Although we’re still a couple of months away, the April 15th tax deadline will be here before you know it, and if you already owe income taxes for previous tax years, you could be facing an even larger tax debt when the dust settles.
The IRS is a notorious creditor and, if you decide to bury your head in the sand, the IRS will start garnishing wages, seizing bank accounts, and start placing liens on your home and other personal property. Nevertheless, you still have other options. Bankruptcy is a great tool to help you minimize your existing tax debt and this blog will explore how bankruptcy can help you get rid of some of that unwanted tax debt.
Different Types of Tax Debt
First, you should begin to understand the different types of tax debt and how they are classified pursuant to the Bankruptcy Code.
I. 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 and 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 there is equity in a person’s personal or real property. For example, you are currently financing a vehicle that is worth $10,000 and you still owe the finance company $5,000. Here, the vehicle would have an equity of $5,000 (value of vehicle minus any liens) which the IRS can attach a lien to.
II. Priority Tax Debt
These are taxes that you owe from the previous three (3) tax years that have come due. As of the date of this blog, this refers to tax debt owed for the tax years of 2018, 2019, and 2020 (2021 does not become part of this calculation because 2021 taxes are not due until April 15, 2021). If we are past the April 15th deadline, the “priority tax years” would be 2021, 2020, 2019. In a Chapter 7 bankruptcy, this “priority tax debt” is non-dischargeable, and the debtor will be liable to pay these taxes after the bankruptcy case is over. In a Chapter 13, the debtor must pay these taxes through a Chapter 13 Plan.
III. General Unsecured Tax Debt
Unsecured tax debt is tax debt that is neither secured nor priority tax debt as explained above. If a person can meet the requirements outlined in the next segment, these taxes are dischargeable in a Chapter 7 bankruptcy. However, in a Chapter 13 bankruptcy, the debtor may have to pay back a small percentage of the general unsecured tax debt.
Eliminating Tax Debt in a Chapter 7 Bankruptcy
In a Chapter 7 bankruptcy, general unsecured tax debt can be discharged if the following requirements are met:
1. The tax debt must be from income taxes
Taxes must be from income earned. 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.
2. The debtor has not committed tax fraud or willful evasion of taxes
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.
3. The tax debt must be at least 3 years old
Let’s say that you file your 2015 income taxes on time (before April 15, 2016) and you end up owing the IRS $10,000 for the tax year of 2015. The following year, you file your 2016 income taxes (before April 15, 2017) and you end up owing the IRS an additional $10,000 for the tax year of 2016. Finally, the following year, you file your 2017 income taxes (before April 15, 2018) and you owe the IRS an additional $10,000. Now you owe the IRS $30,000 for the tax years of 2015 through 2017. 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 insurmountable. This is where the filing of a bankruptcy can help.
In accordance with Bankruptcy Code Sec. 507(a)(8)(A)(i), following 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 2015 through 2017 (assuming that the taxes aren’t secured by personal or real property and haven’t been audited by the IRS at any point). That’s $30,000 of tax debt that could possibly be discharged through bankruptcy.
In order for income taxes to become dischargeable in a bankruptcy, the Debtor must meet the following rules:
4. 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.
5. 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 2015 through 2017; 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. This is beneficial for anyone who is currently carrying a heavy tax burden which increases every tax year.
Chapter 13 Repayment Plan and Treatment of Taxes
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 non-exempt equity in any real or personal property.
We Can Help
Owing taxes should not be a scary thing – it happens to most of us and will happen to you at one point in your life. Owing taxes isn’t the end of the world and all it takes is educating yourself about your options. 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 me directly so I can 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 973-786-1582.