INCOME TAXES CAN BE DISCHARGED IN BANKRUPTCY

Yes, income taxes can be discharged in bankruptcy. The myth that taxes cannot be discharged is just that, a myth. In general, outstanding personal income tax liabilities (federal and state) can be resolved through bankruptcy in a manner far more 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 woes.

In a nutshell, the ideal situation is a complete discharge of the tax obligation (inclusive of interest and penalties). Given the right combination of timing and facts, a chapter 7 case can provide for the complete discharge. 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.

To illustrate, take the following example: an individual owes income taxes for the tax year 2000. He/she filed the tax return on time with no extension and the taxes were assessed within months after the return was filed (almost always). The 2000 tax liability would be dischargeable today in a chapter 7 proceeding, assuming no fraud or willful tax evasion occurred. The tax return's due date antedates today by at least three years, the taxes were assessed more 240 days prior to today and the tax return was filed more than two years prior to today's date.

Although a chapter 13 bankruptcy requires some payback of taxes, it does provide flexibility and several advantages unavailable in a chapter 7. One of the chief advantages of chapter 13 is the court-imposed plan whereby outstanding non-dischargeable taxes can be paid over time in deferred cash payments, interest and penalty free. The amount of the monthly payment is geared to accommodate the individual's budget and ability to pay. This process is often referred to as personal reorganization. Chapter 13 is especially useful as it can stop collection efforts by the taxing agency while forcing a lengthy payment plan for the nondischargeable taxes.

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 (see above). 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 .

To illustrate, assume the following: an individual has not filed tax returns for the past eight (8) years. His/her accountant prepares the returns (but does not file them) and based upon the returns prepared (including interest and penalty), the individual would owe approximately $80,000.00 for the years 1996-2000 and $15,000.00 for the years 2001-2003. In a chapter 7 case, all of the taxes would be nondischargeable as the returns have not been filed by the taxpayer more than two years prior to the bankruptcy filing. In a chapter 13, however, the person could file the chapter 13 case with unfiled returns and only end up having to pay off the 2001-2003 liabilities, interest and penalty free over a three to five year period. Upon completing the chapter 13, all remaining unpaid taxes for the years 1996-2003 would be discharged.

We all live in America and although we do not like it, we should all pay our fair share to Uncle Sam. However, we only get one life to live, so if the government is willing to provide relief to the debt laden taxpayers, why not get a fresh start? People who desire to purchase a home or who wish to get back into the system can solve their tax problems and get their lives in order through a tax-motivated bankruptcy. Keep one thing in mind, however, this is only a brief description of a complicated area of the law. To insure a tax discharge, a qualified tax-bankruptcy attorney well versed in this area of the law should be used so that a loophole in the client's case will not go undetected leaving the tax liability unresolved.