When people file bankruptcy, they either discharge or pay their debts. Some may file a Chapter 7 to liquidate as many assets as possible and then discharge any unsecured debt. Some may file a Chapter 13 to reorganize their debts through a five-year plan. Some may file a Chapter 11 to reorganize their debts or—if a small business—may choose Subchapter V of Chapter 11 to reorganize their debts. Some may choose Chapter 12 if their income is primarily from farming.
Whatever chapter they choose, many people will have this creditor in common: the Internal Revenue Service (IRS). Most people (some attorneys included) think that you have to repay the IRS in full for all tax debts, but this just isn’t true. This article will provide guidance on what tax debt is dischargeable and what tax debt is non-dischargeable.
The Bankruptcy Code (in 11 U.S.C. §507) lists debts that are “priority.” Priority debts are not dischargeable in a Chapter 7 and must be paid through the life of a bankruptcy plan, whether that plan is created through Chapter 13, Chapter 12, or Chapter 11 of Subchapter V. Bankruptcy Code Section 507(a)(8) tells us that some tax debt falls under that priority umbrella by requiring unsecured (that is, no liens) claims of governmental units (IRS) be paid in full, but only to the extent that such claims are for certain taxes. There are three ways that taxes become priority:
- Tax returns are last due (including extensions) more than three years before you file bankruptcy.
Example: Jody files his federal income tax return for 2017 on October 15, 2018. October 15, 2018, is the last date that the 2017 return is due, which includes the extension. Jody filed bankruptcy on April 14, 2021—but wait, three years haven’t passed between that October 15, 2018, date and the date Jody filed bankruptcy. Jody would need to wait to file bankruptcy after October 16, 2021, or else his 2017 tax return will not be dischargeable, and Jody would still need to pay his 2017 tax debt.
Here’s something else to keep in mind: if Jody filed his 2016 federal income tax return on April 15, 2017, adding three years would still bring him to October 15, 2020, because October 15 of 2017 is the last day the 2016 return is due with extensions. Using the above example, if Jody filed his bankruptcy case on April 14, 2021, then his 2016 tax return is dischargeable in his bankruptcy case because it is not priority under §508(a)(8). Since his tax debt is not priority (and if there are not liens, not secured), Jody would not have to pay his 2016 tax debt.
- Tax return debt is assessed within 240 days of the filing of the bankruptcy case.
Example: This type of tax debt is typically an audit by the IRS. Let’s look at Jody again, who files his bankruptcy case on April 14, 2021. The IRS has been auditing his tax returns for 2015, and they decide that he took a deduction that he was not supposed to take, so they assess additional tax debt for him based on the audit. The audit assessment is August 23, 2020, which is 217 days before the filing of the bankruptcy case. Because this time frame is less than 240 days, this tax debt becomes priority and must be paid in full in the bankruptcy case. It doesn’t matter that the 2015 tax return was due more than three years before the filing of the bankruptcy case; the fact that the IRS assessed Jody’s tax debt less than 240 days before the filing of the bankruptcy case means that Jody must pay this tax debt in full as priority debt.
- Tax debt that is not specified in 11 U.S.C. §507(a)(8)(iii).
Example: Any other kind of tax debt, such as 941 employee tax debt, 940 unemployment tax debt, 1123 corporate tax debt, etc. is not priority tax debt and therefore cannot be discharged in a bankruptcy case.
This is a lot to digest when trying to figure out if you have to pay tax debt. Many attorneys have to reread these sections of the bankruptcy code yearly to refresh their understanding of what kinds of taxes are not priority and what kinds of taxes are priority and therefore must be paid through the case. If you need help in your journey through bankruptcy with tax debt, talk to a bankruptcy attorney; they will be able to help.