Considering Bankruptcy During Tax Time
If you are like the numerous other Americans who file for bankruptcy protection every year, you may be concerned about the long-term implications of filing. Maybe you worry how you will be able to afford a bankruptcy lawyer, or how long it will take to rebuild after the initial financial crash. But one thing you may not be thinking about is your taxes. Before you file your returns, here is what you should know about bankruptcy and taxes.
What happens to my tax refund if I file for bankruptcy?
It is important to consider what type of bankruptcy you are filing. In general, however, the bankruptcy court is concerned with making sure your creditors get paid as much as possible, while allowing you the protections you are allowed under the law. It can be a delicate balancing act. Therefore, if you have money, the court will want to use it to pay creditors.
Money received from a tax refund based on earnings in the year prior to or same year as the bankruptcy filing is considered part of the estate. Nevertheless, there is a little wiggle room. Any refunds you receive in the years following your bankruptcy filing will be all yours in a Chapter 7 bankruptcy but not in a Chapter 13 bankruptcy. Therefore, if bankruptcy is in your future, you should consult an experienced attorney as soon as possible.
Can I discharge tax debts?
Yes. In fact, one of the most helpful aspects of a bankruptcy is the ability to write off certain older and seemingly never-ending tax debts. You will want to discuss whether your debts qualify with a knowledgeable bankruptcy attorney. In general, to qualify to discharge tax debts the following five conditions must apply:
Condition #1: Income-based taxes only
Taxes on investments, capital gains, or rental properties are not dischargeable. The only taxes you can discharge are state or federal taxes based on earned income.
Condition #2: Return was due more than three years ago
The Bankruptcy Code does not allow you to discharge a debt you just incurred. The logic is that people would time their bankruptcy by simply not paying taxes all year then filing for bankruptcy in the spring. To prevent this, the law only allows you to discharge outstanding tax debts that were due more than three years prior to filing for bankruptcy. Therefore, if you have outstanding tax debts from 2013, including any extensions you received in that year, you may be able to get them discharged in 2017, depending on the precise due dates and when you file.
Condition 3: You filed at least two years ago
Bankruptcy courts have become increasingly strict with this condition, requiring that you actually filed your tax returns more than two years prior to filing for bankruptcy. This is one very important reason to file your taxes on time. Even if you do not have the money to pay the IRS, you should still file your return on time. Otherwise, you run the risk of the court years later not allowing you to discharge taxes owed from that year.
Condition #4: It has been at least 240 days since the taxes were determined
Sometimes audits and other delays can set the schedule back a bit, but 240 days must pass between the taxing authority’s decision on amount owed and the date when you file for bankruptcy.
Condition #5: Fraud or willful evasion
Perhaps somewhat obviously, you cannot discharge taxes incurred based on fraudulent filings or if you are guilty of intentional tax evasion.
What if I think I can discharge my tax debts?
The information provided here is general in nature and based on IRS tax laws and bankruptcy laws. State tax laws may have unique implications. Similarly, no two bankruptcies are exactly alike. If you think you might be eligible to discharge a tax debt or are considering bankruptcy over the next few years, call the law firm of Goodblatt · Leo, to find out if you can get rid of your tax debts in bankruptcy.