As a CPA, tax professional, or enrolled agent, one of the most challenging aspects of your work may be assisting clients with bankruptcy discharge tax debt. The process of determining which tax debts are dischargeable in bankruptcy can be complex, and understanding the nuances of the bankruptcy code is essential to providing accurate and effective advice. In this in-depth guide, we will explore the ins and outs of bankruptcy discharge tax debt, offering valuable insights and practical tips to help you confidently guide your clients through the process. From identifying the specific criteria that must be met for tax debts to be discharged, to understanding the implications of various types of bankruptcy filings, this article will serve as an invaluable resource for professionals seeking to expand their knowledge and skill set in the area of bankruptcy and tax resolution.
Will bankruptcy eliminate tax debt?
Falling into debt can carry heavy emotional and social burdens in addition to financial hardships. Different solutions exist and one viable option may be bankruptcy, but that too can be shrouded in mystery. Filing bankruptcy can discard some debts (referred to as discharging) or formalize a manageable repayment plan. Specifics regarding tax liabilities and potential discharge of tax debts are subject to the many clauses of the United States Bankruptcy Code. Read more about tax debt forgiveness below.
Some taxes may be dischargeable
Bankruptcy does not automatically exonerate debtors from all debt liabilities but the bankruptcy court may discharge debts, including taxes. A court-ordered discharge permanently prohibits creditors from taking any further action against the debtor to collect certain specified types of debt. Additionally, debt canceled in a bankruptcy proceeding is not treated as income (although it does reduce other tax benefits if any were entitled). IRS Publication 908 outlines taxes that are not subject to discharge under Chapters 7, 11, 12, and 13.
Determine which tax debts may be discharged
Dischargeability may be determined by understanding your client’s particulars and if your client is subject to any of the 19 categories of exceptions under paragraph 523(a) of the Bankruptcy Code. While taxes that are inherently for the benefit of someone else (e.g. trust fund taxes) or penalties for fraudulent activities cannot be discharged by law, some taxes (e.g. income taxes meeting criteria) may be dischargeable. Four initial rules can help to determine if a tax debt may be discharged:
- Assessment is at least 240 days old
- Tax return was filed at least 2 years ago
- Tax return due date must be at least 3 years old (plus extensions)
- SFR (Substitute for Return) cannot have been filed on behalf of the client prior to bankruptcy (There are different opinions in the various courts. Please check with a qualified attorney in your district.)
The scope of a bankruptcy discharge is dependent on the Chapter under which the bankruptcy is filed as well as the nature of the debt.
Federal tax liens in bankruptcy proceedings
Exposure to federal tax liens is affected by multiple codes and subject to different levels of priority under the specific Chapter of bankruptcy filed. Federal tax claims not secured by a Notice of Federal Tax Lien (NFTL) filed before the bankruptcy petition might be able to be discharged. Federal taxes that are more than three years overdue may be dischargeable barring extenuating criteria.
Proof of Claim
Proof of Claim Forms must generally be filed by creditors, including the IRS, to receive funds. The debtor must notify creditors of the pending bankruptcy and it is considered “timely” if provided at least 30 calendar days prior to the deadline (also known as the bar date). If your client filed late or missed filing a claim completely, the circumstances under which the IRS may still demand payment become subject to the commencement of final distribution or filing of a special post-petition administrative claim by the IRS, and could possibly be disallowed.
Keeping Current
Different rules apply to the payment of taxes not discharged, generally ranging from immediate payment in Chapter 7 bankruptcy (as long as assets suffice) to 3-5 years in Chapters 11 and 13 filings. During repayment periods it is essential that your client keeps current with all subsequent tax returns and is up to date on associated obligations.
How IRS Solutions Software Can Help Tax Pros Manage Bankruptcy Discharge Tax Debt
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