5 Crucial Facts about Income Taxes in Bankruptcy

Law Office of Robert L. Firth Oct. 9, 2017

There are many misconceptions about how bankruptcy affects income tax debts. These facts will help make sense of this confusing arena.

1. Filing Your Bankruptcy Case Immediately Stops Virtually All Tax Collection Actions Against You.

The IRS, your state taxing agency, and all other tax entities have to obey the “automatic stay” just like any other creditor. This law requires them to stop all collection actions immediately upon your filing. This means no more paycheck garnishing and no recording of tax liens on your home, vehicles, or other possessions. And no collection threats and phone calls from them.

2. There Are Some Very Limited, Sensible Contacts that ARE Still Allowed.

The IRS and state tax agencies can still, after you file your bankruptcy case:

  • start or continue an audit to determine your tax liability,

  • send you a notice that you owe taxes (but it can’t try to collect on that tax),

  • make a demand for a tax return, and

  • make an assessment of a tax.

Essentially, the tax authorities can still take action to determine the amount of a tax. But they can’t act to collect on any taxes.

3. Certain Income Taxes Can Be Completely Written Off (“Discharged”) in Bankruptcy.

The law does get complicated. But most of the time discharging an income tax debt requires just meeting two conditions:

  • the pertinent tax return was due more than 3 years before the bankruptcy case was filed (plus any tax return filing extension), and

  • that tax return was actually submitted more than 2 years before your bankruptcy case is filed.

There are other conditions but they involve circumstances that don’t often apply to most people. The main point is that most income taxes can be discharged by filing the tax return and waiting long enough.

4. Some Income Taxes Can Never Be Discharged.

There is one circumstance that doesn’t apply to most people but is worth emphasizing. If a taxpayer filed “a fraudulent return or willfully attempted in any manner to evade or defeat” a tax, that tax can never be discharged. What this covers and does not cover is open to some interpretation. For example, would not filing a tax return for years be considered “tax evasion” for this purpose? Discuss any situation like this with your lawyer to find out whether it may cause you a problem.

5. A Bankruptcy Case Cannot Discharge Any Taxes that Become Due After the Case Is Filed.

A bankruptcy filing can only cover and affect those debts that you legally owe as of the date of that filing. That applies to income taxes as well. So, especially under Chapter 13 consider delaying filing until the current year’s tax is due. Then you can include that tax in the payment plan and be protected from its collection.

In our next blog post we’ll give you 5 other crucial facts about income taxes in bankruptcy.