Income Taxes Can Be Discharged

Income taxes can be discharged in bankruptcy if the tax meets the following criteria:

1) The tax is at least 3 or more years old, measured from the time the tax is due;

2) The tax return for the year in question must have been filed at least two years prior to the filing of the bankruptcy;

3) The taxing authority has three years in which to assess a tax liability; once assessed, the taxing authority has 240 days in which to collect the assessed tax, during which time the tax retains its collection priority (i.e., it must be paid);

4) The tax must be the type of tax that is dischargeable [i.e., income taxes, excise taxes, which (in California) include sales tax, and the employer’s portion of payroll taxes]; and

5) There can be no tax evasion (i.e., the willful attempt to evade paying taxes, such as by failing to report all income, or by reducing taxable income by falsifying expenses or tax deductions).

Obtaining one’s tax transcripts helps in determining whether or not the tax year in question is dischargeable. In Chapter 13 cases, tax penalties are dischargeable, even when the underlying income tax is not old enough to be dischargeable; also, in Chapter 13 cases, interest (generally) stops accruing on pre-petition tax claims once the bankruptcy is filed. In Chapter 7 cases, the tax penalty is dischargeable only if the underlying tax is dischargeable, and interest continues to accrue on any tax liability that still retains its priority.

Chapter 13 is a great way to deal with delinquent tax debts – especially if (as is typically the case) the tax payer has other substantial debts (including, but not limited to, credit cards, personal loans, medical bills, or an auto repossession). A Chapter 13 bankruptcy will allow the debtor to pay those non-dischargeable taxes which have to be paid, while simultaneously discharging all dischargeable unsecured debts – including dischargeable taxes.

A bankruptcy generally will discharge any debt resulting from debt forgiveness, because insolvency is a defense to tax liability based on debt forgiveness, and bankruptcy is evidence of insolvency.

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