taxes qualify for discharge in a Chapter 7 bankruptcy case, your victory may be bittersweet. This is because bankruptcy will not wipe out prior recorded tax liens. A Chapter 7 bankruptcy will wipe out your personal obligation to pay the debt, and prevent the IRS or DOR from going after your bank account or wages, but if the IRS or DOR recorded a tax lien on your property before you file for bankruptcy, the lien will remain on the property. In effect, this means you’ll have to pay off the tax lien in order to sell the property.

All Hope Is Not Lost

Ok, so your income tax debt is not dischargeable, now what? If you are unsuccessful in working out a repayment arrangement with the IRS or DOR, and they plan to or already are garnishing your earnings, you can protect yourself by filing a Chapter 13 repayment plan and repay the tax debt over a three to five year period. This will stop any further collection activity by the tax authorities, it may prevent certain interest and penalties from accruing, and will allow you to pay the debt over a longer period that the IRS or DOR would normally give to you. And in some cases not all of the tax debt will be required to be paid back.

Income tax debt and how it relates to bankruptcy can be very complicated. The above-listed information is general information only. If you have income tax debt that has become burdensome to pay back, feel free to contact the experienced attorneys at the Bankruptcy Law Center LLP at (414) 257-1900 for more information on how bankruptcy can ease your income tax burden.

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