Personal Income Tax Debt: Can Bankruptcy Help?

No creditor knocks quite as loudly as the Internal Revenue Service when they come to collect.  The consequences of not timely paying your personal  income tax debt can result in the seizure of your personal property, levying of your bank accounts, garnishment of your wages , and/or foreclosure of real property.

You may be considering bankruptcy as a way to discharge your personal income tax liability, but before you rely too heavily on bankruptcy to discharge that tax debt completely, you need to ask yourself some important questions to determine what portion of your tax debt can be discharged.

Rather than listing what tax debt is dischargeable, it is more efficient to identify which income tax debt is not dischargeable:

  1. Priority income tax debt is not dischargeable.  Several types of this non-dischargeable tax is identified in bankruptcy code section 507(a)(8)(A).  Priority status of tax debt often relies heavily on timing, and includes:
  • Taxes for which a return, if required, is last due, including extensions, on a date more than 3 years before the date that the bankruptcy case was filed.For example,  if Mary Smith filed bankruptcy on July 4, 2015 and she listed tax debt for tax years 2010, 2011, and 2012.  If no tax filing extensions were obtained, then the 2010 and 2011 tax debts would be dischargeable in Mary’s bankruptcy case because those tax returns were due by April 15 of the following year: i.e.  2010 tax return due by April 15, 2011 and 2011 tax return due by April 15, 2012.  Because April 15, 2012 is the latest date that either of these returns was due,  and that date is more than 3 years before the date that the bankruptcy case was filed, then the 2010 and 2011 tax debt is dischargeble.  

Now consider that Mary received an extension until October 2012 to file her 2011 tax return.  As a result of the extension, the last date the 2011 return is due is less  than 3 years from the filing date of the bankruptcy case. Consequently, the 2011 income tax debt is no longer dischargeable in the bankruptcy case.   The 2012 income tax was due by April 15, 2013 and was never eligible for discharge in a bankruptcy case filed on July 4, 2015.

  • Priority debt also includes any tax assessed within 240 days before the filing date of the bankruptcy case, exclusive of-
  • Any time during which an offer in compromise with respect to that tax was pending or in effect during that 240 day period, plus 30 days; and
  • Any time during which a stay of proceedings against collections and arising out of an earlier bankruptcy filing was in effect during that 240 day period, plus 90 days.
  • Tax debt is not dischargeable in bankruptcy for tax years for which:
  • returns were never filed;

Note – late filed returns should be reviewed thoroughly with an attorney to determine the circumstances and timing, and whether that tax is likely to be deemed dischargeable.

  1. Tax debt is not dischargeable with respect to returns in which the debtor fraudulently filed a return or willfully attempted in any manner to evade or defeat such tax.

It is tempting to believe that any tax debt not described here as non-dischargeable is therefore dischargeable, but this conclusion will not always be true.  Always seek legal advice when you need greater clarity regarding your specific circumstances, and especially when the amounts at issue are large.

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