When people decide whether or not to file bankruptcy, they often wonder, “Does bankruptcy clear tax debt?” While most forms of tax debt cannot be discharged by filing bankruptcy, there are some that can be discharged. If you’re struggling with tax debt and you need a fresh financial start, filing for bankruptcy may be the solution for you. Our Louisville bankruptcy lawyers will evaluate your case and help you determine what steps to take.
At O’Bryan Law Offices, we strive to help our clients in Kentucky and southern Indiana when they file for bankruptcy. We primarily handle Chapter 7 bankruptcy and Chapter 13 bankruptcy cases. Our attorneys will work with you to help you determine whether or not you can discharge tax debt in your case. To learn more about your options, please contact our law office and schedule a free consultation with us. You can either call us at 502-339-0222 or fill out our online intake form to schedule.
What Is the Best Type of Bankruptcy for Tax Debts?
If eliminating tax debt is one of your main goals for your bankruptcy filing, Chapter 7 is likely a better option for you. This is because Chapter 7 usually takes around four to six months, while Chapter 13 takes around three to five years. However, not everyone qualifies for Chapter 7 bankruptcy. In order to have your tax debt wiped out in Chapter 7, you must pass the bankruptcy means test. Your tax debts must also qualify for a discharge.
Although most people prefer Chapter 7 when they have tax debt, many people do benefit from Chapter 13 bankruptcy. We’ll explain the benefits of each chapter in the following sections, as well as how each chapter handles tax debt.
Tax Debts in Chapter 7 Bankruptcy
Although there are certain restrictions, it is possible to discharge tax debts in Chapter 7 bankruptcy. As long as your taxes meet the following criteria, you can discharge tax debt through bankruptcy Chapter 7.
- No tax fraud or tax evasion. The tax return you are trying to discharge must not be identified as fraudulent, and you must not be found guilty of violating or evading tax laws. Even if you are filing jointly, neither you nor your spouse can be found guilty of bankruptcy fraud or tax evasion.
- Assessed at least 240 days before you file. Your taxes must have been assessed during this time period, unless you had a compromise with the taxing authority or if you had a previous bankruptcy filing.
- Tax return was due no less than 3 years ago. The bankruptcy court will verify whether the tax return was due no less than 3 years ago. For example, if your taxes were due in 2015, you would be able to file a bankruptcy petition in 2018.
- They are income taxes. Chapter 7 can only discharge income tax debt. Therefore, your tax debt must be for either state income taxes or federal income taxes to qualify for a discharge.
- Tax return was filed at least 2 years ago. You must also have filed your return no less than 2 years before your bankruptcy filing date. There are very few exceptions to this rule.
What Tax Debts Are Not Dischargeable in Chapter 7?
Most forms of tax debt that do not count as income tax debt cannot be discharged by filing for bankruptcy. The following types of debt will not be discharged in Chapter 7 bankruptcy.
- Employment taxes: This also includes customs duties and excise taxes, which are imposed on certain services, goods, and activities.
- Third-party and trust fund taxes: This covers Medicare, FICA, and any other form of income tax that an employer must withhold from your pay.
- Tax liens: Also known as a secured tax, a tax lien cannot be discharged if it was recorded as attached to your property before filing for bankruptcy.
- More recent property taxes: If you incur property tax obligations within one year prior to filing bankruptcy, you cannot discharge these property taxes. However, if those taxes were incurred more than one year before you filed, you can discharge them.
- False or fraudulent tax refunds: Any tax refund that is erroneous may not be discharged through bankruptcy.
Tax Debts in Chapter 13 Bankruptcy
Chapter 13 bankruptcy is more complicated in terms of discharging tax debts. Most Chapter 13 filings will not allow you to discharge your tax debt. However, if your tax debt meets certain criteria, you will be able to repay those back taxes. If any portion of your state or IRS tax debt does not meet the requirements, it will not be discharged. Keep in mind that Chapter 13 may allow you to obtain a more favorable schedule of monthly payments than if you worked out a payment plan with the taxing authorities.
First, determine whether you have a priority debt or nonpriority debt. Priority debts will need to be fully paid in your Chapter 13 repayment plan. Nonpriority debts will be paired up with your unsecured debts, such as credit card debt and medical debt.
