When Bankruptcy Can Discharge Federal Taxes

Understanding Bankruptcy and Tax Discharge

Facing overwhelming tax debt can be a daunting experience. For some, bankruptcy may provide relief by discharging certain federal taxes. However, not all tax liabilities can be discharged through bankruptcy. Understanding the conditions and types of taxes that can be discharged is crucial for anyone considering this option. This article explores the intricacies of discharging federal taxes in bankruptcy, complete with official IRS guidelines.

Types of Bankruptcy: Chapter 7 and Chapter 13

Bankruptcy, a legal procedure governed by federal law, provides individuals with a structured way to eliminate or repay debts. The two most common types of bankruptcy filings for individuals are Chapter 7 and Chapter 13.

• Chapter 7 Bankruptcy: Also known as "liquidation bankruptcy," Chapter 7 involves the sale of a debtor's non-exempt assets by a trustee. The proceeds are used to pay creditors. Qualifying federal tax liabilities can be discharged.
• Chapter 13 Bankruptcy: This type involves a repayment plan, which allows the debtor to pay off debts over three to five years. Some federal tax debts can be included in this plan and may be discharged at completion.

Criteria for Discharging Federal Taxes in Bankruptcy

Not all tax debts are eligible for discharge in bankruptcy. To have federal taxes discharged, you must meet the following criteria:

• Three-Year Rule: Taxes are dischargeable if the return was due at least three years prior to filing for bankruptcy, including valid extensions (26 U.S.C. § 507(a)(8)).
• Two-Year Rule: The tax return must have been filed at least two years before the bankruptcy petition was filed (11 U.S.C. § 523(a)(1)(B)).
• 240-Day Rule: The tax assessment must have occurred at least 240 days before filing for bankruptcy. This time may be extended if an offer in compromise was pending or if a previous bankruptcy case was filed (11 U.S.C. § 507(a)(8)(A)(ii)).
• No Fraud or Evasion: The tax return must not be fraudulent or designed to evade taxes (11 U.S.C. § 523(a)(1)(C)).

Non-Dischargeable Tax Debt

Certain tax debts are generally non-dischargeable, including:

• Trust fund taxes (e.g., payroll taxes withheld from employees)
• Taxes for which no return was filed or a fraudulent return was filed
• Taxes assessed on the basis of late returns filed within the last two years

The Role of Tax Liens

Even if a tax debt is dischargeable, a tax lien that the IRS has placed on your property before filing bankruptcy remains. Bankruptcy discharges the debtor's personal obligation to pay the debt, but it does not eliminate the lien itself. As such, the IRS may still enforce the lien against the property, which could result in foreclosure or sale by the IRS.

The Process of Discharging Taxes in Bankruptcy

If you are considering bankruptcy to discharge your federal taxes, here is a step-by-step overview:

1. Consult a Bankruptcy Attorney: Ensure you meet the criteria for discharging tax debts.
2. File for Bankruptcy: Submit the necessary paperwork and gather relevant documents.
3. Attend Credit Counseling: Mandatory courses before filing and acquiring discharge.
4. Get the Automatic Stay: Once you file for bankruptcy, courts issue an automatic stay stopping all collections.
5. Finalize Discharge: After meeting all criteria and plans, eligible tax debts are discharged.

Important Considerations and Implications

Filing for bankruptcy has significant financial and legal implications. Before proceeding, consider the following:

• The impact on your credit score and overall financial future.
• Potential costs associated with filing for bankruptcy.
• Alternatives such as negotiating a payment plan with the IRS or exploring an Offer in Compromise.

Frequently Asked Questions

• Can all federal taxes be discharged in bankruptcy? No, only specific tax types meeting certain criteria are eligible.
• What happens to tax liens after bankruptcy? Tax liens remain valid and enforceable against property.
• Is consulting with a professional necessary? Yes, professionals can navigate complex legal frameworks effectively.
• Are state taxes dischargeable in bankruptcy? Similar rules apply, but state-specific laws may differ.
• What other debts can be discharged in bankruptcy? Credit card debt, medical bills, and some personal loans can be discharged.
• How long does the bankruptcy process take? Timing varies: Chapter 7 can take about four to six months, while Chapter 13 lasts three to five years.
• Does bankruptcy affect future tax returns? It can, especially concerning the handling of discharged debts and any tax liens.

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