Tax professionals regularly refer their clients to me to determine if any tax liabilities can be discharged in Bankruptcy. Here are the general rules

  1. Sales tax and Payroll taxes that a business withholds are non dischargeable.
  2. Income taxes that are not filed are not dischargeable
  3. Income taxes based upon a return which the IRS filed for you are not dischargeable
  4. Income taxes based upon a fraudulent return are not dischargeable.
  5. Income taxes that have been filed can be discharged if (i) more that 3 years have passed since the return was due; (ii) more than 2 years have passed since the return was filed; and (iii) more than 8 months have passed since any assessment has been made [that period is extend while a bankruptcy or an offer-in-compromise is open during that 8 month period]

Once we know whether a particular tax liability can be discharged, we determine if there would be an advantage to waiting a little longer, to include a more recent period.

if a tax is non-dischargeable, then the interest is also non-dischargeable. Penalties (except penalty assessments against business owners to make them personally liable for the business’s payroll taxes) can be discharged.

The next step is to determine if a chapter 7 or a chapter 13 filing would be the best course of action. In chapter 7, dischargeable taxes can be wiped out, but not everybody is eligible for chapter 7. This depends upon whether most of your debt is consumer debt or business debt.

Even if you are eligible for a chapter 7 case, it might not be a good idea, if you will risk losing certain assets, or if relatives might be sued by a bankruptcy trustee.

If a debt is non-dischargeable, chapter 13 can be used to pay it over 5 years without interest.   But if husband and wife are both liable, they should both file chapter 13: if they don’t then the non-filing spouse could be liable for the interest when the five-year payment plan is completed!

If there are risks to a chapter7 bankruptcy, a chapter 13 payment plan can be used to pay non-dischargeabile taxes, sometimes at less than 100%.

This is a complicated subject and must be analyzed carefully on a case-by-case basis: a false step could be sadly regretted.