Thursday, 12 July 2012

Does Bankruptcy Erase Tax Debt

If you're struggling to make ends meet and dodging bill collectors, the last thing you want to worry about is a visit from the tax man looking for back taxes. Although bankruptcy can be used at times to discharge personal taxes, this tactic is not always completely effective. Other types of taxes beyond income taxes are exempt from discharge in bankruptcy, so a tax debt may not be wiped out by bankruptcy proceedings.

- Automatic Stay

Once an individual or corporate entity files for bankruptcy, the court issues an automatic stay of debt. This order temporarily prevents all creditors, including the Internal Revenue Service, from collecting debts during bankruptcy proceedings. The IRS may petition the court to lift the stay to collect back taxes, although it will generally need to prove the taxpayer engaged in fraudulent activity to remove the stay. During the time the automatic stay is in effect, the IRS will not be able to attempt to collect taxes, regardless of the type of tax debt owed.

- Requirements for Discharge

Back taxes aren't immediately erased when a taxpayer files bankruptcy. To qualify for discharge, the tax debt must be at least three years old at the time bankruptcy is filed, the taxpayer must have filed a return at least two years before filing and the taxpayer cannot have been shown to have made a willful attempt to evade taxes or defraud the IRS. Additionally, only income tax debts may be discharged by bankruptcy. Payroll taxes and fraud penalties may not be discharged by bankruptcy proceedings.

- Chapter 7

In Chapter 7 bankruptcy, an individual or corporation's assets are liquidated by a trustee and the proceeds are used to pay off creditors. If the IRS filed a tax lien against a taxpayer before the bankruptcy filing, the tax debt will not be discharged in filing. If the taxpayer emerges from Chapter 7 with property remaining, the lien is reduced to match the value of property. For example, if the IRS filed a $15,000 tax lien against a taxpayer, and the taxpayer emerges from Chapter 7 with $8,000 in assets, the lien amount is adjusted to $8,000.

- Chapter 13

Taxpayers who enter Chapter 13 bankruptcy renegotiate their debt amount with their creditors in the process. In these proceedings, debt amounts, including property taxes, are reduced as the court develops a payment plan to help a debtor emerge from bankruptcy. In these cases, if a judge decides the taxpayer only has the ability to pay $8,000 on $15,000 of back taxes, the amount will be adjusted as part of the payment plan developed as part of Chapter 13 filings. As with Chapter 7, tax liens aren't discharged by Chapter 13 protections.

- Chapter 11

Although it's rarely used by individuals and favored by corporations, taxpayers who file Chapter 11 receive a six-year grace period to repay tax debt. During this period, interest on the unpaid balance accrues.

Reference: www.uscourts.gov

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