Can I get rid of tax debt through the bankruptcy discharge?

“I live in New York. Will My Taxes Be Discharged In Bankruptcy?”

The purpose of filing for bankruptcy is to receive a discharge of all of your debts, meaning that you will never have to pay them.  Most debts are discharged.  Credit card debts, loans and medical bills are almost always discharged.  Taxes, however, are not always discharged.  This post discusses when they should be discharged and when they might not be.  As always, there are exceptions to every rule, and you should consult with a lawyer to find answers for your particular case.

The taxes that we are concerned about here are income taxes.  Whether the income taxes are owed to the Internal Revenue Service or a state, the rules are the same.  There are three main rules, along with a few minor rules.  You have to meet each of the rules to have your taxes discharged.  There is also a question of what happens when a tax lien has been filed.

The first major rule is the 3-year rule: was the tax return due more than three years ago?  Tax returns are usually due on April 15th of each year for the previous year.  Thus income taxes for 2009 were due on April 15, 2010.  Three years after that is April 15, 2013, so in a bankruptcy case filed after April 15, 2013, taxes from 2009 and earlier will be discharged if the following rules are also met.

The second major rule is that the return has to have actually be filed two years before the bankruptcy filing.  This rule supplements the first and comes up in situations where the return was filed late.  If the return was filed more than two years prior to filing, but it still has not been more than three years since the return was due, then the first rule applies.  For example, if you applied for the automatic six-month extension and filed the return in October of 2010, you will still be within the three years of the first rule and will have to wait until April 2013 because the taxing authority gets the benefit of the longer period of time.  If you file your return several years late, the rule still extends two years after you actually file.

The third major rule is that the taxing authority assessed you more than 240 days prior to filing.  An assessment is what happens when the taxing authority decides you owe a tax.  When you file a proper return on April 15th, the official assessment happens about the time the return is filed.  However, if the taxing authority detects a mistake and recalculates the amount due, the assessment occurs when the recalculation is done.  Thus if you file your 2009 tax return on April 15, 2010, but the taxing authority sends you a letter telling you of a mistake and informing you of the new balance due on June 1, 2010, that is the assessment.  However, the taxing authority still gets the benefit of the 3-year and 2-year rules, so this third rule only has an effect when an assessment is made long after the return was due.

Two minor rules are that if the tax return is fraudulent or you are guilty of a willful attempt to defeat or evade a tax, none of the three rules apply and the tax will not be discharged.  Also, certain types of taxes are never discharged.  These include what are called trust fund taxes, that is, taxes that you collect and are supposed to pay over to the government.  They usually arise only in business situations.  One is for sales taxes that you collected and did not pay over to the government, and the second is for taxes you withheld from an employee and did not pay over to the government.  Withholding taxes can arise where you have a household employee, such as a nanny or baby sitter to whom you give regular paychecks.

The final issue to note is what happens when the taxing authority has filed a tax lien.  A tax lien is like a judgment in a collection case and allows the taxing authority to garnish your salary or seize your bank accounts.  When a tax lien has been filed, the tax may be discharged but the taxing authority still has the right to execute on the tax lien.  They will not garnish your salary, but they do have the right to realize the full value of everything you own at the time of the filing of your bankruptcy case.  Thus is your bankruptcy schedules show that you have $4,500.00 in assets, the taxing authority can still go after that amount.  Generally, they will not seize your bank accounts, pick up your car of take your retirement benefits, but if you have future refunds due, they will keep them.

When a tax lien is filed, there is a procedure whereby your attorney can go into Bankruptcy Court and have the Court set forth the value of your assets, thus limiting the amount the taxing authority can take.  Of course, one way to solve the problem of losing future refunds is to adjust your withholding allowances so that there are no refunds to be taken.

 Allan Bloomfield practices bankruptcy law in Forest Hills, Queens. Contact Allan today for a free consultation.

About Allan Bloomfield

For over 30 years, my focus in practicing law has been to help people overcome what seems to them to be insurmountable financial difficulties. I have helped thousands of people file both Chapter 7 and Chapter 13 cases, and in most cases, they are able to keep all of their assets, including homes, cars, their retirement accounts and personal property.