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Income Taxes and Bankruptcy.

It is a common misunderstanding that bankruptcy cannot eliminate any tax liability. Although treatment of tax liability is one of the most complicated aspects of consumer bankruptcy law, the Bankruptcy Code does offer many debtors substantial income tax relief. Whether or not your bankruptcy filing relieves your tax debt depends on several factors including the nature and the status of tax liability and the type of bankruptcy proceeding.

Type of Tax

Only individuals, not businesses, can discharge (wipe out) certain taxes through bankruptcy. The only tax eligible for discharge is federal income tax. Bankruptcy offers no relief from taxes for which the debtor/taxpayer was responsible for collecting from others such as FICA withheld from employees. Bankruptcy also will not relieve liability for excise taxes such as estate and gift tax, sales tax, or fuel taxes.

Secured Tax Debts

In the course of its collection efforts, the IRS has the power to file a tax lien to perfect its tax claim against individuals. A tax lien, once filed, becomes a secured lien on all of the taxpayer’s property. If a tax lien is in place prior to your filing bankruptcy, the IRS’s secured tax lien has priority over the bankruptcy filing, and bankruptcy cannot dislodge the lien from the your property. Even property which would otherwise be exempt in a bankruptcy, such as homestead, cannot be sold or transferred without payment of the IRS tax lien. In this instance, bankruptcy provides no tax relief.

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Tax Relief in a Chapter 7 Bankruptcy

Chapter 7 Bankruptcy will eliminate all income taxes except the following tax liability:

a. Taxes for which a tax return was due to be filed within three years (plus extensions) prior to the date of filing bankruptcy. For example, the tax return for 2003 income taxes was due to be filed on April 15, 2004 (plus any extensions), and therefore, these income taxes cannot be discharged by filing bankruptcy on or before April 15, 2007 (plus the time of extensions); OR

b. Taxes assessed by the IRS within 240 days before the filing of bankruptcy. Assessment date is the date that tax liability is entered on IRS records; OR

c. Taxes not yet assessed but still assessable; OR

d. Taxes for which a tax return was filed late and filed within two years prior to filing bankruptcy; OR

e. Taxes of a debtor who committed fraud related to a tax return or willfully attempted to evade or defeat taxes sought to be discharged.

Income taxes that do not fail any of the above five tests may be wiped out in a Chapter 7 Bankruptcy.

Tax Relief in a Chapter 13 Bankruptcy

Taxes which are non-dischargeable in Chapter 13 are considered priority debts and must be paid in full during the Chapter 13 plan without interest.

Other Points to Remember

Dischargeable taxes are eliminated in Chapter 7 and are treated as general, unsecured creditors in Chapter 13.

Secured tax liens cannot be discharged in Chapter 7. The secured portion of tax liability must be paid during a Chapter 13, in full and with interest, but without further penalty.

Referred from: (http://www.alperlaw.com/)