Delinquent Personal and Business Taxes
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Frequently Asked Questions About Bankruptcy and Delinquent Personal Taxes |
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| Q. |
Can Bankruptcy Provide Individuals, Married Couples and Businesses With a Means to Deal With Delinquent Taxes? |
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Personal bankruptcy may be an effective way to address significant personal tax issues. For individuals (or married couples) who owe federal and/or state income taxes, a Chapter 7, Chapter 11, or Chapter 13 Bankruptcy may provide an alternative to going through difficult and costly programs directly with the taxing authority. |
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| Q. |
Are any delinquent taxes dischargeable in a Bankruptcy? |
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A common misconception is that all taxes of any kind are not dischargeable in a bankruptcy case. Some taxes actually are dischargeable in bankruptcy, including personal income taxes that are more than three years old. Fiduciary taxes are generally not dischargeable. The Bankruptcy Code's provisions relating to taxes are very complex and differ by chapter or type of bankruptcy that you file. |
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| Q. |
How can bankruptcy provide for the repayment of taxes which cannot be discharged? |
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It is often the case that the bankruptcy case allows for debtors to "catch up" on their tax obligations. Because the Bankruptcy Code requires that debtors in Chapter 13 cases be "current" in the filing of their tax returns, the bankruptcy case offers an opportunity to review complete tax records and determine what remains due and if any portion of past due taxes, interest, and/or penalties, may be discharged. Even if amounts are due (including those that result from a federal tax lien), a reorganizational bankruptcy under Chapter 11 or 13 provides a framework to propose a repayment plan to the IRS, while having the opportunity to determine which taxes must be repaid. |
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| Q. |
Will a bankruptcy affect my future tax filings? |
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Some people also believe that filing a bankruptcy may affect their tax filings in the future. Generally, most individuals (or married couples) continue to file their personal tax returns in a normal manner and to ensure that where taxes were owed in the past, the taxing authority properly applies any refund. |
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Can the Bankruptcy Court decide disputes between a taxpayer and the taxing authority? |
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Yes, one of the most useful aspects of bankruptcy is the power of the Bankruptcy Court to decide disputes between the debtor and a creditor, even if the creditor is the IRS or State of New Jersey. In general, the Court in a no-asset Chapter 7, where there will be no payment on claims of creditors, has no interest in resolving disputes about taxes that will survive the bankruptcy. But, in Chapter 13, there is always a distribution to creditors and therefore there is a real need for the Court to decide disputed claims. The Bankruptcy Court may be the quickest and cheapest way to get a fair determination about a tax dispute. Also, even if the Court cannot decide a tax issue in a no-asset Chapter 7 case, generally penalties are dischargeable and therefore may provide a debtor with significant relief. |
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Frequently Asked Questions About Bankruptcy and Delinquent Business Taxes |
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| Q. |
What are Trust Fund Taxes and how can a Bankruptcy Help with them? |
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Certain tax obligations, such as Federal taxes withheld from an employee's wages (income tax, social security, and Medicare taxes) by an employer, and New Jersey Sales Taxes are defined as trust fund taxes. These tax obligations are not dischargeable in any bankruptcy case filed by an individual, married couple or a business entity. However, penalties associated with these taxes may be dischargeable in a bankruptcy case depending on the circumstances. Further, in a reorganization Chapter 11 or Chapter 13 case, a taxpayer may propose to repay outstanding amounts owed on trust fund taxes through a plan of reorganization and stay collection efforts by the taxing authority on such unpaid taxes. |
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More Information: Information on Federal Trust Fund Taxes may be found at IRS Small Business Section and information on New Jersey State Trust Fund Taxes at New Jersey State Website |
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| Q. |
Is the debt discharged in bankruptcy "income" that has to be reported on my income tax return? |
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No. Debts discharged in a case under Title 11 of the United States Code (the Bankruptcy Code) are not "cancellation of debt income" on which you can be taxed 26 I.R.C. 108 and 11 U.S.C. 346 (j)(1). That doesn't always deter creditors, some of whom issue debtors a Form 1099-C, reporting the canceled debt to the IRS as income. If that happens, the debtor's remedy is to file IRS Form 982. Note that the tax treatment of debt forgiven in bankruptcy is a marked difference between bankruptcy and debt management programs. |
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| Q. |
What happens to tax liens that survive the Chapter 7 Discharge? |
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If the discharge in the Chapter 7 case eliminates the debtor's personal liability for the tax year or years for which there is a lien, the lien survives only as a charge on the equity in the property that the debtor owned at the beginning of the case. As the bankruptcy code is a federal law, like the tax code, there are specific treatments for tax liens held by the IRS which may be different from other lienholders. The lien, though not discharged, does not attach to assets that you acquire after the case is filed. Your choices after the discharge are:
- pay the IRS the value of the equity in assets to which the lien attached at the beginning of the case;
- do nothing in the expectation that the IRS will not attempt to enforce a lien, if the collateral is of little value or is exempt from levy by law;
- file a Chapter 13 to pay the lien over time if it attaches to assets of significant value.
Due to the complexity of the interplay between state and federal tax laws and the Bankruptcy Code, anyone who is interested in learning their legal rights relating to personal income taxes and bankruptcy should consult with an experienced attorney who can review how these laws specifically apply to their situation.
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