Although you may think that bankruptcy is only useful to discharge the more common debts, such as credit card debt, a bankruptcy can in certain circumstances, allow you to wipe out your tax liability. However, discharging your taxes in a Chapter 7 bankruptcy imposes stringent requirements on you as a debtor.
It is important to understand that this article does not constitute tax or legal advice, and cannot be relied upon as such. I highly recommend that you consult an experienced bankruptcy attorney and tax attorney if you are considering filing for bankruptcy and have tax debt.
1. Type of Tax
Chapter 7 bankruptcy will only discharge income tax liability. Therefore, any other taxes, such as, for example, gift, sales, estate, and self-employment taxes are not dischargeable. In other words, if you file a bankruptcy, you must still list these non-dischargeable tax debts, but they will survive the bankruptcy and continue to haunt you.
2. Tax Years
For the income tax to be dischargeable in a Chapter 7 case, the most recent due date for filing your tax return for the tax in question must be more than 3 years old. For example, identify the year the income taxes accrued. Perhaps they accrued for income in 2010. Usually, the most recent due date for filing a return is April 15 of the following year. So, the most recent due date to file a return for income tax owed for 2010 is probably April 15, 2011. This date must be more than 3 years from the date you file your bankruptcy case. However, any extensions that you filed with the IRS or state taxing authority will extend this 3 year period.
3. Filed Tax Return
Have you filed tax returns for the tax years for which you owe income tax? To have your income tax discharged, you must also have filed a tax return for each tax year which you have back income taxes, at least more than 2 years prior to filing your bankruptcy case.
4. Assessment
The IRS or state taxing authority must also have “assessed” the tax at least 240 days prior to the date you file your bankruptcy case. Assessed may mean different things to different taxing authorities, but it generally refers to when you are told you owe the income tax. Sometimes you will receive a letter stating that certain taxes have been “assessed” against you. Look for a letter with the word “assessment” on it.
5. Proper and Legal Tax Returns
For all of the tax years that you owe income tax, did you file proper and legal tax returns? Specifically, you cannot have filed fraudulent returns. This requirement prevents the rewarding of fraudulent activity.
6. Evade or Defeat Tax
Did you attempt to willfully evade or defeat the income tax? If you did, you probably cannot get the income tax discharged. Generally, this means more than just failing to file your tax return, but actively and intentionally avoiding paying the income taxes. By filing for bankruptcy with income tax debt, a taxing authority may accuse you have willfully evading the payment of your tax in order to block the discharge of the debt.
7. Tax Liens
Although a Chapter 7 can discharge taxes if the above requirements are met, if a tax lien has been recorded against your property, the bankruptcy will not remove the lien. That is, the tax lien will remain in place against your property after the bankruptcy, allowing the tax authority to foreclose on your property. This is an important facet to understand as it can defeat the purpose of seeking a discharge of your income tax debt if there is an outstanding lien.