Bankruptcy and Tax Obligations

In Chapter 7 bankruptcy, most of the debtor’s debt will be discharged.  However, some tax debts are not dischargeable in bankruptcy.  The obligation to pay taxes is one of the most rigid duties we all share.  In bankruptcy, this usually does not change.  Unless the taxes meet very specific elements required for discharge, the bankrupt debtor must still pay his or her taxes.

Generally, unsecured income taxes are likely to be discharged in bankruptcy proceedings.  Unsecured income taxes are taxes that are not secured by any kind of collateral or a lien.  Collateral is proposed as a borrower’s pledge of specific property to a lender, to secure repayment of a loan.  Similarly, a lien is a form of security interest granted to a lender over an item of property to secure the payment of a debt.   In order for the unsecured income tax to be discharged, the income taxes must have become due over three years before the bankruptcy filing and the tax must have been assessed over 270 days prior.  In order to discharge these older taxes, the taxpayer should have filed a timely and non-fraudulent return.

Still, most taxes have to be paid even after a bankruptcy filing.  As a result, debtors must file taxes yearly.  In addition, filing taxes is the only way tax debt can be determined.  In a Chapter 13 plan, the only way a bankruptcy plan can be constructed is if the bankruptcy trustee and the court knows exactly what the tax debt is.

For the above reason, in a Chapter 13 bankruptcy, the IRS will object to the bankruptcy plan if the debtor has not filed taxes.  It can object on several grounds including lack of good faith, lack of feasibility, or best interests of creditors. The IRS will want to confirm that the tax obligations are a part of the bankruptcy plan.  As a result, the IRS may request that taxes be assessed before any plan is implemented.

If the debtor has filed taxes properly, the IRS generally will not object to a Chapter 13 bankruptcy filing.  As long as the IRS can secure the tax debt it is owed, it will generally accept the methods proscribed.  Sometimes bankruptcy provides the best way for the IRS to obtain the tax payments because the debtor is able to adjust their debt obligations and create a plan that is reasonable for the debtor to stick to.

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