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Declaring Bankruptcy and Tax Debts

Posted on 07, Oct, 2013

If you've been forced into a position where you've had to declare bankruptcy then there are some circumstances where you can discharge some of your debt to the IRS under either a Chapter 7 or Chapter 13 filing. Not every type of tax debt can be eliminated by declaring bankruptcy and there are certain conditions which your IRS debt must meet for it to be fully or partially discharged under the terms of your filing.

In fact to even petition for bankruptcy in the first place you'll need to prove that your previous four tax returns have been filed, and that you're also able to provide a copy of your most recent tax return to the court.

How old your tax debt is, and what type of tax debt it is are important considerations from the very outset.

If, for example, you're filing for Chapter 7 you'll find that any taxes/tax debt due within the last 3-years isn't dischargeable - these are usually referred to as priority taxes. If your tax debt is older than that there's a good chance it can be written off as part of your bankruptcy petition, but any newer taxes will still need to be paid after your Chapter 7 filing is complete. The "3-year rule" for IRS tax debts also applies to Chapter 13 filings - the tax laws were recently overhauled to have bankruptcy proceedings for Chapter 7 and 13 more closely mirror each other.

So the 5 basic rules for ensuring that your tax debt is discharged as part of your bankruptcy filing are as follows:

a.       3-year Rule: the tax debt you want to discharge must be in relation to a filing which was due at least 3 years ago, including any extensions you were granted

b.      2-year Rule: the tax debt in question must be related to a return which was filed at least 2-years before you actually declared yourself bankrupt

c.       240-day Rule: the IRS' assessment of that same tax debt must have taken place at least 240-days before you filed for bankruptcy

d.      No Fraud: the tax return in question cannot be fraudulent, either by decision, by accident or misadventure

e.      No Tax Evasion: the person filing for bankruptcy must not have been willfully avoiding their tax debts, either now or in the past

It's also worth mentioning that any tax debts which arise from unfiled tax returns cannot be discharged, except if you file a tax return for that year, including all returns information due. Another sting in the tail is that if there was a tax lien on your property before you declared bankruptcy the lien will still be there after you've filed for Chapter 7, for example. This means that even after declaring bankruptcy you'll still need to find the funds to pay the tax lien on your home, if such a lien exists.

As with any major life decision, especially those involving bankruptcy, it's always wise to seek professional advice on the matter - in this case the counsel of a qualified and experienced bankruptcy attorney and accountant (preferably a CPA).

Declaring bankruptcy can't simply erase all of your tax debt, but it can help you mitigate the debt to make it more manageable.

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