FAQs: Bankruptcy

How does declaring bankruptcy affect my tax obligations?

      Your goal in declaring bankruptcy is to gain a "fresh start". You may either file bankruptcy under Chapter 13 or Chapter 7 of the Bankruptcy Code. Whether you decide to file bankruptcy under Chapter 13 or Chapter7, depends on your decision to get relief from tax debts through liquidation or a repayment plan.

      One of the immediate benefits of declaring bankruptcy is the "automatic stay" function that halts all collection activities by the creditors including the IRS. The automatic stay also operates to suspend U.S. Tax Court proceedings. In addition, during the automatic stay period, the running of the statute of limitations on assessment of tax is suspended. When the bankruptcy case is dismissed or discharged, the automatic stay is lifted.

      In a bankruptcy proceeding, your debts can be classified as either a tax debt or a nontax debt; a prepetition or a postpetition debt and a secured or an unsecured debt. Whether a particular debt qualifies as a tax debt depends on a host of factors. Prepetition debt refers to debt incurred before the petition for bankruptcy was filed. A postpetition debt is a debt incurred after the bankruptcy petition was filed. A tax lien makes an unsecured tax debt into a secured one. Discharging secured tax debts is more difficult than discharging unsecured tax obligations.

      Under Chapter 7, you receive discharge of personal liability for most prepetition debts in return for giving up all of your non-exempt assets. Most taxes are not dischargeable under Chapter 7 bankruptcy. Under Chapter 13, you enter into a plan of payment in return for discharge of your obligations.

      In general, several conditions need to be met in order for a tax debt to be discharged in a bankruptcy procedure:

1.  The  taxes  sought  to be  discharged  must be  for those  taxable  years, for  which the  tax
    returns were due more than three years before the date of filing for bankruptcy;
   
   
2.  The  tax return  for those  taxes must  have been  filed at least two years before the date of
    bankruptcy filing;
   
   
3.  At  least 240  days  must  have  elapsed  between the  tax assessment  date and  the date
    when the bankruptcy petition was filed;
   
   
4.  The tax returns referred to above must not have been fraudulent.
   
   

      Complex rules govern the priority of tax claims over other debts sought to be discharged in a bankruptcy proceeding.

      To sum up, declaring bankruptcy may be a viable option for reducing or eliminating your tax debts. However, many taxes may not be dischargeable in bankruptcy. Other options such as entering into an installment payment agreement with the IRS or filing an offer in compromise may be less drastic ways of achieving the same goal.

      Declaring bankruptcy is an important decision both for an individual and for a business. Deciding whether bankruptcy is a tax efficient resolution for your financial problems requires expert knowledge of tax laws. An experienced tax attorney is well-equipped to help you navigate the legal intricacies at the crossroads of tax and bankruptcy laws.