You may hear radio commercials offering the hope of eliminating income tax debts in bankruptcy. But it’s not as simple as it sounds.
For example, if the income taxes you owe are for one of the last three tax years, then they can’t be wiped out (discharged) in bankruptcy — you’ll continue to owe them at the end of a Chapter 7 bankruptcy case, or you’ll have to repay them in full in a Chapter 13 bankruptcy repayment plan.
If you need to discharge tax debts, Chapter 7 bankruptcy will probably be the better option — but only if your debts qualify for discharge (see below) and you are eligible for Chapter 7 bankruptcy (see “What Is The Means Test in Bankruptcy?”).
You can discharge (wipe out) debts for federal and state income taxes in Chapter 7 bankruptcy only if all of the following conditions are true:
1. You did not commit fraud or willful evasion. If you filed a fraudulent tax return or otherwise willfully attempted to evade paying taxes, such as using a false Social Security number on your tax return, bankruptcy can’t help.
2. The debt is at least three years old. To eliminate a tax debt, the tax return must have been originally due at least three years before you filed for bankruptcy.
3. You filed a tax return. You must have filed a tax return for the debt you wish to discharge at least two years before filing for bankruptcy.
4. You pass the “240-day rule.” The income tax debt must have been assessed by the IRS at least 240 days before you file your bankruptcy petition, or must not have been assessed yet. (This time limit may be extended if the IRS suspended collection activity because of an offer in compromise or a previous bankruptcy filing.)
If your taxes qualify for discharge in a Chapter 7 bankruptcy case, your victory may be bittersweet. This is because bankruptcy will not wipe out prior recorded tax liens. A Chapter 7 bankruptcy will wipe out your personal obligation to pay the debt, and prevent the IRS from going after your bank account or wages, but if the IRS recorded a tax lien on your property before you file for bankruptcy, the lien will remain on the property. In effect, this means you’ll have to pay off the tax lien in order to sell the property.
If you would like to speak with a knowledgeable attorney regarding the discharge of taxes in bankruptcy, contact me today to schedule a FREE initial consultation. Just fill out the Contact Dan form on the far right side of the page and click the Submit button and I’ll get back with you as quickly as I can. Or just pick up the phone and give me a call at 918-615-8260. I’ll answer all of your questions in plain English so that you’ll have the information you need to make the decisions that will help you the most.
{ 4 comments… read them below or add one }
Hi Dan,
I filed Chapter 13 last March and it was confirmed in January of 2010. I owed back taxes of $900 and it was covered in my Chapter 13 filing, which is now part of my repayment plan. Will the IRS take the $900 from my tax return this year and send me a check for the difference? My anticipated tax return this year is $1400. Or, because the back taxes of $900 was included in the filing and is now part of the payment plan, will my refund be the original $1400?
I realize I have to remit my refund to my trustee, I just want to know for my own education.
Dan,
You don’t say where you live, but as I am licensed to practice law only in Oklahoma, I cannot give advice to those who do not live in Oklahoma.
I will say that for clients of mine who are paying back taxes to the IRS through a confirmed Chapter 13 plan, the IRS is bound by the terms of the confirmed plan and is prohibited from intercepting future income tax refunds for purposes of set-off as you describe.
Dan Nunley
Hello sir,
I lost a house to foreclosure in Nevada ( we moved here to Oklahoma and bought a property using a HELOC, a 2nd loan on that property in Nevada), and also have other debts to various creditors. I was told (by an attorney) that I should file my 2009 income tax return and spend the refund before I file for bankruptcy for I am insolvent (unemployed). Is there a certain amount I need to come in under maybe to get a refund of $1,500.00 or less in order to spend it? Is it capped at a certain amount so the creditors get something from us filers?
Thank you sincerely,
Jim
Jim,
The most conservative advice I can give you regarding protecting an income tax refund is to get your refund and spend it on reasonable and necessary expenses before you file bankruptcy. If you do that, the refund does not become an asset of the bankruptcy estate once you file and you cannot be forced to turnover the refund.
If you file bankruptcy before you get your refund, whether or not you will be able to keep a portion or all of the refund depends on several issues including most importantly what exemptions you will be using to determine whether your assets are exempt or non-exempt property. If you have lived in Oklahoma for 91 days, you can file bankruptcy here but you can’t use Oklahoma exemptions unless you have lived here two years. Oklahoma exemptions allow you to exempt only that portion of an income tax refund that is due to the earned income credit. Any refund not due to the earned income credit is subject to being taken by the Chapter 7 trustee. Whether the trustee takes the refund depends on the amount of the refund and the dividend that amount would pay to your unsecured creditors. However, if you moved to Oklahoma from Nevada less than two years ago, then you will have to use either Nevada or federal exemptions and their treatment of income tax refunds is different than Oklahoma exemptions.
I would suggest that you contact a knowledgeable bankruptcy attorney to discuss your specific situation and follow his/her advice. You may want to use the Attorney Finder provided by the National Association of Consumer Bankruptcy Attorneys. I wish you well.
Dan Nunley