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What Type of Tax Debt is Dischargeable in Bankruptcy?

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Bankruptcy allows debtors to discharge a wide range of unsecured debts, with some notable exceptions. These exceptions include court-ordered family obligations such as alimony and child support, student loans in most cases, and court fines and fees. Tax debt is also typically included on the list of non-dischargeable debt. Certain types of tax debt, however, can be discharged, or wiped clean in bankruptcy. Read on for a discussion of how tax debt is treated in bankruptcy, and call a savvy Poughkeepsie bankruptcy lawyer to explore your options for debt relief.

Chapter 7: Discharging Federal Income Tax

The majority of back taxes are not dischargeable in bankruptcy. Property tax, sales taxes, certain employment taxes, and others are not subject to discharge. However, under certain circumstances, income tax can be discharged. Income tax is the only kind of tax debt dischargeable in bankruptcy, with limitations.

Federal income tax may be discharged if the following rules are met:

  • The debt is income tax. Other types of taxes are not dischargeable.
  • The debtor has not filed a fraudulent tax return or otherwise willfully avoided paying their taxes. If the debtor tried to get around their taxes or otherwise defraud the government, they will not benefit from the income tax exception.
  • The debtor filed a tax return for the subject debt at least two years before filing for bankruptcy. Typically, if the debtor filed a late return (meaning the debtor’s extensions expired and the IRS filed a substitute return on their behalf), then the debtor did not file a “return” and the tax debt cannot be discharged.
  • The tax debt was originally due at least three years before the bankruptcy filing. More recent taxes cannot be discharged.
  • The 240-day rule. The IRS must have assessed the income tax debt at least 240 days (eight months) before the debtor filed a bankruptcy petition.

If all five of these conditions are met, the federal income tax may be discharged in bankruptcy. If any element is not met, then the tax debt is not dischargeable. Bankruptcy can still help free up resources to pay off back taxes, however, so it is still often a worthwhile strategy for dealing with tax debt even when the debt itself can’t be discharged.

Chapter 13: Relaxation of Tax Debt

Chapter 13 also offers a road to lessening tax debt. Most tax debts will be listed as “priority debt” and can be repaid over the three or five-year repayment plan, which eases much of the burden on the debtor. Additionally, income tax that meets the criteria for dischargeability under Chapter 7 can be labeled as non-priority and unsecured.

Non-priority, unsecured claims will only be repaid after priority debts are repaid, and most debtors can get away with paying back only a portion of those claims during the repayment period. So long as the debtor continues to file all required tax returns and pay newly-assessed taxes during the repayment period, then unpaid non-priority, unsecured income tax debt can be discharged at the end of the repayment period.

If you are struggling with debt in New York, contact the experienced and thorough Hudson Valley bankruptcy lawyers at the Law Office of Taran M. Provost, PLLC for a free consultation on your case at 845-675-3243.

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