How to Discharge Tax Debt Explained By Ex-IRS Attorneys

Our tax bankruptcy attorneys are experts in taxing agency practice and procedure and the interrelationship between federal and state tax laws and the US Bankruptcy Code. In each case, they prepare a comprehensive Tax Dischargeability Report, reviewing and analyzing each tax claim and all events related to that tax claim. This allows us to achieve the best possible result for each client by filing the most appropriate type of bankruptcy at the optimal time to eliminate tax claims, penalties, and interest to the greatest extent possible, along with all other dischargeable debt. Our Tax Dischargeability Analysis is the cornerstone of each bankruptcy filing and essential for understanding the proper treatment of the tax claims to file the best type of bankruptcy at the most advantageous time.

What Type of Tax Debt is Dischargeable

In most cases, the type of tax involved is “income” taxes. However, when a business is involved, payroll, employment, sales, property, and excise taxes may be involved. The good news is that most of these tax claims can be discharged in either a Chapter 7, Chapter 13, or a Chapter 11 bankruptcy case, even if you or your business own assets with equity. In addition, even if a particular tax claim is not dischargeable, oftentimes bankruptcy allows you to pay that tax claim over time and without penalties and interest (which, otherwise, is compounded daily). At Tax Workout Group, we perform a comprehensive “Tax Dischargeability Analysis” (TDA). We analyze each tax claim to file the right type of bankruptcy and then file it at the right time to ensure the maximum discharge of all tax claims, penalties, and interest. If we recommend delaying the bankruptcy filing to maximize the discharge of your tax claims, we will represent you before the IRS or state taxing agency throughout the delay and during the bankruptcy case.

Employment Tax Claims – are dischargeable if they relate to wages, salaries, or commissions accrued for compensation paid more than 3 years before the bankruptcy filing.
Sales Tax Claims – are dischargeable if they are imposed on the retailer for the privilege of doing business and arise from transactions occurring more than 3 years before the bankruptcy case filing.
Property tax Claims – are dischargeable if incurred before the commencement of the case and last payable without penalty more than one year before the bankruptcy case filing.
Excise Tax Claims – are dischargeable if they arise from transactions occurring more than 3 years before the bankruptcy case filing.

Which Tax Claims are Not Dischargeable?

Income Tax Claims – If the rules above are not satisfied.
Trust Fund Tax Claims – While trust fund tax claims are not dischargeable, it is important to note that there is still hope. We regularly litigate what constitutes a “trust fund” liability and whether the taxpayer is “responsible” for it. Thus, an avenue to explore may remain even in a trust fund tax claim case.
Employment Tax Claims – Taxes on a wage, salary, or commission accrued for compensation paid within 3 years of the bankruptcy are nondischargeable. These taxes are typically “accrued” on April 15th, following the close of the taxable year in which the quarter falls. However, they are dischargeable if the taxes are paid more than 3 years after the bankruptcy filing.
Sales Tax Claims – If the sales tax is determined to be a true sales tax, one that is imposed on the customer, it is not dischargeable as a trust fund tax. If the sales tax is determined to be imposed upon the retailer for the privilege of doing business, it is an excise tax and dischargeable if the transaction giving rise to the tax occurred more than 3 years before the bankruptcy.
Excise Tax Claims – Excise taxes are dischargeable if they arise from transactions occurring less than 3 years before the bankruptcy case filing.
Property Tax Claims – Property Taxes are non-dischargeable if incurred before the commencement of the case and last payable without penalty less than one year before the case filing.
Fraudulent Tax Claims – The tax return filed must not have been fraudulent.
Willful Attempt to Evade or Defeat the Tax – The issue of what (conduct and mental state) constitutes a willful attempt to evade or defeat the tax is unclear. Typically, evidence of willful evasion for one tax period cannot render a tax for a different period non-dischargeable. The courts define “willful attempt to evade or defeat the tax” differently – most apply the criminal standard (where mere omission is not sufficient), and others employ a civil standard where they define willful as being a voluntary, conscious, and intentional act.
Erroneous Tax Refund Claims – Recent court cases have established that refund claims bear the same character as the underlying tax claims they relate to.

Note – Any debt incurred to pay non-dischargeable taxes is now non-dischargeable in Chapter 7. However, these claims remain dischargeable under Chapter 13.

What is the Process of Discharging Tax Debt?

There are no bankruptcy code sections that statutorily define which tax claims are dischargeable; instead, one must examine various sections of the bankruptcy code to determine which tax claims are not dischargeable. Depending on the facts and circumstances surrounding each tax claim, most tax debt can be discharged in bankruptcy.

In the case of income taxes (gift taxes follow the same rules), once the tax claim was incurred (based on the later of the due date or the extended due date of the return) more than three (3) years before the bankruptcy filing date and assessed more than 240 days beforehand, there is a strong likelihood that the tax is dischargeable in either a Chapter 7, 13 or 11 bankruptcy filing. However, this assumes that the taxpayer filed a tax return (before the IRS filed one for the taxpayer) and that if the taxpayer filed it late, more than two (2) years have passed since it was filed. In addition to the timing rules described above, certain conduct rules provide that the taxpayer must not have engaged in conduct that constitutes a willful attempt to evade or defeat the tax, and the tax return filed must not be fraudulent.

Different rules relating to the timing of transactions involving sales taxes, excise taxes, property taxes, employment taxes, and penalties dictate when those claims can be discharged. We review the timing of all transactions to determine the proper timing and the best type of bankruptcy filing. Note that even in the few instances where a tax claim may not be fully dischargeable in Chapter 7, a Chapter 13 (or Subchapter V, in the case of a business debtor) proceeding may allow the taxpayer to eliminate the tax claim or at the very least, pay it without penalties and interest.

Interest

If the income tax claim is dischargeable, any interest accrued with respect to that income tax claim is also dischargeable (assuming there are no tax liens attached to the property before the bankruptcy). However, even if the income tax claim is not dischargeable because it violates one of the above timing rules, it can still be repaid in bankruptcy without interest.

Penalties

Tax penalties, including tax fraud penalties, are dischargeable if (a) they are related to a dischargeable tax claim or (b) the event giving rise to the penalty occurred more than three years prior to the filing of the bankruptcy case.

Tax Workout Group Specializes in Handling These Tax Matters!

At Tax Workout Group, we craft innovative and tailored solutions with one goal in mind—resolving tax claims in bankruptcy. Our clients hire us to ensure that they eliminate or otherwise reduce their tax claims to the greatest extent possible. We Do What Matters Most: Focus on eliminating tax debt in bankruptcy—plain and simple.

Let us help you receive a fresh start, one free from the claims of all your creditors—including the taxing agencies. Contact us for a free consultation today.