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Tax Liability and Bankruptcy

The filing of a bankruptcy is certainly not the end of the world.  When contemplating the filing of a bankruptcy, there are many issues of concern. A significant one can be what happens to your tax liability? Are they dischargeable? While you will want to consult a qualified tax attorney to take a look at your specific case, there are some rules in place regarding the discharge ability of tax liability.  Here is a look at some of the things you will want to consider.

While Chapter 7 Bankruptcy provides for full discharge of allowable debts,  Chapter 13 Bankruptcy does not.  It provides a payment plan to repay some debts, with the remainder of those debts being discharged. Under current bankruptcy laws, tax debts are treated the same way in both Chapter 7 and Chapter 13 petitions. Not all tax debts are capable of being discharged in bankruptcy. The bankruptcy petitioner must have tax debts that meet certain criteria for discharge.

  • The taxes are income taxes. Taxes other than income, such as unpaid “trust fund liabilities” like withholding taxes, sales taxes, meals taxes or fraud penalties, can never be discharged 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 cannot 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 tax return. You must have filed a tax return for the debt you wish to discharge at least two years before filing for bankruptcy.
  • You pass the “240-day rule.” The income tax debt must have been assessed by the IRS 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 suspended collection activity because of an offer in compromise or a previous bankruptcy filing.)