Tax penalties seem like a further insult when you’re having trouble paying the tax itself.
Everything seems subject to an additional penalty: failure to file timely; failure to pre pay sufficiently; failure to be accurate.
They mount up quickly, often equaling the unpaid tax.
Bankruptcy can not only eliminate your liability for certain taxes, it can wipe out the tax penalties as well.
Here’s how it works.
Three rules for discharging tax penalties
Penalties for dischargeable taxes are dischargeable
Tax penalties are tied to a particular tax year. If the tax for that year is dischargeable in bankruptcy, the discharge wipes out the penalties too.
The formula for a dischargeable tax, roughly speaking, says you can get rid of an unsecured tax if 1) the return for that year was due more than three years before the bankruptcy was filed; 2) if the return wasn’t filed on time, it’s been on file for at least two years; and 3) the tax for that year was assessed at least 240 days before bankruptcy.
Discharge the tax, discharge the penalty.
Penalties tied to events more than three years before filing are dischargeable
If the failure that triggered the penalty happened more than three years before filing, the penalty is dischargeable.
It’s dischargeable even if the the tax for that year isn’t dischargeable, for instance, because the returns weren’t filed on time. see 11 U.S.C. 523(a)(7).
All tax penalties wiped out in Chapter 13
That’s right: all tax penalties are discharged by a Chapter 13 discharge. Hard to beat, right?
Chapter 13 requires that you pay in full the priority taxes and the interest that accrued up to the date the bankruptcy case was filed. But at the end of the case, all tax penalties are wiped out, even on the priority taxes. More on taxes in Chapter 13.
Fraught with rules
So much of discharging taxes depends on knowing the maze of rules that apply to taxes in bankruptcy. It’s critical to get a tax transcript to verify the dates of all the important transactions.
Get experienced legal help if you want to discharge taxes and tax penalties. This is not the time or place for the cheapest or closest bankruptcy lawyer in town.
Image courtesy Flickr and Sharon Drummond