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Discharging Taxes in Bankruptcy

In order to discharge tax obligations in a bankruptcy case, all four of the following four conditions must be satisfied:

1. The tax must be the right kind of tax. Income taxes are the right kind. Fiduciary taxes, such as the taxes an employer withholds from its employee's pay and then is supposed to turn over to the taxing agencies, is the wrong kind of tax. The trust fund portion of fiduciary tax liability, i.e., the portion withheld, is never dischargeable in a bankruptcy case.

2. The tax must be one that has been due and owing for three years or greater. For example, the taxes owing for 2007 would become due and owing on 041508, and would therefore reach three years of age on 041611. However, if the debtor filed an extension in early 2008 for the 2007 income tax year, then the 2007 income tax year wouldn't become three years of age until 101611. Note that if the debtor filed an extension in early 2008 but still filed his 2007 tax return prior to 041608, i.e., he didn't "utilize" the extension, the taxes nonetheless still do not become three years of age until 101611.

3. The debtor filed his tax return for the year that he's hoping to discharge at least two calendar years prior to the filing of the bankruptcy petition. Note that it must be the debtor filing his own return. If the Internal Revenue Services files a substitute return for the debtor, the prong is not satisfied.

4. The taxing agency, whether it be the Internal Revenue Service or the state taxing agency, must have assessed the tax a minimum of 240 days prior to the date of the bankruptcy filing.

Note that just as with mortgages and auto loans, bankruptcy only discharges debts; it does not affect liens. So if the Internal Revenue Service or the state taxing agency has filed tax liens within the county in which the debtor owns assets, whether real estate or personal property, the liens will survive the bankruptcy filing and the Internal Revenue Service or state taxing agency is not required to release its liens. The taxing agencies might release the liens if requested to do so if the debtor owns nothing of significant value. Conversely, once the bankruptcy case is concluded, nothing prevents the Internal Revenue Service and/or state taxing agency from foreclosing on its lien and seizing liened assets.

If the Internal Revenue Service has liened an otherwise dischargeable tax year such that the lien survives bankruptcy, can the Internal Revenue Service then grab assets that the debtor acquires after bankruptcy? No. The tax lien would only be a lien against those assets that the debtor owned on the date of bankruptcy; assets acquired after bankruptcy would not be subject to the tax lien.

In a Chapter 13 proceeding, taxes are generally no more dischargeable than they are in a Chapter 7 proceeding. The difference is that in Chapter 13, the debtor must repay in full over the five year maximum duration of his proposed repayment plan all secured/liened tax obligations as well as priority tax obligations, i.e., those taxes not satisfying the four required conditions noted above. In exchange, as long as the debtor's repayment plan proposes to pay all such secured and nondischargeable tax obligations, the Internal Revenue Service and state taxing agency are stayed from attempting to collect their taxes other than through the proposed repayment plan, i.e., seizures, garnishments and levies must cease.

Note that real estate property taxes generally follow the property. In other words, if the debtor owns a home and intends to keep the home, then the debtor remains responsible for all unpaid property taxes, whether they accrued prior to bankruptcy or after. If the debtor loses the property to foreclosure, whether that foreclosure occurs before bankruptcy or after, then the property taxes become the responsibility of the next owner, and the debtor need not pay them.