Many of my clients delay calling for advice because they believe that tax debts cannot be discharged in Chapter 7 bankruptcy. They share a misconception that you cannot discharge tax debts in Chapter 7, but that isn’t entirely true. You can discharge some income tax debts, but as Professor Dick Aaron, my law school instructor for debtor/creditor law, was fond of saying: The Bankruptcy Code is the best collection tool Congress ever created for the IRS. This means that some tax debts can be discharged, but there are many restrictions on the scope of the discharge/forgiveness of debt.
Requirements for Discharging Income Tax Debt
You can discharge some income tax debt in Chapter 7 bankruptcy if the following requirements are met:
- The taxes are income-based. Income taxes are the only kind of debt that Chapter 7 is able to discharge. The tax debt must be for federal or state income taxes or taxes on gross receipts. If you have personal liability for unpaid employer withholding taxes (commonly referred to as trust fund taxes), you cannot include those assessments in your Chapter 7 discharge, see the discussion below.
- The return was due at least three years ago. The taxes must be from a tax return that was due (including all valid extensions) at least three years before you filed for bankruptcy. For example, if taxes are related to a 2017 income tax return for which extensions to file the return expired on October 15, 2018, the tax return due date test will be satisfied if the bankruptcy petition is filed after October 15, 2021.
- You filed the return at least two years ago. You must have filed the tax return at least two years before filing for bankruptcy. In the District of Utah, a late return does not count as a "return" and you won't be able to discharge the taxes (late means your extensions have expired and the IRS filed a substitute return on your behalf).
- The taxes were assessed at least 240 days ago. The taxing authority must have assessed the tax (entered the liability on the taxing authority’s records) against you at least 240 days before you filed for bankruptcy. This time limit may be extended if there was an offer in compromise between the taxing authority and you or if you had previously filed for bankruptcy. It is important to request a tax transcript from the IRS before your Chapter 7 case is filed to make sure of the assessment dates.
- No fraud or willful evasion. The tax return must not be fraudulent or frivolous and you cannot be guilty of any intentional act of evading the tax laws. If you file a joint return, the taxing authority must prove that both you and your spouse committed an act of fraud related to the applicable return or willfully attempted to evade the tax in order for the court to deny the discharge of the tax debt.
Non-dischargeable Tax Debts
You cannot get a discharge most non-income-related tax debts. The following debts won't be discharged in Chapter 7 bankruptcy:
- Tax liens. A Chapter 7 bankruptcy discharge of income taxes wipes out the personal obligation to pay the tax and prevents the taxing authority from going after your bank account or wages. However, tax liens, also known as secured taxes, will remain attached to your property. This rule applies only to tax liens recorded against your property before you file for bankruptcy. This means that although you might not be personally liable for the tax debt, you'll have to pay the lien from any profits when you sell the property.
- Recent property taxes. If a property tax is incurred before you file for bankruptcy, the tax is non-dischargeable. However, this only applies to property taxes last payable within one year of your bankruptcy filing. You can discharge your personal liability for property taxes that were payable (without penalty) more than one year before your bankruptcy filing. Keep in mind, though, that many counties attach a lien to your property upon assessment or one year afterwards. If you have a lien against your property for the property tax, that lien will remain after your Chapter 7 discharge (although your personal liability will be removed). T
- Taxes that a third party is required to collect or withhold. This covers the so-called “trust fund” taxes such as FICA, Medicare, and income taxes than an employer must withhold from the pay of employees, and sales taxes paid by the debtor’s customers that the debtor is required to send to a governmental unit. If you were responsible for the decision for a business not to pay its withholding and sales tax deposits, you cannot discharge that responsibility in a bankruptcy filing.
- Certain employment taxes, excise taxes, and custom duties, depending on specific time periods.
- Non-punitive tax penalties on non-dischargeable taxes if the transaction or event that sparked the penalty occurred less than three years before filing the bankruptcy petition.
- Erroneous tax refunds or credits relating to non-dischargeable taxes.
If you have tax debts and are uncertain is some or any of the debt can be discharged in Chapter 7, request a tax transcript from the IRS and then call our office to make an appointment to review your options - 801-478-0479.