Consideration #1: The Basic Rules for Taxes in Bankruptcy
It’s easy to rattle off the rules regarding the dischargeability of taxes in a bankruptcy case:
- The tax must have come due at least 3 years before the filing of the case. (§507(a)(8)(A)(i))
- An actual return must have been filed at least two years before the case is filed. (§523(a)(1)(b)(ii))
- The tax must have been assessed by the IRS, if at all, at least 240 days before the filing of the case. (§507(a)(8)(A)(ii))
- You can’t have committed fraud or willful evasion. (§523(a)(1)(C))
- Only income tax can be subject to discharge.
Sounds great, right? Let’s say it’s February 2018. You had a tax liability for 2013, which came due on April 15, 2014. That’s more than 3 years ago. You filed a return on time, and you and the IRS agree to the amount owed (and hence, as a practical matter, it’s assessed). It’s income tax, and you’re not a member of a tax deniers group. You can file a bankruptcy case and it’s all gone, right? Not so fast.
Consideration #2: Is There a Lien?
When you file a bankruptcy case, the law puts your tax debt into three categories: Priority, Secured, and Unsecured. Any tax that does not meet the 3 year/2 year/240 day rules above is subject to “priority,” and that’s the reason why it’s not going to get discharged.
But then you take a look at all that remaining non-priority tax. If the IRS has not recorded a lien, then great! All of the remaining tax goes into the “unsecured” and is subject to discharge.
However, if the IRS has recorded a lien, then you take a look at your assets. You add up the value of all your assets: equity in your home, in your vehicle, money in the bank, personal belongings, everything. (Everything, that is, except funds in ERISA-qualified retirement accounts such as 401(k)s.) Whatever the value of all that is, an equal amount of the non-priority tax becomes “secured.” And so, that amount doesn’t get discharged either, but for a totally different reason.
Thus the question of whether there is a lien becomes very important. If there is, the only amount that will be subject to discharge will be the amount that’s left after a) you subtract the priority amount, and b) you subtract the secured amount.
Consideration #3: Your Assets and Income
Let’s say you’ve gotten this far and it’s looking good. All your tax is old and you filed your returns on time, and there’s no lien. Next you have to look at your assets and income. This is more a question of basic bankruptcy law than tax law.
If you file a Chapter 7 case, the law puts your assets into different categories, and then puts caps (“exemptions”) on those categories. If you have assets over those caps, a Chapter 7 trustee has the authority to liquidate those assets and divvy up the proceeds amongst your creditors.
So even if all of your tax debt falls into the “unsecured” category, if you have significant assets (such as a house with lots of equity), the IRS is still going to get at least partially paid: they will get a portion of the proceeds from the trustee’s distribution.
If you file a Chapter 13 case, the Trustee does not have the authority to liquidate your assets. However, the Court cannot confirm your Chapter 13 Plan unless your creditors get paid at least as much as they would receive in a hypothetical Chapter 7 case. So whatever the IRS would get if you filed Chapter 7, your Chapter 13 Plan must propose to pay them at least that much over 5 years.
There’s also a consideration of income. Even if all your tax debt is non-priority and unsecured, and even if your assets are below the exemption caps, there is a thing called the Means Test. This is a calculation that tries to come up with an amount that you can supposedly afford to pay to your unsecured creditors through your Chapter 13 Plan. Again, the Court cannot confirm your Chapter 13 Plan unless it pays your creditors what the Means Test says you can afford. And so again, the IRS would at least get something.
It’s Complicated, But There Is Help (and Hope!)
Dealing with taxes in bankruptcy is more complicated than just knowing the dischargeability rules. But perhaps I’ve depicted it as overly complicated here. It’s not really; these are concepts that any experienced bankruptcy lawyer is going to be readily familiar with. What’s more, I have represented a large number of clients in getting rid of a large amount of tax debt. It’s the rare case in which the Bankruptcy Court doesn’t have any kind of assistance to offer.
I post this because I know that there is a great deal of misunderstanding out there about what happens to taxes in bankruptcy, both on the part of individuals and on the part of professionals helping them. It may be more complicated than you think, but there is also more that the Bankruptcy Court can accomplish for you than you think, and only an experienced bankruptcy lawyer can sort it out for you.