Navigating the realm of personal finance can sometimes be likened to a treacherous path with pitfalls and challenges. One such challenge for many individuals is the inability to repay mounting income tax debts. However, in certain situations, the United States bankruptcy code offers a potential remedy. It’s a common misconception that tax debts cannot be discharged in bankruptcy. The reality is that, under certain conditions, they can.
1. Different Types of Bankruptcy
Before delving into the specifics of tax discharge, it’s crucial to understand the two primary types of personal bankruptcy:
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Chapter 7: Also known as a “liquidation bankruptcy,” this allows debtors to discharge unsecured debts after non-exempt assets have been sold and the proceeds distributed to creditors.
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Chapter 13: Referred to as a “reorganization bankruptcy,” this allows debtors to create a three- to five-year repayment plan to pay off a portion or all their debts. Upon completion of the plan, remaining unsecured debts may be discharged.
2. The “Three-Year, Two-Year, 240-Day” Rule
For income tax debts to be eligible for discharge under Chapter 7 or Chapter 13, they must meet the following criteria:
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Three-Year Rule: The tax return must have been originally due at least three years before the bankruptcy filing.
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Two-Year Rule: The tax return (whether filed on time, late, or amended) must have been filed at least two years before the bankruptcy filing.
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240-Day Rule: The tax debt must have been assessed by the IRS at least 240 days before filing for bankruptcy. This period can be extended if there was a prior bankruptcy filing or an offer in compromise was made.
3. Other Key Considerations
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Tax Evasion or Fraud: If you have been found guilty of intentionally evading tax payments or committing tax fraud, you won’t be able to discharge the debt.
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Secured vs. Unsecured Tax Debts: While unsecured tax debts might be dischargeable, secured tax debts (those with a tax lien attached to your property) won’t be. The lien remains, even if personal liability for the debt is discharged.
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Tax Return Filed on Time: If you did not file a return, or if the IRS filed a substitute return on your behalf, the tax debt from that return is generally not dischargeable.
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Certain Taxes are Exempt: Payroll taxes or “trust fund” taxes cannot be discharged. Additionally, penalties for tax infractions that aren’t specifically tied to a tax debt might not be dischargeable.
4. The Advantage of Chapter 13
While Chapter 7 might entirely eliminate qualifying tax debts, Chapter 13 offers other benefits. It can allow individuals to repay non-dischargeable tax debts over a three to five-year period without interest and penalties accumulating during the bankruptcy case.
5. Seek Professional Guidance
Deciding whether to file for bankruptcy and understanding which debts can be discharged is a complex process. It’s imperative to consult with both a tax professional and a bankruptcy attorney to ensure you’re making the best decisions for your individual situation.
In conclusion, while discharging income tax debts in bankruptcy is possible, it’s bound by specific rules and conditions. By familiarizing oneself with the intricacies and seeking expert counsel, individuals can find the best path to financial recovery.