“I” stands for IRS in my Bankruptcy Alphabet. Bankruptcy law treats the IRS little different than other creditors. The tax collector is just one of the boys.
But the most important point is that income taxes can be erased in bankruptcy. There are rules, three of them in fact, that govern when income taxes can be discharged:
- The return for the tax must have been due, including extensions, more than 3 years before the filing.
- If the return was not filed on time, it must have been filed more than 2 years before the filing.
- The tax must have been assessed by the IRS more than 240 days before filing.
The IRS must respect the automatic stay. When a bankruptcy case is filed, all creditors, including the feds, must stop all efforts to collect. The IRS must lift garnishments.
There are a couple of exceptions: the IRS can assess taxes after the filing without violating the stay and they can audit tax returns. But collect they can not.
Taxes for recent years get a priority for payment in bankruptcy. If the trustee gathers up money for creditors, the priority taxes are paid in full before general, unsecured creditors get anything.
If a tax is dischargeable, the penalties associated with that tax get discharged as well.
Each of these rules applies to state income taxes as well.
Part of the appeal of Chapter 13 to me is that priority taxes, that can’t be discharged, can be paid over time, without interest and the penalties discharged! Sweet deal. And IRS liens, which cover everything a taxpayer owns, can be paid to the extent they attach to something with value, and stripped to the extent there is no value for the lien to attach to.
In this day of epidemic foreclosures, know that a foreclosure or short sale after filing your case immunizes the homeowner from cancellation of debt income under Internal Revenue Code 108. A discharge of a debt in a case under Title 11 does not produce a tax debt.
Image courtesy of takomabibelot.