TAX ISSUES IN BANKRUPTCY

Many debtors are faced with mounting pressure from the IRS and State taxing authorities but bankruptcy can provide relief from tax obligations.  The benefits of filing for bankruptcy to address tax debts may be summarized as follows:

• Discharge of Taxes in Bankruptcy

  Generally, a taxpayer may discharge federal income taxes in Chapter 7, 11 and 13 if the tax claims are old enough. Thus, income taxes may be dischargeable in bankruptcy if ALL of the following criteria are met.
  

  1. The tax is for a year for which a tax return is due more than 3 years prior to the filing date of the bankruptcy petition;  (Example: Assuming no tax filing extension, if Client files for bankruptcy on 4/16/11, income tax for 2007 will be discharged; not discharged if he files on 4/14/11) ;
     

  2. A tax return was filed late but more than two years prior to the filing of the bankruptcy petition;
     

  3. The tax was assessed more than 240 days prior to filing of the bankruptcy petition;
     

  4. The tax must not be due to a fraudulent tax return and the taxpayer is not attempting to evade or defeat the tax.
     

  5. Note: If no tax return is filed, the tax for that year is not discharged. This is a common problem when the IRS increases the tax due since the taxpayer is required to file a report of the change with DOR but usually doesn't.
     

  6. Note: So-called trust fund taxes such as sales and meals tax are not discharged.

• Stretch out payment of tax claims in bankruptcy
  

  Generally, in both Chapter 11 and Chapter 13, repayment of “priority” tax claims may be made over a period of time ranging from 3 to 5 years. 
  

  Secured tax claims must be paid in full with interest at the applicable rate then in effect for the taxing authority holding the claim. There may be a possibility of reducing the amount of a secured tax claim to conform to value of security, commonly known as cramdown.  Tax liens remain valid for collection period (10 years) unless extended and attach to exempt property if unpaid, including retirement assets, which matters depending on the age of client.
  

  Tax penalties are subject to less favorable treatment than the underlying tax and interest portion of the tax claim such that the penalty portion of the claim may not have to be paid in full but may be paid in the same manner as general unsecured claims.
  

  Most importantly, interest on tax claims that are not secured tax claims (i.e. a federal or state tax lien recorded in the appropriate Registry of Deeds for Court Clerk’s Office) will stop so that the taxpayers only obligation is to pay the amount of tax and interest due on the date the bankruptcy petition was filed.  

Remember that your tax returns should be up to date before filing for bankruptcy