The “right kind” of payroll taxes can be dischargeable.

Federal payroll taxes are of two kinds: Form 941 payroll withholding taxes and Form 940 employer payroll contribution taxes. The 940 tax, known by the acronym “FUTA,” consists entirely of employer contributions. No portion of this type of tax is withheld from the employee’s wages.

For this reason, FUTA taxes are dischargeable to the extent that said taxes meet the standard requirements for discharging taxes in bankruptcy [In re Zecco, 211 B.R. 109 (Bkrtcy. D. Mass. 1997)], to wit: a) the tax must be more than three years old, b) the tax return must be filed more than two years before the bankruptcy, c) there has been no attempt to evade the tax, and d) the tax is not subject to a tax lien (i.e., the tax liability has not become a secured obligation).

Even if the payroll tax is subject to a lien, most IRS liens are subject to being attacked. Any lien – including any tax lien – can be avoided entirely to the extent that the lien does not attach to property, or it may be crammed down (i.e., reduced in value) to the extent that the IRS lien exceeds the value of the property to which it purportedly has attached. Since most tax liens do exceed the value of the property to which they attach, most tax liens end up being partially unsecured, and subject to being successfully attacked by an bankruptcy attorney skilled at attacking and cramming down liens.

941 taxes, commonly known as FICA, are primarily – but not exclusively – trust fund payroll taxes. That portion of 941 payroll taxes which are the employee’s contribution – and which are withheld from the employee’s pay check and transmitted by the employer to the IRS – are trust fund taxes. They are always non-dischargeable. Not only does the failure by the employer to transmit such trust fund payroll taxes create a non-dischargeable employer tax liability, but such corporate tax liability can be assessed against the corporate officer/director who was responsible for transmitting the payroll tax to the IRS, but who failed to transmit it.

However, 941 taxes also include some employer contributions. Typically, about two-thirds of the 941 taxes are employee trust fund payroll taxes and about one-third of the 941 taxes represent employer contributions. The employer’s 941 payroll tax contribution is not a trust fund tax; hence, the employer’s 941 payroll tax contribution is dischargeable, if it meets the general requirements for discharging taxes.

To the extent that the payroll tax is not dischargeable in bankruptcy, it may be possible to negotiate a reduction of the tax liability through an Offer in Compromise.

One Response to The “right kind” of payroll taxes can be dischargeable.

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