Dealing with Personal Income Taxes Through Bankruptcy

Once we enter into another tax preparation season we are beginning to get quite a few calls from potential bankruptcy clients who else also have tax problems. Income taxes present special problems and issues when it comes to bankruptcy. This informative article brief summary of this complicated rules that govern taxes for those who document bankruptcy.

As we enter into another taxes preparation season we are beginning to get quite a few calls from potential bankruptcy clients who also have tax difficulties. Income taxes present special problems and issues with regards to bankruptcy. This article brief summary of this complicated rules that govern taxes for those who file bankruptcy. The Personal bankruptcy Discharge

In bankruptcy, a “discharge” is the elimination of a debt. The goal of either a chapter 7 or a chapter 13 bankruptcy is obtaining a release of your unsecured debts. However , not all unsecured debts are dischargeable. Types of non-dischargeable debts are student loans, child support and most taxes. However , while most taxes are not dischargeable, in some cases, income taxes are.

Bankruptcy Discharge of Taxes

In some instances Bankruptcy can be an effective way of dealing with past due federal and state income tax debt. Under the Bankruptcy Code, whether a tax obligation is definitely dischargeable is determined by when the tax grew to become due. If a bankruptcy debtor owes state or federal income taxes the particular taxes are dischargeable if the debtor filed their tax return plus:

3 Year Rule: The tax return was due more than three years prior to the bankruptcy filing. (If the particular debtor obtained an extension, the due date would be the extension deadline); and
two Year Rule: The debtor’s income tax return was actually filed greater than 2 years prior to the date the borrower files his bankruptcy; and
240 Day Rule: The income taxes were assessed by the IRS or Ma DOR more than 240 days before the bankruptcy filing; and
The borrower did not file a fraudulent return or willfully attempt to evade having to pay taxes.
If a Bankruptcy debtor fulfills all of the above criteria, then their particular income tax debt is dischargeable. Nevertheless it is important to remember that these rules only apply to individual income taxes. Moreover, within a Chapter 7 Bankruptcy if the fundamental tax obligation is dischargeable, the interest and penalties thereon are also dischargeable. However , if the underlying obligation can be non-dischargeable, so are all related curiosity and penalties.

Tax Lien in the Chapter 7 Bankruptcy

If the IRS . GOV of Massachusetts DOR has already documented a lien on your property, then their debt is secured, and in the case of a Chapter 7 bankruptcy, the tax cannot be discharged; even if a debtor meets all of the problems listed above. However , that lien can simply be assessed against the property the fact that lien is recorded. For example , in case you owe the IRS $10, 000. 00 in taxes and you satisfy all of the qualification above, and the INTERNAL REVENUE SERVICE records the lien against house that is only worth $5, 000. 00, after your bankruptcy, the IRS cannot record a mortgage against any other property that you possess. Moreover, once the IRS sells the property that their lien is recorded against, the remaining balance that you are obligated to pay is discharged.

Chapter 13 Bankruptcy

In a Chapter 13 bankruptcy, bankrupties debtor makes payments to a bankruptcy trustee for a period of 3 to 5 years. The trustee in turn pays the debtors creditors according to a repayment schedule, or “Chapter 13 Plan”. Certain debts are paid completely such as mortgage arrears and particular “priority debts” and general unsecured debts (such as credit cards, unsecured loans and medical bills) are paid with whatever is left over to get a fraction of their value.

In a Section 13 Bankruptcy, income taxes are treated as priority debts; meaning that they must be paid before any other debts, and like all priority financial obligations, they must be paid in full with the chapter 13 plan. However in order for an income tax to be considered concern the tax must meet the particular 3 year rule and the 240 day rule. If the bankruptcy debtor has any tax debts that will fall outside these two rules; that debt is considered a general unsecured debt and the tax debt will be treated just like the debtor’s other unsecured financial obligations and thus be discharged. However , if the bankruptcy debtor does not satisfy these two rules, then the tax debt is known as a priority debt and it must be repaid in full through the Chapter 13 Plan. If the debtor cannot repay completely of their priority debt through the Chapter 13 bankruptcy, they will have to convert their debt to a Chapter seven bankruptcy.
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Another important consideration for section 13 debtors is the accrual of penalties and interest. The filing of a chapter 13 bankruptcy stops the IRS and the Massachusetts DOR from assessing additional penalties plus stops the accrual of interest.

Taxes Lines in a Chapter 13 Bankruptcy

Another consideration in a chapter thirteen is a tax lien. If the IRS . GOV of Massachusetts DOR has recorded a tax lien against a debtor’s property for unpaid income taxes, that debt becomes secured financial debt and cannot be discharged; even if the taxes would have qualified for discharge beneath the 2 year and 240 time rules. However , if the amount of the particular lien exceeds the value of the property which the lien is attached, a debtor may seek relief from the Bankruptcy Judge and have the portion of the particular lien that exceeds the value of the house striped; something known as a “cram down”. The portion of the lien which is stripped then becomes unsecured.


The Bankruptcy rules are complicated when it comes to dealing with income taxes and tax issues should not be handled by a pro-se bankruptcy filer or even an inexperienced personal bankruptcy attorney. If a debtor has income tax issues they should consult with an experienced bankruptcy attorney who is familiar with the personal bankruptcy rules regarding taxes and the several exceptions.


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