A common myth is that taxes are not dischargeable in a bankruptcy. Taxes can be dischargeable in a Chapter 7 bankruptcy. It can be categorized in the same bucket as all your other unsecured debts. Here are some basic rules to know:
3 Year Rule
The first is the 3-Year Rule. This states that in order for your taxes to be dischargeable, they must be older taxes that were due 3 years before you begin filing your case. For example, if you filed your taxes on time in April 2015, you can potentially file for bankruptcy in April 2018 and potentially have these debts discharged.
If you received an extension for your taxes, then you might have to wait until October 15, 2018 to file your bankruptcy. If you filed your taxes during this extension, then this will determine the new date for when you can file for bankruptcy and potentially have your tax debts discharged.
2 Year Rule
Once you have met the rules set forth by the 3-Year Rule, your taxes must comply with the 2-Year Rule. The 2-Year Rule requires that your tax returns are filed at least two years prior to the date you begin your bankruptcy case, regardless of whether you filed late or received an extension.
240-Day Rule
Lastly, the 240-Day Rule must be applied in order to receive relief from tax debt. You must wait at least 240 days after your taxes have been assessed to file for bankruptcy. This means that the IRS has recognized that your taxes were paid. In order to do so, you file a tax return. Tax returns list the total amount of money you owe to the IRS. If you file for bankruptcy prior to this, your tax debts will not be considered for adjustment or discharge.
If you are filing for bankruptcy in hopes of receiving tax relief regarding your income taxes, a Chapter 7 filing may be in your best interests. Chapter 7 considers income tax debt to be a nondischargeable priority debt unless the above rules are met. This means that debtors are required to pay these debts before others. In order for the tax debt to be discharged, your debts must comply with the rules mentioned above. Additionally, you must not have been involved in any form of tax fraud.
Chapter 7 bankruptcy also does not allow you to remove any tax liens placed on your property. Normally, liens are placed on your property by lenders to provide them with collateral in case you are not able to pay off your debts. For example, your home mortgage lender can foreclose your home and sell it during an auction. The money earned will then go towards your outstanding debts. In some situations, the IRS may place a lien on your property if you fail to make tax payments. If you have already completed a Chapter 7 bankruptcy and were rid of your income tax debt, your bankruptcy filing will protect you from the IRS taking further action against you. However, you will still be responsible for paying off the lien if it was placed prior to your bankruptcy filing. Just like the rest of your debts, your lien will be paid off by using the funds earned through the liquidation process. Your trustee will liquidate your assets and distribute the money amongst your creditors. In some cases, you still may not be able to rid yourself of the tax lien even after completing the bankruptcy process. Instead, you can continue making payments on the lien to attempt to negotiate with the IRS. They may be able to work with you to create a repayment plan or even remove the lien from your property.
If your taxes do not qualify for a discharge under Chapter 7, then you may still be able to file a Chapter 13 bankruptcy. When you file a Chapter 13 case, your tax debts will be factored into your Chapter 13 Repayment Plan. The amount you will be required to pay depends on whether or not the debts can be considered a priority claim or a non-priority unsecured claim. When filing for bankruptcy, you must split your debts into secured and unsecured claims. Secured claims are those backed by some form of collateral. This provides lenders with a sense of security. If you fall back on secured debts, creditors are able to take back the asset. For example, if you default on your home mortgage payment, the lender can foreclose on your property. Unsecured claims are those not backed by any collateral. For example, if you default on your credit card payment, your credit card company is not going to take back what you purchased. Unsecured debts are further split into priority and non-priority claims. Priority claims receive preferential treatment over all other claims you have listed and cannot be wiped out through a bankruptcy filing. This means that you must pay these off before attending to your non-priority debts. Non-priority unsecured claims receive the least priority out of all of your claims. This means that you must focus on paying off all other debts before tackling your non-priority unsecured debts. Examples of non-priority unsecured debts include medical bills or credit cards debt.
If you have documentation of the amount of taxes owed, you did not partake in any form of tax fraud, and pass the 3-Year, 2-Year, and 240-Day Rules, then your tax debts may be considered nonpriority. Unlike your priority debts, these will not have to be paid entirely through your Chapter 13 Repayment Plan. Instead, your Chapter 13 Repayment Plan will require you to pay any tax related to sales tax collected, payroll taxes, penalties acquired through nondischargable debts, and errors made when filing.