Then, you will need to determine what your “discretionary income” level is. This is the amount of money that you have left over after you have paid all of your bills and living expenses, such as car loans and mortgages. Discretionary income will be paid to your nonpriority unsecured creditors. You likely won’t end up paying all of your nonpriority debts, and therefore they will be discharged along with your remaining unsecured debts.
Nonpriority taxes must meet the following criteria.
- They are income tax or gross receipt taxes.
- The income tax debt was due at least three years before you filed your bankruptcy petition.
- You did not commit fraud or evade paying your taxes on purpose.
- You filed your tax returns at least two years before filing for bankruptcy.
- The relevant taxing authority performed a tax assessment at least 240 days before you filed bankruptcy.
What Tax Debts Are Not Dischargeable in Chapter 13?
The following types of debts are not considered dischargeable debt, and they must be paid in full throughout the course of your case.
- IRS penalties on taxes
- Payroll taxes
- Sales taxes
- Erroneous or fraudulent tax returns
- Tax liens
- Property taxes from the year before you began your bankruptcy case
How Does Bankruptcy Affect Filing Taxes?
Many people who file for bankruptcy wonder if it will affect how they file their taxes. Although it may seem complicated, having help from experienced bankruptcy and tax professionals can make the entire process much simpler. After you have submitted your bankruptcy petition, you’ll want to make sure you prepare the right forms when the next tax periods roll around.
If you are filing taxes after a Chapter 7 case, you must file a 1040 tax return. Your bankruptcy trustee may also need to file Form 1041. If you are filing taxes after a Chapter 13 case, the same forms will be required from you and the trustee in your bankruptcy case.
Should You File Bankruptcy Before or After Filing Taxes?
Regardless of whether you are expecting a tax return or if you owe back taxes, it is most likely a better idea to file your tax returns before you file for bankruptcy. If you file your taxes before your Chapter 7 bankruptcy case starts, you may be able to exempt your tax return and keep it. Otherwise, you may be required to turn it over to the trustee to pay your creditors.
If you plan to file Chapter 13, you’ll need to be up to date on your tax returns. This is because you must provide your returns from the last four tax periods to the bankruptcy trustee before the 341 meeting occurs. Failing to file your taxes before the 341 meeting can risk a dismissal of your case.
Can You Discharge a Federal Tax Lien?
No. Even if your tax debt qualifies for a discharge, bankruptcy does not wipe out your previously recorded tax liens. Filing bankruptcy will discharge your personal obligations to pay qualifying tax debts. It will also stop the IRS from garnishing your wages or going after your bank account.
However, if the IRS has already recorded tax liens on any of your property before you file for bankruptcy, those tax liens will remain on the property. Before you can sell the property or transfer the title to another owner, you will have to pay off the tax lien.
What Happens to Property Taxes if I File for Bankruptcy?
It depends on your specific situation as well as which bankruptcy chapter you file. In Chapter 7, any property taxes that are at least one year old may be discharged through bankruptcy. Property taxes that are under a year old when you file are not considered eligible debts for discharge. In Chapter 13, you will generally repay any delinquent property taxes over the course of three to five years.
How Will an Automatic Stay Affect Tax Debts?
As soon as anyone files a bankruptcy petition with one of the bankruptcy courts, they receive the protection of the automatic stay. This prevents basically any debt collection activities. Any tax debts that are eligible will be discharged, while other tax debts will not. Regardless of whether or not a certain tax debt will be discharged, the taxing authorities can’t engage in their usual collection efforts. This means they cannot garnish your wages, place a tax levy on your assets, mail you notices about your debts, or force you to pay your back taxes. The automatic stay is a popular option in terms of how to stop a tax levy.
Contact a Kentucky Bankruptcy Attorney Today
If you’re struggling to pay creditors and seeking lasting debt relief, bankruptcy is a great option. Rather than working with shady debt relief companies that can’t guarantee you any legal protections, consider filing for bankruptcy. Bankruptcy comes with the benefits of the automatic stay, which stops wage garnishments, collection activities, lawsuits, foreclosures, creditor harassment, and more. The Kentucky bankruptcy lawyers at O’Bryan Law Offices are here to help you get started on your path to financial freedom. To schedule a free consultation with us about your bankruptcy tax debt, please call our office at 502-339-0222 today.