Tax Impact of Bankruptcy Under Chapter 7 and Chapter 13
For taxpayers who are struggling to pay other creditors in addition to their tax debts, filing bankruptcy may be an option. Taxpayers feeling pressure from IRS collection actions know that once the IRS assesses tax and provides notice of demand for payment, the generally IRS follows up with increasingly aggressive enforcement strategies to collect the tax debts, including filing tax liens and tax levies.
Other creditors generally have difficulty competing with the IRS once the IRS has filed a Notice of Federal Tax Lien on all of a taxpayer's property. Further, tax liabilities are not easily discharged in bankruptcy and require careful planning and analysis to confirm that the tax debts will be discharged and the tax lien will not continue after the bankruptcy is completed. Taxpayers who have unfiled tax returns generally will not benefit from filing bankruptcy to reduce the tax debts, but bankruptcy may provide a taxpayer with the ability to reorganize and pay the debt off over time.
What Tax Liabilities are Subject to the Bankruptcy Rules?
Federal and state tax liabilities are subject to specific rules under the U.S. bankruptcy code. The bankruptcy code further complicates the tax related rules by distinguishing between liquidations under Chapter 7 and adjustments of personal debt under Chapter 13. Taxpayers must review their options to determine whether they qualify to file Chapter 7 or 13 bankruptcy and if their objectives will be achieved. Bankruptcy does not resolve tax debts if they are not discharged or if the IRS enforces its lien on exempt property the debtor keeps after bankruptcy.
Can Tax Debts be Discharged for Unfiled Tax Returns?
In general, if a taxpayer has not filed tax returns for certain years, any tax debts related to those unfiled tax returns will not be discharged in bankruptcy. When a taxpayer files the return, even if the return relates to a tax year before the bankruptcy filing, the IRS will be able to assess and demand payment for the debt, with all related enforcement methods available if the taxpayer does not pay the tax. Further, bankruptcy filings require proof that certain tax returns have been filed, so unfiled tax returns must be filed to receive bankruptcy protection. Taxpayers looking to eliminate expected tax debts related to unfiled tax return years generally must use a different tax relief method than bankruptcy.
If you have thought about bankruptcy and have tax debts, you should consult a tax attorney who specializes in tax resolution and bankruptcy law to determine if your tax debts may be reduced or eliminated in a bankruptcy filing. If your primary debts are tax debts, a bankruptcy filing is likely not the best option given the other options available to taxpayers under U.S. tax law.
Debtors should consider non-bankruptcy tax resolutions or understand that additional steps may be required post-bankruptcy discharge to reduce or eliminate tax debts. Debtors should have a clear understanding of which tax debts may be discharged in bankruptcy and what steps may be required to discharge tax debts outside of bankruptcy. Taxpayers should also be aware of the powers that the IRS may retain after bankruptcy to collect debts.
If you are considering filing for bankruptcy in Michigan, or believe that bankruptcy may be an option to eliminate your IRS or state income taxes, call Michigan tax attorney Andrew Steiger for a free consultation to understand how bankruptcy may impact your tax debts. Bankruptcy may or may not help you, and there may be a better alternative using an IRS Fresh Start program to reduce or eliminate your tax debts.