Filing bankruptcy stops tax collection just like it stops other debt collection by more conventional creditors. But there are exceptions.
The last several weeks of blog posts have been about bankruptcy’s “automatic stay” protection from creditor collections. We’ve also gotten into many of the exceptions to that protection—when certain creditors CAN take certain actions.
Today we focus on some very limited exceptions to the automatic stay protection, those which apply specifically to income taxes. In bankruptcy you don’t want surprises, especially from a tax collector. These limited exceptions are reasonable. But it’ll still help you to understand them in order to not be surprised by them.
Tax Determination is Allowed, Tax Collection is Not
Simply put, the exceptions to the automatic stay protections are about determining the amount of tax owed. The IRS and the state tax authorities can take steps during bankruptcy to figure out how much you owe. They can make you do what the law requires along these lines. For example, they can require you to file your tax returns, regardless that you’ve filed bankruptcy. But then they can’t take any action beyond that to collect any taxes owed.
The IRS/State CAN’T…
The automatic stay immediately stops virtually all debt collection activity against you when you file bankruptcy. This protects you, your income, and your assets. Everything is put on hold so that the bankruptcy laws can be applied to your entire financial situation.
Debts that the law discharges—legally writes off—disappear. Other possible debts that the law does not discharge you continue to owe. With income taxes, if they’re old enough and meet other conditions, they’re discharged. Otherwise you’ll either owe them after completing the Chapter 7 case or you’ll pay them through the Chapter 13 case. But in the meantime the IRS and state are forbidden from collecting the debt. They are also forbidden to take any action directly related to collection, like recording a tax lien against your home or vehicle.
So to be clear, the automatic stay exceptions we’re discussing here do NOT allow the tax authorities to take any action to get your money or assets. The IRS and state tax authority can’t start or continue garnishing your paychecks or bank accounts. They can’t levy on (take away) anything else you own. They can’t call you to pay the tax, and can’t send you tax bills.
The IRS/State CAN…
As we said above, the taxing authorities can take certain specific steps to determine how much tax you owe. Some of these steps you wouldn’t expect your bankruptcy filing to affect—they’re probably not surprising. You filing bankruptcy does not prevent the IRS/state from doing the following:
- Start or finish a tax audit “to determine tax liability.” (See Section 362(b)(9)(A) of the Bankruptcy Code.) But there can be no attempt to collect whatever that tax liability ends up being.
- Send you a notice about the amount of tax that you owe—a “notice of tax deficiency.” (Section 362(b)(9)(B).) That notice is NOT a demand to pay the tax.
- Demand that you file your tax returns. (Section 362(b)(9)(C).) In fact this step is often essential for the processing of your bankruptcy case.
- Make an “assessment” of your taxes and issue a “notice and demand for payment.” (Section 362(b)(9)(D).) “Assessment” is a formal determination of the tax amount. The “demand” here is a term of art meaning that you are put on notice that you are obligated to pay the debt. But whether and when you really owe it usually depends on bankruptcy law.
The interplay between bankruptcy law and tax law can be quite complex. The rule of thumb is that bankruptcy stops tax collection but not tax determination. But your situation may have nuances that could make that rule of thumb misleading. If you are in the midst of, or fear, tax collections, be sure to see an experienced bankruptcy lawyer to find out what would happen in your unique situation. And it really does make sense to do so as early as possible. Tax debts are very much an area where early and wise planning could save you a lot of money.