How to Get Your Tax Debt Discharged When You File for Bankruptcy
Filing for bankruptcy itself is difficult enough to consider, but it is even more daunting when one considers how bankruptcy and taxes affect each other.
In certain circumstances, bankruptcy law allows taxes that are owed to be discharged, or cancelled. This usually depends on the type of bankruptcy that’s been filed or the type of taxes that are owed.
Type of Bankruptcy for Tax Debt Discharge
You have a higher chance of getting your tax debt discharged if you file for a Chapter 7 bankruptcy instead of a Chapter 13 bankruptcy. A Chapter 7 bankruptcy allows for discharge for some types of debts, including federal tax debt in certain situations.
On the other hand, a Chapter 13 bankruptcy puts all your debt into a payment plan so that you can repay it in three to seven years.
When you file for bankruptcy, keep in mind that it won’t be able to stop inspections from the Internal Revenue Service (IRS) that are already being carried out. However, if you do not have a Relief from Stay motion with your bankruptcy, the process in which financial firms collect the money owed to them can be stopped while your bankruptcy filing is pending. The statute of limitations is extended as well.
What Qualifies A Tax Debt for Discharge
- Tax debt comes from personal income taxes
- The person in debt has filed for a return for the tax debt two or more years before a bankruptcy was filed. Substitute returns by the IRS do not count.
- The person in debt must have had the tax debt for three or more years before a bankruptcy was filed.
- The IRS has to have evaluated the tax debt 240 days or more before the person in debt filed for a bankruptcy.
- The person in debt has not, and has not tried to, evade taxes or committed tax fraud.
It should be noted that once the tax debt was discharged, so are the penalties that had came with it. As well, even though discharged taxes are typically seen as taxable income by the IRS, discharged taxes through bankruptcy are not. If you have filed for bankruptcy and had a debt discharged but received a 1099, you might want to get a tax professional on board. This is because a 1099 is complicated and has to be dealt with delicately.
Taxes that Can’t Be Discharged
- IRS liens that were issued to a property before a bankruptcy was filed.
- Penalties on tax debt that are not discharged.
- Taxes owed without filed returns. In this case, the debt cannot be discharged no matter how long ago the debt was issued.
- Trust fund taxes
- Taxes that were taken from an employee’s paycheck by their employer
Last Thing to Note
Because of their relationship with each other, it may be extremely helpful for a person in debt to file for bankruptcy and sort out their taxes at around the same time, instead of doing them separately. Filing for bankruptcy, though extremely difficult and discouraging, could be a good way for either businesses or individuals to start over when dealt with in a correct manner.
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