Does Bankruptcy Cover Back Taxes?
Not all debts are created equal, especially when it comes to bankruptcy. While Chapter 7 and Chapter 13 both allow debtors to greatly reduce or wipe out many of their debts, some liabilities are difficult if not impossible to escape. So which category does tax fall into? Does bankruptcy eliminate tax debt, or not? In short: it depends. Our bankruptcy lawyers explain when taxes are (and aren’t) dischargeable.
Does Bankruptcy Erase Tax Liability?
Debts which can be eliminated are known as dischargeable debts, because they are wiped out once the bankruptcy case is finalized or “discharged” by the court. Discharge is always the goal in bankruptcy. If a case is dismissed, it means the court found a problem, and the result is that the debtor is still liable for their debts and can still be pursued for repayment by creditors.
Most debts are dischargeable under both forms of bankruptcy, including but not limited to the following:
- Medical Bills
- Personal Loans
- Social Security Overpayments
- Business Debt
- Credit Card Debt
- Past Due Rent
- Utility Bills
- Civil Court Judgments
- Dishonored Checks
- Collection Agency Accounts
It’s a long list, but you may have noticed something missing: back taxes.
That’s because – generally speaking – back taxes are considered nondischargeable. Other debts bankruptcy doesn’t erase include alimony, child support, and student loans.
While taxes can potentially be discharged, wiping out tax debt can be difficult because there are several factors which must be in place.
Moreover, there are certain types of tax liabilities which simply cannot be eliminated, regardless of the debtor’s financial circumstances. For example, it is impossible to discharge payroll tax, or tax to which employers and employees are subject. Payroll tax can either come directly out of an employee’s wages or salary, or the employer can pay tax based on how much money the employee makes. If you have any uncertainty at all about your payroll tax liability, you should consult with a CPA and/or an attorney who handles tax matters. Otherwise, you might find yourself being targeted for an audit by the IRS (Internal Revenue Service).
When Are Tax Debts Dischargeable in Chapter 7 or Chapter 13?
Getting back to tax debts which can be erased, it is critical for debtors to understand the four main criteria which must be in place. Three out of four of these criteria hinge on strict time limits.
First and foremost, the tax liability absolutely must not involve any element whatsoever of fraud. The IRS defines fraud as “deception by misrepresentation of material facts, or silence when good faith [transparency] requires expression, which results in material damage to one who relies on it and has the right to rely on it.” In simpler terms: causing financial harm by lying about money. Tax fraud occurs when (1) a taxpayer owes a tax, and (2) has “fraudulent intent” (intent to commit fraud).
Next, you must have filed a tax return – even if you didn’t pay what you may have owed – at least two years before the date you filed (or plan to file) for bankruptcy. Failure to file and failure to pay are separate matters, and the IRS is generally more concerned with failure to file.
Furthermore, the tax needs to be old, dating back at least three years. Therefore, back taxes you owe from this year or last year would be not be considered dischargeable. The three-year period starts counting backward from the date you filed for bankruptcy, so if you filed on January 1, 2015, the tax would need to originate from a date earlier than January 1, 2012.
Not only does a debt need to be at least three years old, it also needs to pass what’s called the 240-day rule. As you might have guessed, this rule takes its name from a 240 day period, or about eight months. Think of the date you filed for bankruptcy (or intend to file for bankruptcy), and then consider the following statements:
- The income tax was assessed (meaning that its value was determined) at least 240 days before your filing date.
- The tax has not been assessed yet.
If either of those statements is true, the tax is potentially dischargeable (provided all other criteria are met). If not, you are probably stuck with your tax liability.
If you’re struggling with tax debt or other types of debt, bankruptcy may be able to give you a clean financial slate so that you can start repairing your credit. To discuss whether filing for Chapter 7 or Chapter 13 could be a good option for you, call the bankruptcy attorneys of Young, Marr & Associates at (609) 755-3115 in New Jersey or (215) 701-6519 in Pennsylvania. Your first consultation is completely free of charge, and we will keep your information confidential. We have more than two decades of experience and represent clients throughout New Jersey and Pennsylvania.