January 26, 2010 - William L. Henry IV
Bankruptcy is the legal process designed to help individuals, families, and businesses restructure or eliminate their debts. That said, many debts are nondischargeable. Federal and state taxes are dischargeable only in certain circumstances.
Whether the tax will be discharged in bankruptcy generally depends on the type of tax or penalty (economic or noneconomic), the non-filing or late filing of the tax return, the priority of the tax in bankruptcy, and whether the tax liability is secured by a recorded tax lien. If a tax debt is not discharged in bankruptcy, the IRS can levy your bank accounts, garnish your wages, and impose tax liens on your property after the bankruptcy discharge.
Our bankruptcy attorneys and tax attorneys work together to determine if your tax debt is dischargeable. For example, if the claim is secured by a recorded federal tax lien, then even if tax underlying the tax lien is discharged the lien may remain (to the extent of the fair market value of the property). Likewise, if the tax is an eight priority tax claim, for example, taxes assessed within 240 days of the filing, income tax for which the due date of the return (including extensions) was within three years of the date that the bankruptcy petition was filed, or employment taxes, the tax will not be discharged. Also, non-filed and late filed tax returns filed within 2 years of the bankruptcy petition will not be discharged. The date of assessment, which normally occurs after a notice of deficiency, is usually the critical date for determining if the tax will be discharged.
Finally, a perfected lien that is not subordinated or set aside by the bankruptcy court will pass through bankruptcy unscathed to the extent the liability it secured is not satisfied. Practically, that means that if the IRS has filed a Notice of Federal Tax Lien, and it is secured by property that was exempt or excluded from the bankruptcy estate (or abandoned by the bankruptcy trustee), the tax debt will not be discharged. If the debtor receives a discharge in bankruptcy, but the liens survives as discussed above, then the debtor is generally not personally liable for the debt. The IRS can, however, bring an action (such as foreclosure) to collect the debt. Further, the lien remaining after bankruptcy may continue to impact your credit rating and make it difficult to sell your home because the loan must be released or subordinated before the sale can close. An offer in compromise to remove a federal (IRS) tax lien where the debtor no longer has personal liability is not effective.
If you attempt to settle your tax debts with the IRS before you file for bankruptcy, however, you may be in a better position to settle your tax debts. For example, the IRS may be willing to settle your tax debts if it believes that it could collect more money from you before bankruptcy than after bankruptcy. The determination is complex and requires an analysis of such things as the exempt and non-exempt bankruptcy property. Our tax attorneys and bankruptcy attorneys can determine if waiting until after...