Tax Debt in Bankruptcy
1. Discharge Old Tax Debt
The rules are a bit complicated. But generally, old tax debt in bankruptcy can often be discharged (i.e. wiped out). If a tax return was due more than 3 years ago and was actually filed, then you may be able to able to avoid paying that year’s tax debt. For those owing on multiple tax years, bankruptcy may offer tremendous savings.* And if you qualify to discharge a portion of your tax debt, it does not require the consent of the IRS or FTB.
2. Discharge Penalties
Even if the tax liability for a certain tax year is non-dischargeable (i.e. cannot be wiped out), all penalties are subject to discharge in bankruptcy. In addition, once a bankruptcy case is commenced, the accrual of any new penalties on old tax debts must stop. This is huge benefit in preventing those tax balances from growing.
3. Halt Collection Activity
Upon a bankruptcy filing, creditors must immediately cease all collection activity. It surprises many people, but this includes the IRS and the Franchise Tax Board. That means all wage garnishments must cease, and all bank account levies halt.
4. Pay Balance Over Time
If an individuals files a chapter 13 bankruptcy reorganization, the individual can then repay all non-dischargeable tax debt over the course of the plan period. Since chapter 13 plans can last as long as 5 years, there is usually ample time to repay the non-dischargeable portion of the tax debt. The bankruptcy filing creates that breathing room to allow individuals to knock out past tax debts.
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* The law governing whether tax debt in bankruptcy may be discharged is complex. To determine what portion of your tax debt is discharged requires an attorney to review a Tax Account Transcript for each year you owe. Whether each separate years is dischargeable depends on (including, but not limited to):
- when a tax return was required to be filed,
- when it was filed (if ever),
- whether the taxing agency already filed a return on behalf of the individual, and
- whether there were any intervening factors which may have tolled (i.e. delayed) the running of the time periods within the statute.
In Summary: Consult a bankruptcy professional to determine whether your tax debts are dischargeable (or at what point they might be dischargeable in the future). As part of that analysis, we recommend you obtain ahead of time a Tax Account Transcript from the IRS with regards to each year for which you owe any taxes. You can download these at the IRS Website, or by visiting an IRS Office Location.