Bankruptcy & Taxes: Discharge of Income Taxes in Bankruptcy

With mounting company layoffs along with massive housing foreclosures, many taxpayers find themselves seeking bankruptcy protection (either under Chap...


With mounting company layoffs along with massive housing foreclosures, many taxpayers find themselves seeking bankruptcy protection (either under Chapter 7 or Chapter 11of the bankruptcy code).  A common question they often ask their accountant or CPA is whether or not tax obligations can be discharged in a bankruptcy petition.  This can be a difficult question to answer as there are many issues that need to be investigated.

Prior to examining whether the taxes can be discharged in a petition, the taxpayer should first determine whether there are any administrative methods available that can reduce the tax debt.  This could be an offer in compromise or currently non-collectible status.  Other options available might include innocent spouse relief or penalty and interest abatement requests.  Make sure to exhaust these options first prior to examining the bankruptcy discharge option.

In order for a personal tax debt to be discharged in bankruptcy, there must be a few rules that are satisfied: (1) more than a 3 year period must have elapsed since the return that resulted in the liability was due.  Certain circumstances can extend this requirement. (2) The tax return is required to have been filed more than two years before the bankruptcy petition was filed.  This is important for late filed returns. (3) a minimum of 240 days has lapsed since any IRS audit adjustments or return amendments.

It is important to note that payroll tax withholdings, trust fund recovery liabilities, and state sales taxes are generally not dischargeable in bankruptcy.  Income tax liabilities discharged in bankruptcy are a complex issue and should be addressed with both the experienced CPA and a bankruptcy attorney.

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