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Dischargeability of Income Taxes in Bankruptcy

Do you owe Federal or State income taxes? Well, then you might consider filing for bankruptcy. By filing for bankruptcy, you may be actually able to discharge some or all of your income tax debts. However, there are strict limitations on what kinds of tax debts that can be discharged through bankruptcy. This article will provide an insight as to how federal and state income tax debt can be managed or eliminated with a Chapter 7 bankruptcy.

Requirements Set Forth Under Chapter 7

Under Chapter 7 Bankruptcy, income tax debt may be discharged if several requirements are met. Generally, to be qualified in filing for Chapter 7 bankruptcy, an individual is required to pass a “means test”.

Understanding the “Means Test”

The purpose of the “Means Test” is to limit the use of Chapter 7 bankruptcy to those who cannot pay their debts. Under the “Means Test”, monthly expenses are deducted from your “current monthly income.” The “current monthly income” includes your average income over the six calendar months before filing for bankruptcy. The number gives you the monthly “disposable income.” The higher the disposable income, the more likely Chapter 7 bankruptcy won’t be the solution. Only bankruptcy filers with primarily consumer debts, are required to take the means test. Before taking the “means test” you need to figure out whether your income is more or less than medium income in the state of Georgia. If the income is more than median income, then you must figure out whether you would have enough left over, after certain expenses are deducted. The deducted expenses can be used to repay some of the debt.

Income Taxes in a Chapter 7 Bankruptcy

To discharge income tax debt in Chapter 7 bankruptcy, several requirements must be met:

  • The Taxes have to be Income Taxes: Only income tax can be discharged, including state income taxes under the same rules.
  • No Fraud or Tax Evasion: The Income Tax Debt must not be a result of tax evasion or fraudulent returns. Any attempt to defraud IRS will result in non dischargeable tax debt.
  • Tax Returns Filed: Tax returns must filed at least two (2) years prior to the debt: This does not include any I.R.S. prepared “substitute for returns.”
  • Three Year Rule: The tax debt must be at last three (3) years old: The taxes must have been due at least three years before the bankruptcy is filed.
  • Tax Amount Determined: The income tax debt must have either been assessed by the I.R.S. at least two hundred forty (240) days before the filing or not been assessed at all, include audit adjustments and amended returns.

Determining Discharge Eligibility

If all the requirements listed above are satisfied, the obligation to pay the income tax debt back to the I.R.S. is likely to be discharged. Additionally, no wage garnishments may be imposed. Nonetheless, if I.R.S. decides to place tax lien on any property as a result of unpaid debt, the tax lien remains on the property must be paid off.

Tax Debts Not Eligible for Discharge

Several types of tax debts are likely not eligible for discharge, depending on why the penalty was incurred. Penalties for fraudulent returns are not eligible.  Tax debts that accrued as a result of unfiled returns are not dischargeable. Additionally, payroll taxes such as trust fund taxes or withholding taxes that are withheld by an employer are not dischargeable.

Tolling of Statute of Limitations in Bankruptcy

Generally, tolling is defined as an extension of a stated time period. As outlined above, the I.R.S. imposes three different time periods that must be met:

  • Three (3) years;
  • Two (2) years; and
  • Two Hundred Forty (240) days.

Time periods can be extended if tax extension is filed, prior bankruptcy is claimed, collection due process hearing is ongoing, or if an innocent spouse relief or tax assistance order is received. The I.R.S. may extend a time period if it has suspended collections or has prepared a “substitute for returns” on behalf of an individual. In order to discover if the time periods were met it will be necessary to order an account transcript from the I.R.S. for each year in question. The transcript will contain all necessary information to determine whether a given time period has been met.

Available Alternatives

An individual may be allowed to enter into an installment agreement. It is likely possible to make the I.R.S an offer less than the amount owed in order to settle the remainder of the debt. If for some reason, an individual cannot qualify for Chapter 7 bankruptcy, but does qualify for Chapter 13 bankruptcy, a repayment plan may be possible.

It may be possible, however that in certain cases, the statute of limitations may have run on the debt, making it unavailable for collection. The statute of limitations is ten years for federal income tax. 26 U.S.C. § 6502. As with filing for bankruptcy, certain actions and extensions may toll the statute of limitations so it is not advisable to assume the statute has run without first consulting an attorney and obtaining an account transcript.

If all eligibility requirements are met, income tax debt may be eligible for discharge. If you are interested in filing for chapter 7 bankruptcy, in the hopes of eliminating the income tax debt, you should consider immediately filing all delinquent returns. It is advised you consult your local bankruptcy attorney on whether late returns will be eligible for discharge.

If you are thinking about filing bankruptcy to alleviate income tax debts, call us today at 770-609-1247 and ask to speak with one of our experienced bankruptcy attorneys.

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