How Filing for Bankruptcy Affects Taxes

In 2018, more than 25,000 individuals and businesses filed for bankruptcy protection in the state of New Jersey. Filing for bankruptcy can have a profound effect on both any past tax debt you may owe and future tax liability. Working with an experienced bankruptcy attorney is the best way to understand the tax complications that may ensue when you file for Chapter 7 or Chapter 13 protection.

What Is Bankruptcy?

Bankruptcy is a legal protection for individuals and businesses that are struggling with debt and want to rectify their finances. The three types of bankruptcy are:

• Chapter 7. This type of bankruptcy is known as liquidation bankruptcy. Upon the successful completion of a Chapter 7, you can discharge debts like credit card bills and medical expenses. However, dependent support; student loan debt; and, in many instances, tax debt may not be waived.
  
• Chapter 13. A Chapter 13 allows you to reorganize your debt so that it can be repaid in a more manageable way. In order to qualify for this kind of bankruptcy, you must have a reliable source of income.
  
• Chapter 11. Although filing for Chapter 11 exists as an option for high-income individuals, it’s mostly utilized by businesses and corporations that are looking for a way to restructure their debt obligations.
  

Does Filing for Bankruptcy Wipe Out Tax Debt?

Filing for Chapter 7 has the potential to wipe out federal tax debt. However, certain qualifying conditions must be met, such as:

• The tax debt is at least three years past due.
  
• Tax returns were filed for the tax amounts owed.
  
• Tax returns filed for the tax amounts owed were filed at least two years before the bankruptcy filing.
  
• Any IRS assessment of your tax debt was made at least 240 days before the bankruptcy filing.
  

You may also be able to discharge past-due New Jersey state taxes, but you must meet the conditions above.

Only taxes assessed on income can be discharged in bankruptcy. You will still be responsible for paying past-due payroll taxes. If you filed a fraudulent tax return in an effort to evade paying taxes, you will not be eligible to discharge that tax debt nor be able to discharge any penalties assessed for tax fraud. Additionally, bankruptcy will not wipe out any outstanding tax liens that were placed on any property you owned before the date you filed.

While filing for Chapter 13 won’t completely discharge your past tax debt, it will stop the accrual of penalties and interest on the debt you owe. Filing for Chapter 13 will also give you a longer period of time in which to pay non-dischargeable priority income taxes. If you complete all payments under the Chapter 13 plan, the bankruptcy court may discharge your tax debts if they meet the conditions described above, but this is solely at the court’s discretion.

Tax Obligations During Bankruptcy

While filing for bankruptcy has the potential to discharge past tax debts if the conditions above are met, you’ll still be responsible to the IRS for present and future tax obligations. After you file for bankruptcy, you must submit all tax returns by their deadlines unless you file for an extension. If you fail to meet this stipulation, your bankruptcy proceedings may either be halted or converted into a different type of procedure.

If you’re filing for Chapter 13 bankruptcy, you’ll be required to have returns for four past tax years on record before you will be able to work out a debt repayment plan with your creditors. If you are filing for Chapter 7 bankruptcy, both you and the court-appointed administrator who assumes management of your assets throughout the duration of your bankruptcy will be required to file tax returns.

Bankruptcy and taxes are a very complex topic. If tax debt is among the reasons why you are thinking about filing for bankruptcy, it’s very important to consult with an experienced bankruptcy attorney who can evaluate the specific circumstances of your situation and advise you on what’s feasible. Contact the law firm of Neuner & Ventura in Marlton, NJ, at (856) 596-2828 to schedule a free initial consultation.