After many years helping people deal with tax debt and the IRS, and with all the information on the Internet about solving tax debt problems, I am still surprised when someone tells me that tax debt can’t be wiped out in bankruptcy.
But it happens all the time.
The truth is that tax debt can be discharged in bankruptcy and not just income tax. Here is a quick review of income tax debt and bankruptcy as well as other types of tax debt and bankruptcy.
Income tax debt is the most common type of tax debt discharged in bankruptcy. I have helped clients get rid of millions in income tax debt. Income tax debt is wiped away in bankruptcy if it meets a few requirements.
- The return was due more than three years before the bankruptcy filing
- The return was filed by you not the IRS more than 2 years before the bankruptcy filing
- The debt was by the IRS more than 240 days before the bankruptcy filing.
- The return that the tax is based on cannot have been filed “Fraudulently” and:
- The Taxpayer cannot have attempt to “evade or defeat” the tax
There are exceptions to these rules and exceptions to the exceptions. If you have serious tax debt, it is mandatory that you have an experienced lawyer review the history of each tax year before filing a bankruptcy.
Now…as mentioned above, other tax debts can be discharged in bankruptcy too.
Payroll Tax – Non Trust Fund
If you are self employed or own a small business you are required along with every other employer withhold income, social security and Medicare tax (FICA) from your employee’s paycheck.
You have to match the FICA and send it all in. If you don’t send it in, you will owe the entire amount personally without any action being taken by the IRS, if your are self employed or the business is a “Single-Member LLC”.
This means that you will owe the Employee’s Income Tax, FICA and your matching amount with penalty and interest.
The employee amount along with penalty and interest that attaches to it is never going to be discharged in bankruptcy, as it is a “trust fund” tax i.e. you were holding it in trust and were responsible for it.
But…your part, the employer part, can be discharged in bankruptcy if the criteria mentioned above under the income tax requirements are met and there haven’t been any “tolling” events.
I just finished a Bankruptcy case where my client owed more than $50,000.00 in old employment related debt that consisted of the employee portion and her portion. The Bankruptcy stripped off the employer portion with it’s interest and discharged her obligation on it, making it possible for her to more easily set up a payment plan with the IRS.
Arizona Transaction Privilege Tax
Arizona Transaction Privilege Tax is thought of as a sales tax, but it isn’t. It isn’t collected from your customer. It is just a tax for the privilege of doing business here in Arizona. Not every business has to pay for the privilege of course.
The amount of the tax is determined by a percentage of sales and because you as the business owner weren’t collecting and holding the money that belonged to someone else…this money isn’t considered “trust” money. This is key.
Because if isn’t a trust fund tax…it is dischargeable if it meets the basic criteria laid out above.
This is usually an issue where a small business went south a few years ago, filed the Transaction Privilege Returns while struggling to stay afloat, but just couldn’t pay the amount with the returns. Now, the business owner is on to something else and the State of Arizona Department of Revenue is on her heels.
I recently helped a client use bankruptcy to discharge personal debt and some of this old Arizona TPT debt of more than $25,000.00 that was lingering around and causing the State to take enforced collection action. It happens.
The IRS likes penalties. Penalties are the primary way it “teaches” us all not to do the same thing twice. File your return late…penalty. Pay the tax late…penalty.
These Failure to Pay and Failure to File Penalties are the most common.
Chapter 7 Bankruptcy will wipe away these two penalties if the “triggering” event or the event that resulted in the penalty assessment occurred more than 3 years ago.
Chapter 13 Bankruptcy will wipe them out …but they don’t have to meet any of the date criteria above.
These penalties can easily double a tax debt over a relatively short period of time. Many of my clients have used Chapter 13 Bankruptcy to treat these penalties as dischargeable and pay the non-dischargeable tax debt over 3-5 years.
If your property tax bill is 1 year old, your obligation to pay it can be discharged in bankruptcy. However, the Property Tax may be a lien on your property, so even if the obligation is discharged, you still may have to pay the debt to protect the property.
IRS Civil Fraud Penalty (IRC Sect. 6663)
A Civil Fraud Penalty is serious business. It is a penalty assessed by the IRS on a tax return filed fraudulently with the intent to pay less than what was really owed. The penalty amount is 75% of the principal tax debt amount. If the tax debt is $100,000.00 than the penalty is $75,000.00.
If the fraudulent returns were filed more than 3 years before the bankruptcy filing…this penalty could be dischargeable as well.
The myth will endure of course…but now you know better. If you have a serious tax debt problem, talk to someone with experience in these matters and find out whether a bankruptcy can help.