For individuals who have fallen on hard times financially, bankruptcy can be a good way to obtain financial relief and gain a fresh start. There are two general types of bankruptcy that are available to consumers; Chapter 7 and Chapter 13. Chapter 7 is also known as a “straight bankruptcy” or “liquidation bankruptcy” in which qualifying debts can be discharged (i.e., forgiven). Chapter 13 is a court-supervised debt consolidation/repayment plan in which the debtor repays his/her debts over a three to five-year period with a more affordable monthly payment.
Most unsecured debts can be discharged with a Chapter 7 bankruptcy. Some common debts many consumers struggle with that can be eliminated through Chapter 7 include credit cards, unsecured personal loans, and medical bills. There are some unsecured debts, however, that you cannot get rid of through Chapter 7. Among the most notable non-dischargeable debts include student loans and most tax debts.
When can Income Taxes be Discharged through Chapter 7 Bankruptcy?
While most of the time, you are not allowed to eliminate federal income tax debt through a straight bankruptcy, it is possible to have income taxes discharged if you meet certain criteria:
- What you Owe is Actual Income Tax Debt: Tax debt cannot be discharged under any circumstances if it is anything other than income taxes. This would include payroll taxes (such as Social Security and Medicare), penalty assessments, and tax debt that has been converted into a tax lien and secured by your personal property.
- You did not File a Fraudulent Tax Return or Commit Willful Tax Evasion: You did not falsify any of the information on your return (e.g., use a false Social Security number), fail to report income, deduct expenses that are not allowed, or participate in any other activity that would be considered tax fraud or tax evasion.
In addition to meeting these two conditions, there are three other criteria that must be met having to do with the timing of the tax return due date, the date when the return was actually filed, and when the tax debt was finally assessed:
- The Three-Year Rule: The filing deadline for the tax return in question must have been at least three years prior to the date in which to file for bankruptcy. For most individuals, the annual deadline for filing your federal tax return is April 15. So, for example, if you filed for bankruptcy after April 15, 2019, you would meet the first qualification test for discharging income tax debt from the 2015 tax year, in which the filing deadline was April 15, 2016.
- The Two-Year Rule: If you meet the three-year rule, it is usually pretty easy to meet the two-year rule. The two-year rule applies to the date in which you actually filed your tax return. This date must be at least two years prior to the day you file for bankruptcy. Looking at the previous example, the filing deadline for the 2015 tax year was April 15, 2016, so as long as you filed your return on or before April 15, 2017 (up to one year late), you would meet the two-year rule.
- The 240-Day Rule: The income tax must have been assessed by the IRS at least 240 days (about 2/3 of a year) prior to filing for bankruptcy, or not assessed at all. In general, the tax assessment date is considered to be the same date the IRS receives and processes your tax return. However, that date could be different if the IRS audits your return later on and assesses a different amount.
Can you Discharge Income Taxes through Chapter 13 Bankruptcy?
Some consumers who do not qualify for Chapter 7 bankruptcy or do not want to go that route opt for a Chapter 13 bankruptcy. With this type of bankruptcy, unpaid income taxes will usually be considered priority debt, which means it must be paid back in full. However, if you owe actual income tax debt, you did not commit tax fraud or willful evasion, and you meet all the aforementioned timing requirements, your tax debt may be considered non-priority, in which case you might not have to pay it all back.
Speak with a Seasoned Alabama Bankruptcy Lawyer
Figuring out which tax debts can be discharged through bankruptcy can be complicated. There are specific guidelines that must be met, and it is important to work with attorneys who have extensive bankruptcy experience, so you can emerge from the process in the best possible financial position. For a personalized consultation with one of our experience Alabama bankruptcy lawyers, call our office today at (205) 244-1115 or 1-800-THE-FIRM. You may also message us through our online contact form.