The Effects of Bankruptcy on Your Tax Obligations
While tax obligations generally cannot be avoided by filing for bankruptcy, there are certain exceptions. Taxes may be dischargeable depending upon the nature of the tax debt and the debtor’s actions prior to filing bankruptcy.
There are two prerequisites for seeking discharge of taxes in bankruptcy. First, the obligations must be for federal, state or local income taxes. Other types of taxes, such as employee payroll, sales tax and property taxes, are not dischargeable. Second, the debtor must have acted in good faith at all times. Debtors who have intentionally filed a false income tax return or who have attempted to evade valid tax obligations do not qualify for a discharge.
The law imposes other requirements for discharge of tax debts in bankruptcy. Whether an income tax debt qualifies depends upon the following:
- Age of tax debt — The tax debt must have accrued at least three years before the debtor files for bankruptcy. Newer income tax obligations do not qualify for discharge under any chapter of the bankruptcy code.
- Age of income tax return — The debtor must have filed a valid income tax return at least two years before filing for bankruptcy. In addition, the debtor must have filed the income tax return on time. Debts based on late tax filings do not qualify for discharge unless the debtor was granted an extension of time by the taxing authority.
- 240 day rule — The taxing authority must have assessed or “booked” the debt against the taxpayer at least 240 days before filing bankruptcy. Debts that the taxing authority never officially recognized may also qualify for discharge if 240 days or more have passed before the bankruptcy filing.
- Tax liens are not discharged — Government authorities sometimes place liens on property for unpaid income taxes. Bankruptcy does not expunge a property lien for taxes due. Although the bankruptcy will block collection of the tax debt, tax liens on real property or other assets will have to be cleared if the property is ever sold.
- Local rules — Some taxing jurisdictions have other requirements for the discharge of income tax debts. While the federal statutes still apply, these local rules constitute valid supplemental restrictions on the discharge of income taxes.
Dischargeability of tax debt is a complicated area. Debtors will benefit from the guidance of a knowledgeable bankruptcy attorney.
The Law Offices of Michael Jay Berger in Beverly Hills is one of Southern California’s most preeminent bankruptcy law firms, with 12 locations in the region. Feel free to contact us online or call 310-271-6223 to schedule a consultation.