BANKRUPTCY AND TAXES

The bankruptcy code is an effective tool for the management of any debt, even tax debts.  Under the bankruptcy code, a debt can be discharged (declared legally not due), or modified, depending on its status under the bankruptcy code, which is totally independent of its status under any other body of law.  Bankruptcy can be an effective tool to avoid offsets from various taxing authorities, elimination of tax debt, or compelling taxing authorities to accept payments plans outside of what would normally be permitted by the taxing authority.  The rules cited for the IRS are also the rules followed under the code for any other taxing authority. This article provides a brief overview of what is possible, depending on a taxpayer's particular facts.

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Taxes are the debts that are most frequently nondischargeable in bankruptcy cases. However, it is important to realize that not all taxes are nondischargeable. A rather complicated series of cross-references within the Code can be followed to the conclusion that, basically, only the types of taxes listed below are not discharged in a bankruptcy case, however, not being discharged does not eliminate the possibility of a favorable payment plan for the debtor under the code:

• Any tax for which a return, or equivalent report or notice, if required, was not filed,  for which a fraudulent return, report, or notice was filed,  or which the debtor willfully attempted to evade; 

• Any tax with respect to which a late return was filed within two years before the date of filing of the bankruptcy;

• Taxes on income or gross receipts

• (a) for which a return, if required, was last due within three years of the filing of the bankruptcy, or

• (b) assessed within 240 days before filing of the bankruptcy, or

• (c) not yet assessed, but assessable after filing of the bankruptcy;

• Property taxes assessed before commencement of the case and last payable without penalty less than one year before filing of the bankruptcy;

• Excise taxes

• (a) On transactions as to which a return was required and last due less than three years before the bankruptcy, or

• (b) On transactions, as to which no return was required, which occurred less than three years before the bankruptcy;

• Taxes required to be collected or withheld by the debtor, such as employment “trust fund” taxes (income taxes and FICA withholding) or sales taxes.

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Any penalties related to nondischargeable taxes are also nondischargeable, unless the penalty is solely punitive in nature or relates to a transaction that occurred more than three years before the filing of the petition.  Erroneous refunds of nondischargeable taxes are similarly nondischargeable.

 

The treatment of prepetition interest is not as clear; but most courts have held that it is nondischargeable.  Post-petition interest on nondischargeable tax debts is clearly nondischargeable.  And in limited situations, a party who has paid the tax claim of the debtor may become subrogated to the claim and eligible for the same priority and treatment related to dischargeability. 

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Some, but not all, of the taxes that are nondischargeable in chapter 7 are also nondischargeable in chapter 13. Under section 1328(a)(2), taxes that are described in section 507(a)(8)(C) (taxes required to be withheld or collected by the debtor), section 523(a)(1)(B) (unfiled return or late return filed within two years before petition), and section 523(a)(8)(C) (fraudulent return or evasion) are nondischargeable when the debtor receives a discharge after completion of a plan. If these taxes are paid in full through the plan, the debtor may still owe postpetition interest on them, at least if the plan does not provide otherwise. However, it has also been held that if no claim is filed for taxes described in section 507(a)(8)(C), the taxes are discharged. Other taxes that are nondischargeable in chapter 7, but may be discharged in chapter 13, are priority debts in chapter 13 (which requires a repayment plan to pay certain debts and discharges others) that are required to be paid in full through the plan unless the creditor agrees otherwise or a claim for them is not filed.  And a chapter 13 plan may designate those payments made under the plan be made toward taxes that are nondischargeable rather than those that are dischargeable.