Bankruptcy

Tax Considerations

The stories you may have heard about taxes not being dischargeable are false. Income taxes can be discharged in bankruptcy. In many cases, outstanding personal income tax liabilities (state and federal) can be resolved through bankruptcy in a manner far superior to any other form of tax resolution. For personal income taxes, most individuals will be able to utilize either a chapter 7 and/or a chapter 13 bankruptcy to completely resolve their tax problems.

Whether an individual’s income tax obligations are eligible to be discharged either partially or entirely in a chapter 7 depends on five main criteria: (1) the income taxes must be personal income taxes, (2) the income taxes must relate to a tax year for which the tax return’s original due date antedates the bankruptcy filing by at least three years, (3) the taxes must have been assessed at least 240 days prior to the bankruptcy filing, (4) the tax returns must have been filed by the taxpayer more than two years prior to the bankruptcy filing and (5) the tax returns must not have been fraudulent and the taxpayer must not have engaged in any willful tax evasion. Under certain circumstances, however, the above time periods can be extended.

In many instances, a tax that cannot be wiped out in chapter 7 is dischargeable, in whole or in part, in a chapter 13 case. The main reason chapter 13 offers a broader discharge is the so called "superdischarge" which allows for the discharge of many debts which cannot be discharged in a chapter 7. For example, one of the most significant requirements to discharge a tax in a chapter 7 is that the tax return be filed by the taxpayer more than two years prior to the bankruptcy filing. In a chapter 13, however, that rule does not apply. This difference can be an enormous incentive not only for the individual to file a chapter 13 case, but also for the person to finally get back into compliance with the taxing agencies. In a chapter 13, if the tax meets all other criteria for dischargeability, the taxes may be wiped out with only pennies paid on the dollar, even though no return was ever filed or if the return was filed within the two years prior to the bankruptcy.

If you are a debtor, you may actually stand to gain from a bankruptcy, at least under regular IRS rules. When you have a debt of fifty thousand dollars discharged then you have effectively gained fifty thousand dollars. You may still be insolvent, but the rules would seem to indicate that you are wealthier than when you started. In recognition of this paradox, the IRS developed a policy stating that anyone who discharges debt and remains insolvent after the debt, it is not recognized as having received income. If you become solvent in any amount due to filing, then that amount is considered taxable. Because the tax ramifications are complex, it is advisable to seek professional advice before filing.

Contact our office to speak with an experienced Arizona bankruptcy lawyer at Platt & Westby.