Will Bankruptcy Affect Your Taxes? - Westgate Law

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Will Bankruptcy Affect Your Taxes?

Bankruptcy is accepted in today’s social climate as a fairly common solution to financial struggle. Most are aware of the potential relief available through filing, but some are still unsure of exactly what they are allowed to include in their bankruptcy petition. For instance, a large number of potential filers are surprised to find that they could receive relief from their tax debt through bankruptcy. Bankruptcy and taxes have a bit of a tricky relationship because both are governed by their own set of rules.

If you are one of the many Americans who feel a sense of desperation when considering the impossibility of ever paying off your tax debt, consider some tips about this particular “tricky relationship:”

Tips on Maximizing the Relationship Between Bankruptcy and Taxes:

  1. File your taxes – you can’t discharge taxes that you never filed on.
  2. Acknowledge the need for both a tax professional and an experienced bankruptcy attorney: together they can make sure you are able to maximize the amount of debt (tax related and other) that you are able to discharge at the conclusion of your filing.
  3. Bankruptcy will not stop a tax audit, but it can stop collective action.
  4. Certain tax debt cannot be discharged. Consult the experts on your specific type of debt before you write anything in stone.

Since bankruptcy will not stop a tax audit, don’t turn to your favorite bankruptcy attorney for solutions if you are already under audit. Bankruptcy WILL stop collection action while the bankruptcy is pending and there is not a Relief of Stay motion from the IRS. The 10-year statute of limitations is extended during the bankruptcy proceedings. (Plus 30 days designated for administrative time). When collection action is halted (i.e. during the processing of an offer in compromise or a tie during which you are deemed “currently not collectible”) the statute is extended.

Not all tax debt can be discharged (i.e. priority debt such as: child support, drunk driving charges, student loans, fines in relation to crime committed, trust fund penalties, trust fund portion of payroll tax debts, fraud assessments, etc.) All such priority debt is required to be paid in full in Chapter 13 reorganization.

Dischargeable taxes are personal income taxes that are at least three years old. (The age of your tax debt is calculated from the due date of the tax return including any extensions). For your personal income taxes to be eligible for inclusion in a bankruptcy discharge, they must have been filed by you, (the taxpayer). If a substitute filed return was prepared by the IRS on your behalf, the taxes are not eligible for inclusion in your bankruptcy filing. Taxes included in your bankruptcy filing must be assessed at least 240 days. So bankruptcy can’t negate liability for a return you just filed until 240 days have passed. If the IRS has filed a tax lien against real/personal property – you can’t have equity in that property. If you haven’t filed your tax returns, you can’t discharge those taxes in bankruptcy no matter how old the liability.

Normally, debt that is forgiven is considered taxable income. Debt forgiven through bankruptcy or insolvency is an exception to this rule. If you are sent a 1099 from a lender whose debt was discharged during your bankruptcy proceeding, take it to your tax professional so that it can be addressed on the next tax return. You don’t want the IRS to feel the need to come after you for debt they feel you owe (even if you don’t). Debt discharged through bankruptcy is not taxable income.

If you have questions regarding the impact that bankruptcy will have on your taxes and whether or not you can discharge tax debt, contact a tax professional and an experienced southern California bankruptcy attorney for more information. We have the answers to all of your questions.

*Photo courtesy of freedigitalphotos.net

About the Author

Justin Harelik

Justin has a singular goal: to get people out of financial distress and move them to financial stability and prosperity. He does this by combining 15 years of in-depth experience in bankruptcy, credit management, debt negotiation and student loan modifications, and he does it with both English and Spanish-speaking clients.

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