The US Bankruptcy Code does not differentiate between Federal and state tax claims. Instead, the nature and type of tax claim dictate its treatment in a bankruptcy case. We will outline the terms in which state income and other state taxes are assessed, within this article.
For state income tax claims, these rules apply:
State Income Tax Claim Timing Rules
- Three Year Rule – The state income tax claim must have been incurred more than 3 years BEFORE bankruptcy. Taxes are deemed incurred at the later of the due date or the extended due date. Various acts (“Tolling Events”) of the taxpayer can extend the three-year rule including prior bankruptcies, Collection Due Process (CDP) hearings and related appeals, Offers-In-Compromise, amended returns, etc.
- Two Year Rule – If the state income tax return was filed late, it must have been filed more than two years BEFORE the bankruptcy case is filed. Moreover, the taxpayer must have prepared and filed the tax return, not the tax agency. Thus, an income tax return prepared by the state tax agency is not a tax return filed by the taxpayer. In states with income taxes, a new federal assessment typically triggers a state requirement to file or “report” the corresponding tax return adjustments to the state, and failure to do so on time can cause a violation of the two-year rule for that state tax claim.
- 240 Day Rule – Each state income tax assessment (there can be multiple assessments for each tax year – i.e., audit adjustment, amended return, etc.) must have been made more than 240 days before the bankruptcy filing (plus any period during which an Offer-In-Compromise was pending, plus 30 days). Like the three-year rule, this period may be extended by several tolling events
State Income Tax Claim Conduct Rules
- No Tax Evasion – The taxpayer must not have engaged in conduct that constitutes a willful attempt to evade or defeat the state tax payment.
- Non-Fraudulent Tax Return – The state income tax return must not have been fraudulent.
Other State Tax Claims
- State Property Taxes are non-dischargeable if assessed within one year of the bankruptcy case.
- State Payroll withholding taxes are non-dischargeable. However, if the responsible party penalty (for entity payroll withholding taxes), the responsible person is only liable for interest accrued from the assessment date. We would like to point out that trust fund taxes are not priority claims and hence dischargeable if secured (and thus not excepted from discharge).
- State Employment taxes on wages, salary, or commissions accrued for compensation paid within three (3) years of bankruptcy are non-dischargeable.
- State Sales taxes. It depends on state law. If determined to be a true sales tax, one that is imposed on the customer, it is not dischargeable as a trust fund tax liability. However, if the sales tax is determined to be imposed upon the retailer for the privilege of doing business, it is an excise tax. Then, if the transaction giving rise to the tax occurred more than three (3) years before the bankruptcy, it is dischargeable. Note that if the sales or excise tax requires that a tax return be filed, it will be dischargeable in Chapter 7 and Chapter 13 only if the required tax return was filed at least 2 years before the bankruptcy filing.
At Tax Workout Group, we craft innovative and tailored solutions with one goal: resolving federal and state tax claims in bankruptcy. Our tax bankruptcy attorneys are ready to provide guidance and representation to businesses struggling with business debt and Federal and state tax claims (payroll and employment taxes, sales and use taxes, excise taxes, property taxes, and income taxes).
