Tax Bankruptcy

    Most people think you can’t eliminate taxes in a bankruptcy proceeding. This is not true.

    The treatment of tax debts is one of the more complicated areas of federal bankruptcy law, but the Bankruptcy Code offers substantial tax relief to tax debtors who meet certain requirements.

    Despite popular belief the Bankruptcy Code offers substantial tax relief to tax debtors who meet certain requirements.

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    Whether your bankruptcy will relieve you from your tax debts will depend on several factors including the nature of the tax liability and the type of bankruptcy proceeding you are in.

    Type of Tax:

    The Orlando and Tampa based tax bankruptcy attorneys of the The Pappas Group have been helping taxpayers discharge and eliminate their tax debts for more than twenty years.

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    Income Taxes:  Federal income taxes may be discharged in bankruptcy provided they meet the discharge rules explained below under the heading “The Bankruptcy Discharge Rules.” Federal income taxes may be discharged in bankruptcy provided they meet the discharge rules explained below under the heading “The Bankruptcy Discharge Rules.”

    Trust Fund Taxes:  Trust Fund taxes are those taxes withheld from employee pay checks for social security and Medicare (“employment tax”).

    The amount withheld includes the employer’s share and the employee’s share of employment tax. A business owner and other responsible persons may be personally liable for the Trust Fund taxes if he or she oversaw the collection and accounting of the tax and made decisions about which creditors the business paid. Trust Fund taxes are not dischargeable in bankruptcy. State sales tax collections are deemed to be held in trust and also cannot be discharged.

    Tax form with pencil

    Trust Fund taxes are not dischargeable in bankruptcy. State sales tax collections are deemed to be held in trust and also cannot be discharged.

    Other Taxes: Excise taxes such as estate and gift taxes, sales taxes and fuel taxes are not dischargeable.

    Secured Tax Debts: In the course of its collection efforts the IRS has to power to file a tax lien to perfect its tax claim against individuals. A federal tax lien applies to all of the taxpayer’s personal property wherever it is located even if the personal property is outside Florida.

    A federal tax lien applies to all of the taxpayer’s personal property wherever it is located even if the personal property is outside Florida.

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    bankruptcy

    The tax lien encumbers the debtor’s real property only in the county or counties where the IRS files its tax lien. Florida’s homestead exemption does not apply to tax liens. A federal tax lien once filed makes the IRS debt a secured claim in bankruptcy and ineligible for discharge. A tax debt which is not secured by a tax lien on property is treated as a “priority debt” which means that like other priority debts it is to be paid in full before money is available to pay general unsecured bankruptcy creditors.

    The Bankruptcy Discharge Rules

    All tax debts are eligible for discharge as described above (e.g., income taxes, etc.) except the following:

    1. Taxes for which a tax return was due to be filed within three years (plus extensions) prior to the date of filing bankruptcy. For example, the tax return for 2009 income taxes was due to be filed on April 15, 2010, (plus any extensions) , and therefore, these income taxes cannot not be discharged by filing bankruptcy filed on or before April 15, 2013 (plus the time of extensions); OR
    2. Taxes assessed by the IRS within 240 days before the filing of bankruptcy. Assessment date is the date that tax liability is entered on IRS records; OR
    3. Taxes not yet assess but still assessable; OR
    4. Taxes for which a tax return was filed late and filed within two years prior to filing bankruptcy.; OR
    5. Taxes of a debtor who committed fraud related to a tax return or willfully attempted to evade or defeat taxes sought to be discharged.
    6. Taxes assessed pursuant to a Substitute Tax Return (i.e. a return the IRS filed on behalf of the taxpayer) cannot be discharged.

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    A tax debt that does not fail any one of the above five tests will be eliminated in a Chapter 7 or a Chapter 13 bankruptcy. In other words, these taxes are dischargeable. The dischargeability test is somewhat different in a Chapter 13 bankruptcy. A Chapter 13 bankruptcy a debtor can discharge:

    1. Taxes for which tax returns were filed late but within the two years preceding the bankruptcy, provided tax assessments have either not been made or have been made more than 240 days prior to the bankruptcy filing; AND
    2. Taxes related to fraudulent returns or taxes the debtor willfully attempted to evade or defeat.

