According to the Internal Revenue Service, the average refund this tax season has decreased by 8.4%. This, of course, is mainly due to the recent changes in tax laws and the loss of certain tax deductions that were available in previous years. With the April 15th tax deadline right around the corner, this could potentially mean that you could be owing taxes when you really expected a tax refund. And if you already owe income taxes for previous tax years, you could be facing an even larger tax debt when the dust settles. With that said, you still have options, and the filing of a bankruptcy can help minimize your already existing tax debt. This blog will explore how bankruptcy can help you get rid of some of that tax debt.
Different Types of Tax Debt
Before we can begin analyzing whether a tax debt is dischargeable through a bankruptcy, we have to begin to understand the different types of tax debts and how they are classified pursuant to the Bankruptcy Code.
- Secured Tax Debt. If you’ve incurred substantial tax debt and have failed to pay these taxes in the past, the IRS has the ability to file a tax lien against a person’s personal property and/or real property. Once the IRS files this tax lien, the tax debt becomes secured by the assets you own. However, this tax lien is only secured to the extent of any equity in a person’s personal or real property.
- Priority Tax Debt. These are taxes that you owe from the previous three (3) tax years. As of the date of this blog, this refers to tax debt owed for the tax years of 2016, 2017, and 2018. As you will see this is tax debt the does not meet the requirements mentioned below. In a Chapter 7, these taxes are non-dischargeable and the debtor will be liable to pay these taxes after the bankruptcy. In a Chapter 13, the debtor must pay these taxes through a Chapter 13 repayment plan.
- General Unsecured Tax Debt. Unsecured tax debt is tax debt that is neither secured nor priority tax debt as defined above. Assuming that a person can meet the requirements outlined below, these taxes are dischargeable in a bankruptcy in a Chapter 7. In a Chapter 13, the debtor will have to pay back a small percentage of the general unsecured tax debt.
Requirements to Eliminate Tax Debt Through a Chapter 7 Bankruptcy
In a Chapter 7 bankruptcy, general unsecured tax debt can be discharged if the following requirements are met:
- The tax debt must be from income taxes. Taxes must be from income earned in the previous tax year. Other types of taxes such as sales and use tax, payroll taxes, etc. or are considered non-dischargeable taxes that cannot be eliminated through a bankruptcy.
- The debtor has not committed tax fraud or willful evasion of taxes. This is pretty self-explanatory. If you have been found guilty of tax fraud for falsifying information on your tax returns or have willfully evaded paying income taxes, taxes cannot be eliminated through a bankruptcy.
- The tax debt must be at least 3 years old. Let’s say that you file your 2012 income taxes on time (before April 15, 2013) and you end up owing the IRS $10,000 for the tax year of 2012. The following year, you file your 2013 income taxes (before April 15, 2014) and you end up owing the IRS an additional $10,000 for the tax year of 2013. Finally, the following year, you file your 2014 income taxes (before April 15, 2015) and you owe the IRS an additional $10,000. Now you owe the IRS $30,000. You enter into an agreement with the IRS to pay back these taxes, but as you continue to file your taxes every subsequent year, your tax debt continues to increase, and now the tax debt has become unmanageable. This is where the filing of a bankruptcy can help.
In accordance with Bankruptcy Code Sec. 507(a)(8)(A)(i), in the scenario above, if this particular person filed for bankruptcy today, and they have filed taxes all of their taxes on a time, they would be eligible to eliminate the tax debt from 2012 through 2014. That’s $30,000 of tax debt that could be discharged through bankruptcy.
- The debtor must meet the “2-Year Rule”. In accordance with Bankruptcy Code Sec. 523(a)(1)(b)(ii), you can discharge tax debt so long as the tax returns are filed at least two years before the filing of a bankruptcy. Even if you filed your taxes late, you can still discharge tax debt so long as there is a two-year gap between the filing of the taxes and the filing of the bankruptcy.
- The debtor must meet the 240-Day Rule. The income tax debt must have been assessed by the IRS at least 240 days before the filing of the bankruptcy.
To put it all together - if 1) you have filed all of your taxes on time from 2012 through 2015; 2) your taxes were assessed by the IRS on or around the time that the taxes were filed; 3) you have not committed tax fraud or willful evasion of taxes; and 4) these taxes stem from income taxes, you will be eligible to discharge any general unsecured tax debt associated with these tax years if you filed for bankruptcy after April 2019. This is beneficial for anyone who is currently carrying a heavy tax burden which increases every tax year.
Treatment of Taxes in a Chapter 13 Repayment Plan
A Chapter 13 bankruptcy enables individuals with regular income to formulate a repayment plan whereby the debtor proposes to pay all or a portion of their debts in a period of three to five years. As I discussed previously, Priority Tax Debt and Secured Tax Debt must be paid back in full through a Chapter 13 repayment plan. However, you will only pay back the Secured Tax Debt to the extent that this tax debt is secured by nonexempt equity in any real or personal property. For example, the IRS has a tax lien on your real property in the amount of $50,000. You file for Chapter 13 bankruptcy, and after analyzing the equity in your home, there is only about $25,000 of nonexempt equity remaining in your home after the bank’s claim. Pursuant to Bankruptcy Code 506, the aforementioned tax lien can be reduced to the nonexempt equity amount of $25,000 and be paid through the repayment plan. The remaining $25,000 gets treated as a general unsecured tax debt.
Whether you need to i) completely eliminate your tax debt through Chapter 7 bankruptcy; ii) formulate a repayment plan in a Chapter 13; or iii) if you’re considering bankruptcy and aren’t sure if your tax liabilities are dischargeable, please contact one of our experienced attorneys to evaluate your individual case. We are well qualified as a full-service bankruptcy law firm for people in this county and other New Jersey counties: Passaic County, Hudson County, Essex County, Bergen County, Morris County, and Sussex County. Call us today at 973-870-0434 or toll free 888-412-5091.