Discharging Tax Debts in Bankruptcy

If you are considering bankruptcy because of tax problems, then you will benefit from reading this article. Most people believe that taxes cannot be discharged in bankruptcy. This myth is not true. There are some technical rules that allow tax debts to be discharged in bankruptcy. If you meet each of the following requirements, then your taxes can be discharged.

The first requirement is that you have filed a legitimate tax return for the year in question. Second, the tax return must have been filed at least two years before you filed for bankruptcy. Third, the tax return was due at least three years before you file for bankruptcy. Finally, the IRS has not assessed your liability for the taxes within 240 days before you filed for bankruptcy.

The following example should make things more clear. Joe filed a tax return in Aug 2003 for the 2002 tax year. In Mar 2005, the IRS audits his 2002 tax return and assesses a tax debt of $10,000. In May 2006, Joe files for bankruptcy. The return was due on April 15, 2003, more than three years before Joe’s filing date. The tax return was filed in Aug 2003, more than two years before Joe’s filing date and the assessment date of Mar 2005 was more than 240 days before the filing date. These taxes can be discharged in bankruptcy.

If you meet all of these requirements, your liability for the taxes should be discharged. Penalties on taxes that are dischargeable are also dischargeable. However, courts are split as to whether you can discharge penalties if the underlying debt is nondischargeable. If you borrow money on your credit card to pay taxes that are not discharged, you cannot eliminate this loan in a chapter 7 bankruptcy.

You cannot discharge debts for income taxes if you did not file a return or you were intentionally avoiding your tax obligations. Returns filed on your behalf by the IRS are not considered returns. Property taxes are not dischargeable unless they were due more than a year prior to your bankruptcy filing. The property taxes remain as a lien against the property and will eventually lead to foreclosure. Trust fund taxes such as payroll taxes cannot be discharged in bankruptcy.

When faced with a tax liability, it is essential to time your bankruptcy. If you do not meet the requirements of discharge, then your only option is to reach an offer in compromise (OIC) with the IRS. Most people are under a misconception that the IRS will settle their debts for pennies on the dollar. The IRS is authorized to settle debts if it determines that there is “doubt as to liability” or “doubt as to collectability” of the debt. The policy behind the OIC program is to compromise debts of those taxpayers who owe more than can be collected in the ten year statute of limitations period.

As you can see, discharging tax debts in bankruptcy is the better alternative for the debtor than entering into a lengthy repayment plan with the IRS.

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