Using Bankruptcy to Discharge Tax Debt in Chicago

Many people recognize Chapter 7 or Chapter 13 bankruptcies as methods of debt relief that enable consumer debtors to get a financial “fresh start” by discharging most and sometimes all of their debts. Bankruptcy is typically associated with individuals who have excessive credit card and medical debt. But what about those saddled with tax debts?

Getting tax relief through bankruptcy is not easy. Whether a tax debt will be dischargeable depends on the type of tax involved as well as the taxpayer meeting certain requirements. While this article should not be a substitute for the advice of an experienced Chicago tax debt attorney, it should provide the reader with a preliminary understanding of the laws governing the discharge of tax debt.

Tax Treatment in Bankruptcy

Bankruptcy laws were established with balance in mind. Congress believed that debtors should not be burdened forever with debts they cannot afford to pay. At the same time, legislators did not want bankruptcy to be used as a means of avoiding obligations entirely.

Because tax revenues are so important in the operation of our government, Congress created special rules to address this kind of debt. These laws make it very difficult to discharge tax debts in bankruptcy. If the debtor is unable to discharge their tax debts, they will be responsible for paying any outstanding obligations after their bankruptcy is complete.

Requirements to Discharge Personal Income Taxes

There are a few simple rules that determine whether a debtor may discharge their personal income taxes. To be eligible for relief, the taxes must meet the following requirements:

3-Year Rule: The tax liabilities must be for taxes that were due at least three years prior to filing the bankruptcy.
Two-Year Rule: The tax return must have been filed at least two years prior to filing the bankruptcy.
240-Day Rule: The IRS cannot have assessed the tax liabilities within 240 days prior to filing the bankruptcy. These timing requirements are complex, and can be reset by numerous events, so caution is advised when calculating them.
In addition to these rules, the taxpayer must make sure they have not breached any other tax laws. For instance, the taxpayer must have filed their tax return for their debt to be dischargeable. Although taxing entities will sometimes file taxes on a taxpayer’s behalf when he or she fails to file their own return, liabilities from these returns will be non-dischargeable because the taxpayer did not file them.

Also, liabilities stemming from fraudulent tax returns are not dischargeable. This logically follows the general bankruptcy rule that any debt incurred through fraud is non-dischargeable.

Similarly, any taxpayer who has intentionally evaded taxes by moving or hiding assets, or attempted to use another person’s name or social security number on a return will be ineligible for discharge of their taxes.

Bankruptcy Rules for Business Taxes

If the rules governing the discharge of personal income taxes seem confusing, the rules covering business taxes are even more confounding. Depending on the circumstances, some business taxes will not be dischargeable at all. Whether business taxes may be discharged will depend not only on what kind of tax is involved, but also whether the taxes are considered “trust fund”, “excise” or “non-trust fund” taxes.

Trust fund taxes are taxes that a business entity holds for someone else and is expected to pay to the taxing authorities. This includes sales taxes assessed on customers at the time of sale as well as unemployment taxes withheld from an employee’s payroll. Trust fund taxes are never dischargeable.

Excise taxes, on the other hand, are dischargeable because the business owner is responsible for paying them rather than the consumer. Not all states have excise taxes. Fortunately for Illinois residents, the state does have a number of excise taxes which can be discharged in bankruptcy.

Non-trust fund taxes refer to payroll taxes paid by the employer. These taxes are generally dischargeable.

Tax Debt in Chapter 7 and Chapter 13 Bankruptcies

As long as all of the requirements are met, taxes may be dischargeable using either a Chapter 7 or Chapter 13 bankruptcy. Unfortunately, many people may not meet all of the requirements. Under these circumstances, a Chapter 13 bankruptcy may offer some advantages.

Depending on the size of tax debt that is owed, a debtor may want to consider using a Chapter 13 bankruptcy. This form of bankruptcy will allow debtors to repay their tax liability over a period of three to five years while controlling the penalties and interest on their tax balance. The trick with this form of bankruptcy is that the debtor must be able to afford to make payments that would pay the entire balance of non-dischargeable tax debt over that period.

The Importance of Experienced Counsel

There are other factors that may affect the calculation of time for discharging tax debts. Because tax liability is a complex aspect of bankruptcy law, it is important to speak with a local bankruptcy attorney who can properly assess your situation and determine which taxes may be dischargeable.

Even if your taxes are not dischargeable, a bankruptcy attorney will be able to evaluate your entire situation and present you with options for alternative ways to address your tax debt, such as an Offer In Compromise. In some situations, it may be advisable for a debtor to employ a combination of solutions to recover their financial footing.

If you are in debt and burdened with tax liability, you should contact a Chicago bankruptcy lawyer as quickly as possible to review your situation and the choices available to you

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