Many of our clients have asked if tax debts can be wiped out (discharged) in a bankruptcy case. Generally, income tax debts that were due more than three years before the filing of your bankruptcy case can be discharged in a bankruptcy if a return for the year the taxes were owed was filed more than two years before the filing date of the case. There are exceptions to this rule regarding a number of factors including whether or not a tax lien has been filed by the taxing authority.
You should keep in mind that there are two types of bankruptcy that most consumer debtors file. One type of bankruptcy is known as chapter 7 and the other type is chapter 13. In chapter 7, a debtor attempts to erase all debts and in Chapter 13, a portion of the debt is paid back.
For example, Husband and wife debtors file a chapter 7 bankruptcy case on April 17, 2014. The debtors owed federal taxes for the years 2009, 2010 and 2011. The debtors also owed state taxes to Virginia for the same years. The debtors filed all tax returns in a timely manner except for 2009. They forgot to file that year.
The debtors received an order from the bankruptcy court called a “Discharge” of debts at the end of their Chapter 7 case. After they received the discharge, the debtors thought their debts had been erased in the bankruptcy, including the tax debt. However, if the debtors had read their discharge carefully they would have discovered that the discharge states that certain types of tax debts were not discharge including some types of tax debt.
After the debtors received their discharge, they were contacted by both the IRS and the Virginia Department of Taxation. Both taxing authorities claimed the debtors still owed taxes. The IRS told the debtors that they owed federal taxes for 2009 because they never filed a return for that year and therefore could not wipe out the taxes for that year under bankruptcy law. The IRS told the debtors the 2010 tax had been discharged in the bankruptcy but the 2011 tax was not discharged because that year’s tax return did not come due until April 15, 2012 and would not be three years old until April 15, 2015. The Virginia tax authorities told the debtors the 2009 tax was never filed and thus not excepted from discharge and the state tax for 2010 was not due until May 1, 2011. Since that date was less than three years before the bankruptcy was filed, the 2010 and 2011 taxes were not discharged.
After the debtors discovered they still owed taxes that they thought had been discharged in chapter 7, they filed a chapter 13 case and proposed to pay all of the non-dischargeable tax debt by making monthly payments to a chapter 13 trustee for five years. The filing of the chapter 13 stopped the IRS and the Virginia Department of Taxation from attempting to collect the tax debt directly from the debtors.
If you decide to file bankruptcy to take care of your tax debt, make sure you discuss in detail whether or not you can discharge your tax debts with your bankruptcy lawyer.