Bankruptcy and IRS Taxes

Bankruptcy and IRS Taxes

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Bankruptcy and Past-Due Taxes

One of the many myths and misconceptions that have arisen since the major changes to bankruptcy law in 2005 is that past-due taxes cannot be discharged in bankruptcy.

While this may be true sometimes, it is by no means true all of the time. Payroll taxes cannot be discharged in personal bankruptcy, but income taxes can be eliminated under certain circumstances.

If you need to discharge tax debts, Chapter 7 bankruptcy will probably be the better option. Your debts must qualify for discharge and you must be eligible for Chapter 7 bankruptcy. In Chapter 13 bankruptcy, you would need to repay all the tax debt.

No matter your needs, you can rest a bit easier knowing that Advantage Tax Relief Inc is here for you. Contact us today for a free consultation.

Discharging Your Tax Debts

You can discharge (eliminate) debts for federal income taxes in Chapter 7 bankruptcy only if all the following conditions are true:
  • The taxes are income taxes - Taxes other than income, such as payroll taxes or fraud penalties, can never be eliminated in bankruptcy.
  • You did not commit fraud or willful evasion - If you filed a fraudulent tax return or otherwise willfully attempted to evade paying taxes, such as using a false Social Security number on your tax return, bankruptcy won’t help.
  • The debt is at least three years old - To eliminate a tax debt, the tax return must have been originally due at least three years before you filed for bankruptcy.
  • You filed the tax return in a timely manner - You must have filed a tax return for the debt you wish to discharge at least two years before filing for bankruptcy. If you failed to file a return within the acceptable window, including extensions, and the IRS filed a substitute return on your behalf, you have not filed a return and cannot discharge the tax.
  • You must pass the "240-day rule" - Your income tax debt must have been assessed by the IRS at least 240 days before you filed your bankruptcy petition, or it must not have been assessed yet.
You can't discharge a federal tax lien!

If your taxes qualify for discharge in a Chapter 7 bankruptcy case, your victory may be bittersweet. The bankruptcy will not wipe out prior recorded tax liens.

A Chapter 7 bankruptcy will wipe out your personal obligation to pay the debt and prevent the IRS from levying your bank account or wages. But if the IRS recorded a tax lien on your property before you file for bankruptcy, the lien will remain on the property. This means you'll have to pay off the tax lien in order to sell the property.

Statutes of Limitations 

As a general rule, there is a ten-year statute of limitations on IRS collections. This means that the IRS can attempt to collect your unpaid taxes for up to ten years from the date they were assessed. Subject to some important exceptions, once the ten years are up, the IRS has to stop its collection efforts.

The ten-year limitations period begins from the date of the tax assessment by the IRS. For example, if you do not pay in full when you file your tax return, you will receive written notice of the amount you owe. The date on this bill starts the ten year limitations period. If you did not file a tax return and the IRS created a substitute return and makes a deficiency assessment, this starts the ten year clock. Not filing a return and hiding for ten years accomplishes nothing.
The ten-year collection period can end up being more than ten-years because it can be suspended or "tolled" for one or more time periods. 

Examples of periods where the IRS is legally barred from collection activities and the ten-year time clock is on hold include the following:
  • If you file for bankruptcy, the bankruptcy court issues an automatic stay preventing the IRS from taking collection action against you. The suspension lasts for the period of the bankruptcy case plus six months. 
  • The IRS is considering your request for an installment agreement, offer in compromise, or request for innocent spouse relief, or while you live outside the U.S. continuously for at least six months. 
  • The IRS can also extend the ten-year period by asking you to voluntarily extending it.

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