Income Taxes and Bankruptcy
Two fun topics: taxes and bankruptcy! Seriously, they can be a very good combination.
Hate to tell you but it’s only a month and a half until the April 15 income tax return deadline. So it’s a good time to look at the many kinds of relief that the bankruptcy laws can give you involving your tax debts.
Today we’ll list these many kinds of relief. And then in the next several blogs we’ll explain each one of these. Any single one of these kinds of relief could help you tremendously. If your tax situation is complicated, a combination of these kinds of relief could set you on the path to permanently fixing a seemingly hopeless situation.
Bankruptcy can help you with your taxes in the following ways.
1. A Chapter 7 “straight bankruptcy” can discharge (permanently, legally write off) some income tax debts. They have to meet a set of conditions, some but not all of which are related to how old the tax is. If you meet those conditions, in a matter of a three or four months you would no longer owe that tax.
2. If you owe an income tax debt that does not meet those conditions and so cannot be discharged, Chapter 7 can still usually discharge all or most of your other debts so that you could potentially enter into a sensible installment payment plan with the IRS or other tax authority.
3. If you owe an income tax debt that cannot be discharged, and have an “asset” Chapter 7 case—in which you are handing over some of your assets to the bankruptcy trustee—then there is a good chance that some of the proceeds of the sale of those assets would be paid by the trustee towards that tax debt.
4. If you owe an income tax debt that cannot be discharged, and especially if that debt is large and/or if you owe a number of years of taxes, paying those taxes through a Chapter 13 case can be much cheaper, easier and safer than dealing directly with the IRS or state tax agency.
5. Chapter 13 is often a cheaper way to pay income taxes that can’t be discharged because usually no more interest or penalties are added after the case is filed, and often you don’t have to pay even the previously accrued penalties.
6. Chapter 13 is usually a significantly easier way to pay such taxes because the payment terms are almost always more reasonable and flexible than what the taxing authorities would otherwise require.
7. Chapter 13 is a much safer way to pay such taxes because you are constantly protected from the taxing authorities’ collection actions—tax liens, wage and bank account levies, for example—especially valuable when your circumstances change and you need to adjust the payment terms.
Income Tax Refunds
8. A tax refund is an asset that belongs to you as of the first day of the tax year, regardless whether the amount is even known, whether the pertinent tax return has been prepared and filed, and whether you have received it. Therefore the bankruptcy trustee will have a right to whatever part of the anticipated refund is not “exempt”—not protected. In fact, a pro rata portion of the refund could be claimed by the trustee even during the tax year, for example before January 1, 2013 for the 2012 income tax refund. Your attorney will discuss with you how to protect your refund, in some cases by waiting to file bankruptcy until you have received and appropriately spent it.
9. The “automatic stay”—the statutory injunction stopping all your creditors from trying to collect their debts once you file bankruptcy—applies as well to the IRS and all tax authorities. There are some sensible exceptions—they can demand that you file your tax returns, can tell you how much you owe, and can do an audit to figure out the amount you owe.
10. If you own a viable sole proprietorship business that you want to keep operating, and the business and/or you are seriously behind on your tax obligations, Chapter 13 can be a very good tool for staying in business while addressing your tax debts with on a reasonable plan and payment schedule.
11. If you have closed or are about to close your business, and owe a lot of taxes from it, whether you file a Chapter 7 or 13 depends on how much and exactly what kinds of taxes you owe, in addition to other non-tax factors.
12. If you expect to owe a significant amount of income taxes for the current tax year, it can make sense to file a partial-year tax return at the time you file bankruptcy, especially if you are filing a Chapter 13 case, so that the taxes owed up to that point in the year can be incorporated into your bankruptcy case.
13. When circumstances otherwise allow, you can include more of your taxes among those that you can discharge, and reduce the taxes that you must pay, by applying the following strategy during the months or even possibly a few years before filing bankruptcy:
a) waiting out the period(s) of time while the tax is not dischargeable, so that you will be able to discharge that tax;
b) staying current on current-year tax obligations since you can’t discharge very recent taxes anyway;
c) filing any past-due tax returns because income taxes cannot be discharged until at least 2 years after filing, so that you may be able to discharge those taxes, and
d) avoid tax fraud and evasion, and withholding taxes, because those can never be discharged.