Bankruptcy and Tax Consequences

Find out how bankruptcy can help you solve your tax problem.

Bankruptcy can be a powerful tool to help people solve tax problems. Not all tax debt will go away in bankruptcy, however—in fact, most won’t. Even so, in the right situation, both Chapter 7 and Chapter 13 bankruptcy can provide solutions that will help you take care of your tax debt.

Taxes That Never Go Away in Bankruptcy

Some kinds of taxes are nondischargeable in bankruptcy—they’re never going to be wiped out. For instance, if you have a business, and you collect “trust fund” taxes on behalf of the government, such as sales or employee withholding taxes, and you fail to turn them over, you’ll have a problem. Why? You can’t discharge them in bankruptcy.

Not only that, the individual responsible for collecting trust fund taxes—as well as the business entity—will be held personally liable for payment of those taxes.

Discharging Income Taxes in Chapter 7 Bankruptcy

You’re likely already aware that taxes don’t usually go away in bankruptcy. It’s true. But while it’s difficult for many to meet the standards necessary to wipe out this type of debt, it can happen. Here’s what you’ll have to do.

  • File your tax returns on time. If you don’t file your return in a timely fashion—or at all—then the taxes owed for that year won’t be dischargeable.
  • Allow three years to pass. If you file for bankruptcy less than three years after your taxes came due, the taxes owed will not be dischargeable. Suppose that you filed your 2012 taxes on April 15, 2013. You’d fulfill this requirement if you filed for bankruptcy on May 1, 2016, because more than three years would have passed.
  • File an accurate return. You risk not receiving a discharge if your return is inaccurate. How will you know? The taxing agency will inform you that it found a problem and that you owe more tax than you claimed. If you file a fraudulent return, meaning that you knowingly misrepresented your income or deductions to avoid paying the appropriate amount, you won’t receive a discharge.

Although it’s likely that your taxes will get wiped out if you follow these rules, it isn’t always that easy. If the primary reason for filing for bankruptcy is to get rid of your tax debt, you should consult with a knowledgeable bankruptcy attorney.

When a Chapter 13 Bankruptcy Might Help

If you owe nondischargeable tax of any kind, you might want to consider filing a Chapter 13 bankruptcy. The fact that the amount you owe will be spread out over a three- to five-year repayment plan might help by giving you additional time to repay the tax. For instance, this can be a good way for a small business owner to repay outstanding trust taxes (although the business debts will not be included in the bankruptcy unless the owner is a sole proprietor). Whatever your situation might be, it is important to get good legal counsel to help you determine whether filing for Chapter 13 bankruptcy is a good option for you.

What Happens to Penalties and Interest?

If you owe taxes, you likely owe penalties and interest, too. The rule here is simple: If you can discharge the tax, then you can discharge the penalties and interest. If the tax isn’t dischargeable, then neither are the penalties and interest.

Other Tax Consequences

It’s not easy to fully understand—or even predict—whether your taxes will go away in bankruptcy. Additionally, filing bankruptcy might have an impact on your tax return. It’s important to consult with a lawyer—or possibly an accountant—experienced in handling these matters to ensure that you receive reliable advice and guidance.

Questions for Your Attorney

  • Will my taxes get discharged in Chapter 7 bankruptcy?
  • If I file for Chapter 13 bankruptcy, how much will I have to pay each month?
  • Will I owe any taxes after my case concludes?
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