If you are experiencing financial difficulties because of a loss of employment, divorce, a lawsuit or judgment, or for other reasons, you may be considering bankruptcy as an option to alleviate the financial liabilities and accompanying stress. Bankruptcy is a legal process a person can use to get a fresh start—that is, to restructure or eliminate their debt so that they can afford to live on their existing income and begin to re-establish their credit. While bankruptcy should not be used without exhausting other options and confirming it will help in your specific set of circumstances, it is a viable option that you may need to consider.
It is possible that part of the financial obligations that you cannot afford to pay includes taxes. Whether payroll, property, or state or federal income tax, taxes can amount to a significant obligation. Therefore, an important question you may be asking is: Can a bankruptcy be used to eliminate my back taxes? The answer is yes, but it depends on the timing and classification of the taxes involved.
What types of taxes can (and cannot) be discharged by filing bankruptcy?
The taxes that can be discharged by filing bankruptcy does not have a straight-forward answer simply based on the type of tax. For example, it is not as simple as saying that federal income tax liabilities are always or are never dischargeable. But there is a classification system used to categorize taxes when considered in a bankruptcy situation. This system uses two classifications: a Priority Tax Claim and a General Unsecured Tax Claim.
Priority Tax Claim
A priority tax claim is never dischargeable in a bankruptcy; you will have to pay 100% of these taxes. A tax is a Priority Tax if it meets one or more of the following criteria:
Sales Tax and Income Tax Withholding
These taxes (also known as Trust Fund Taxes) are often collected by a business (from the customers and employees, respectively) and should be remitted to the appropriate taxing authority. Whether you failed to collect these taxes or you collected them and did not pay them to the appropriate taxing authority, these taxes are not considered your property and therefore they must be paid even in a bankruptcy.
Taxes Secured by a Lien
Whatever the type of tax, if the taxing authority has filed a lien on your property related to the tax, the tax is considered a Priority Tax up to the available value of the property not already covered by a higher-priority lien and must be paid even in a bankruptcy.
For example, take a situation where you own a home worth $200,000, have a mortgage with a balance of $180,000, and a tax lien (whether from property or other taxes) of $30,000. In this situation, the mortgage lien is the first or higher- priority lien, so it is secured up to the full $180,000 value of the mortgage (because the property at $200,000 is worth more than the mortgage). This leaves $20,000 (i.e., $200,000 minus $180,000) in value that can be used to secure part of the tax lien. Therefore, this $20,000 amount is considered a Priority Tax.
Income Taxes for Previous Three Tax Years, Assessed in Past 240 Days, or Related to an Unfiled or Fraudulent Return
Income taxes are Priority Taxes if they are a). due for tax returns filed in the three tax years preceding the date bankruptcy is declared, b). tax assessed within 240 days of the date when bankruptcy is declared, or c). tax due on an income tax return that was never filed by the taxpayer or that was filed in a fraudulent manner.
General Unsecured Tax Claim
A General Unsecured Tax Claim is a tax that is either old or not secured by a lien against a property. In short, these taxes are ones that do not qualify for any of the above methods of becoming a Priority Tax.
General Unsecured Tax Claims can be discharged either fully or partially as a part of a bankruptcy depending on the type of bankruptcy filed.
Do the types of taxes that can be discharged vary depending on the type of bankruptcy filed?
While the types of taxes that can be discharged in a bankruptcy are not dependent on if you file Chapter 7 or Chapter 13 bankruptcy, the amount of tax that can be discharged is dependent on the bankruptcy type.
As noted above, Priority Tax Claims must be paid at 100% by the taxpayer as a part of a bankruptcy, regardless of the type of bankruptcy the taxpayer declares. For General Unsecured Tax Claims, a Chapter 7 bankruptcy can be used to fully discharge the tax liability, so the taxpayer will pay 0%. With a Chapter 11 bankruptcy, the taxpayer will pay a percentage between 0% and 100% of the General Unsecured Tax Claim. The percentage of the General Unsecured Tax ultimately paid will vary from case to case, depending on the specific situation of each individual’s bankruptcy.
Can a bankruptcy attorney help me determine if my tax liability can be discharged through bankruptcy?
Yes, a bankruptcy attorney will have the experience, training, and knowledge of the bankruptcy laws to review your specific situation and determine if a bankruptcy can be used to eliminate some or all of your tax liability. You can obtain this professional help by completing the short form below. When you complete this form, there is no obligation to you and the review is 100% confidential.
Determining how the bankruptcy laws apply to different types of tax is a difficult subject to analyze. Therefore, please complete the form below to get the assistance you need today.
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