    Discharge of Interest and Penalties

    Tax Calculator

    If the income tax is dischargeable then so is the interest related to the income tax. Regarding penalties, however, the general rule is that if the event that gave rise to the penalty occurred more than 3 years before the bankruptcy petition was filed, the penalty is dischargeable.

    Chapter 7 Bankruptcy Tax Relief

    Chapter 7 bankruptcy will eliminate all dischargeable income tax debts but will not avoid recorded tax liens.

    Chapter 13 Bankruptcy Tax Relief

    Chapter 13 bankruptcy involves a payment plan approved by the bankruptcy court under which a debtor pays some of his debts and discharges other debts.

    There are two basic tax discharge rules in a Chapter 13 bankruptcy:

    1. Taxes not dischargeable in Chapter 13 are considered “priority debts” and they must be paid in full during the Chapter 13 plan. The amount of the priority tax debt includes interest and penalties assessed up to the bankruptcy filing date, but the assessment of interest and penalties stops once the bankruptcy petition is filed.
    2. Dischargeable tax debts will be paid in part during the bankruptcy plan, and the unpaid balance is wiped out upon successful completion of the plan.

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    Comparing Chapter 13 and Chapter 7 Bankruptcy

    What happens if…

    You’re behind on your mortgage or car loan.

    Chapter 13

    You can repay the arrears through your plan, over three to five years, and keep the house or car, so long as you keep current on the existing monthly payments. If it’s feasible to pay off the entire loan before the end of your plan, you may be able reduce the amount you have to pay.

    Chapter 7

    You’ll probably have to either give the house or car back to the creditor or arrange to pay its wholesale value in full during your bankruptcy case

    You owe back taxes to the IRS.

    Chapter 13

    The result depends on your circumstances. See Eliminating Tax Debts in Bankruptcy.

    Chapter 7

    The result depends on your circumstances. See Eliminating Tax Debts in Bankruptcy.

    You have valuable nonexempt property.

    Chapter 13

    You keep all of your property.

    Chapter 7

    You keep all of your property. You must give it up, pay the trustee its fair market value or, if the trustee agrees, swap exempt property of equal value for it.

    You have codebtors on personal loans.

    Chapter 13

    The creditor may not seek payment from your codebtor for the duration of your case.

    Chapter 7

    The creditor will go after your codebtor for payment.

    You received a bankruptcy discharge within the previous six years.

    Chapter 13

    No problem; you can file anytime.

    Chapter 7

    You can’t file for Chapter 7 unless the recent bankruptcy was a Chapter 13 case, and you repaid at least 70% of your debts.

    You want to keep secured property by paying the creditor its value.

    Chapter 13

    You pay its replacement value (with interest) over time through your plan.

    Chapter 7

    You pay the wholesale value in a lump sum.

    Your disposable income is sufficient to fund a Chapter 13 plan.

    Chapter 13

    N/A

    Chapter 7

    The bankruptcy court might throw out your case or pressure you to convert it to Chapter 13.

    You owe debts for:

    • back or prospective child support or alimony
    • student loans, unless repayment would cause you severe hardship
    • court-ordered restitution or criminal fines
    • taxes less than three years past due, or
    • debts for personal injuries arising from your intoxicated driving.
    Chapter 13

    These debts must be paid in full in your Chapter 13 repayment plan or you will owe a balance at the end of your bankruptcy.

    Chapter 7

    These debts cannot be erased in Chapter 7 bankruptcy.

    You owe nonsupport debts under a property settlement, agreement, or divorce decree.

    Chapter 13

    If you do not pay them in full during your Chapter 13 bankruptcy, the balance is wiped out at the end under Chapter 13 bankruptcy’s “super-discharge.”

    Chapter 7

    If your ex-spouse or another creditor objects, these debts are not discharged unless you prove to the court that:

    • you will be unable to pay these debts after your bankruptcy case, or
    • the benefit you will get by discharging the debts will outweigh any detriment to your ex-spouse.

    You have debts due to:

    • larceny (theft), breach of trust, or embezzlement
    • fraud, or
    • willful and malicious injury to another or another’s property.
    Chapter 13

    If you do not pay them in full during your Chapter 13 case, the balance is wiped out at the end under the super-discharge.

    Chapter 7

    These debts are not dischargeable if the creditor objects and proves your bad act to the court.

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