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The Dischargeability of Income Taxes in Bankruptcy

Filing for bankruptcy can help alleviate many types of debt. Not all tax debts are dischargeable in a bankruptcy, but income tax debt that meets certain requirements can be. Some types of tax debt are never dischargeable through bankruptcy, but it may be possible to eliminate or manage federal income tax debt. If an individual qualifies, chapter 7 bankruptcy is the best and simplest way to eliminate income tax debt.

Chapter 7 Bankruptcy Requirements

Chapter 7 bankruptcy may allow for the discharge of income tax debt if certain criteria are met. Typically, if an individual can pass a “means test” demonstrating his income is low enough then he may file for chapter 7 bankruptcy.

In order to discharge income tax debt in chapter 7 bankruptcy several requirements must be met:

The tax must be income tax- some federal and state taxes are available for discharge

The debt must not be a result of tax evasion or fraudulent returns– any attempt to defraud the I.R.S. will result in the debt being non-dischargeable

  1. A tax return was filed for the debt at least two years prior– whether this may be extended to include late-filed returns is dependent on the court but will not include any I.R.S.-prepared “substitute for returns”
  2. The debt must be at least three years old– the debt must have been due at least three years before the day the bankruptcy is filed
  3. The income tax debt must have either been assessed by the I.R.S. at least 240 days before the filing or has not been assessed at all- may include audit adjustments and amended returns

What is Tolling?

The I.R.S. imposes three different time periods that must be met: (1) 3 years; (2) 2 years; and (3) 240 days. Tolling is the extension of a stated time period.

An individual may have inadvertently extended a time period if he filed for a tax extension, has claimed prior bankruptcy, been involved in a collection due process hearing, or received an innocent spouse relief or tax assistance order. The I.R.S. may extend a time period if it has suspended collections or has prepared a “substitute for returns” on behalf of an individual. In order to discover if the time periods were met it will be necessary to order an account transcript from the I.R.S. for each year in question. The transcript will contain all necessary information to determine whether a given time period has been met.

What is not eligible for discharge?

If all of these requirements are met, the obligation to pay the income tax debt back to the I.R.S. may be discharged and no garnishment of wages may be imposed. However, if the I.R.S. placed a tax lien on any property as a result of the debt, the tax lien will remain on the property and must be paid off.

Several types of tax debt are not eligible for discharge. Tax penalties may or may not be eligible depending on why the penalty was incurred. For example, penalties for fraudulent returns are not eligible. Tax debts that accrued as a result of unfiled returns are not dischargeable. Additionally, payroll taxes such as trust fund taxes or withholding taxes that are withheld by an employer are not dischargeable.

Are there any alternatives?

The I.R.S. may allow an individual to enter into an installment agreement. It may even be possible to make the I.R.S. an offer less than the amount owed in order to settle the remainder of the debt. If an individual cannot qualify for chapter 7 bankruptcy but does qualify for chapter 13 bankruptcy, it may be possible to implement a repayment plan. In some cases the statute of limitations may have run on the debt, making it unavailable for collection. The statute of limitations is ten years for federal income tax. 26 U.S.C. § 6502. As with filing for bankruptcy, certain actions and extensions may toll the statute of limitations so it is not advisable to assume the statute has run without first consulting an attorney and obtaining an account transcript.

Conclusion

Income tax debt may be eligible for discharge if all eligibility requirements are met. If you plan to file chapter 7 bankruptcy in hopes of eliminating income tax debt, it is advisable to immediately file all delinquent returns in order to begin the countdown of the required time periods. Your attorney will advise you on whether late returns will be eligible for discharge in your jurisdiction. Retain copies of all original tax documents, organized by year so everything is readily accessible for review with your attorney. Your attorney will guide you through this complicated process and the more organized you are, the easier it is for your attorney to maximize any benefits that may be available to you.

If you have questions about bankruptcy and the possibility that your taxes may be included in a bankruptcy discharge, call us at 770-609-1247 to discuss with one our experienced bankruptcy attorneys.

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