The Different Shades of Tax Debt
There are two primary types of tax debts:
Federal Income Tax
Federal income tax is levied by the Internal Revenue Service (IRS) and functions on a graduated system, meaning the more you earn, the greater the percentage you’re taxed.
State Income Tax
Each state operates under its tax system, with rates, terms, and potential penalties that vary widely.
Delinquent Tax Returns
If you miss the tax filing deadline, not only can it result in stiff penalties, but it might also leave you with an unfiled return, which is a federal crime.
Can You Shake the Taxman in Bankruptcy?
Bankruptcy may seem like the last port in a storm, but can it actually offer a clear reprieve from tax debt?
When Taxes Float Away in Bankruptcy
In certain situations, taxes can be discharged in bankruptcy. To do so, the tax debt must meet specific criteria:
The Three-Year Rule
This dictates that for a tax debt to be dischargeable, the return for it must have been due at least three years before the bankruptcy is filed.
The Two-Year Rule
To be discharged, the tax return must have been filed at least two years before the bankruptcy filing.
The 240-Day Rule
The IRS must have assessed the tax debt at least 240 days before the bankruptcy is filed.
The No-Fraud Rule
If the taxpayer engaged in willful evasion or attempted to commit fraud, the tax debt will not be discharged.
Bankruptcy Types and Tax Discharge
The dischargeability of tax debt can vary based on the type of bankruptcy filed:
Chapter 7 Bankruptcy
Allows for certain tax debts to be completely discharged, providing the criteria mentioned earlier are met.
Chapter 13 Bankruptcy
Is ideal for those with high-value assets, as it allows for a reorganization of debts and a payment plan that may reduce the amount paid on tax liabilities.
The Best Buoy for Keeping You Afloat
If considering bankruptcy as a life preserver, it’s vital to understand which type is most suitable for your situation.
The Chapter 7 Lifesaver
This bankruptcy type is often referred to as a “liquidation” bankruptcy, where non-exempt assets are sold to pay creditors. It is a more straightforward and quicker process, usually completed within a few months.
Chapter 7 Discharge and Tax Debt
Chapter 7 bankruptcy is effective for those with a manageable amount of tax debt that fulfills the discharge criteria.
The Chapter 13 Raft
Often called a “wage-earner plan,” Chapter 13 is available to individuals with regular income and unsecured debts below a certain threshold. It involves a repayment plan over typically three to five years.
Chapter 13 and Tax Liabilities
This type allows the debtor to pay back a portion of the tax debt over time, with the remainder potentially discharged at the end of the payment plan.
Where Bankruptcy Meets Tax Liens and Levies
Tax liens and levies are the IRS’s way of ensuring they get what’s owed. However, they don’t always sink with the ship in bankruptcy.
Against The Tide With Tax Liens
While bankruptcy can discharge personal obligation to pay back taxes, it does not always remove a tax lien from a debtor’s property.
Levies Under The Bankruptcy Umbrella
Bankruptcy’s automatic stay can pause tax levies – but only temporarily. After bankruptcy, the IRS can proceed with collection actions if the tax debt was not discharged.
The intersection of tax debt and bankruptcy is a complex one, with many intricate details. To stay afloat, seek knowledge, and professional guidance from a Rio Grande Valley bankruptcy attorney—only then can you chart a course towards calmer financial waters. For those considering bankruptcy as a strategy to manage tax liabilities, understanding the nuanced relationship between the two can provide a much-needed lighthouse in the darkness, steering clear of treacherous currents.