Are Taxes Forgiven in Bankruptcy?
As a general rule, debts owed to the federal government are very hard to get out of. In particular, back taxes and federally subsidized student loans can only be forgiven under exceptional circumstances. A bankruptcy filing is an extraordinary situation and represents one of the few instances where a portion of your tax debt may be forgiven, provided that a number of conditions are met.
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Chapter 7 vs 13
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An individual can file for bankruptcy under Chapter 13 or Chapter 7. In a Chapter 13 filing, creditors who have no lien against your specific assets still receive a certain portion of what they are owed. Chapter 7, on the other hand, is a more dramatic route, and creditors who do not hold liens against your assets usually receive nothing. Taxes owed to the federal government could be partially forgiven only in a Chapter 7 filing. A number of stringent criteria must be met.
Tax Year
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The taxes outstanding must be sufficiently old as of the date of bankruptcy filing. Taxes can only discharged if they are from a tax filing that was due more than three years prior to the bankruptcy declaration. The clause here is rather intricate in that it uses the word due. In simpler terms, you must go back three years from the date of bankruptcy filing and include all tax returns that could have been legally filed as of that date in the non-forgivable category. For instance, if you filed for bankruptcy on May 30, 2010, the reference date is May 30, 2007. Since the taxes for 2006 could legally have been filed as late as April 15, 2007, the taxes owed for 2006, 2007, 2008, 2009 and 2010 are not forgivable.
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Assesment
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Back taxes must meet additional criteria based on filing and assessment dates. The liability must be due to a tax return filed more than two years prior to the bankruptcy and assessed at least 240 days before the bankruptcy date. For most filers, any tax meeting the requirements in Section 2 will also meet these conditions. This may not be the case, however, if you have sent in your tax returns unusually late or if complications in your filing may have delayed an assessment of your exact tax bill.
Fraud and Liens
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Tax liabilities that have been assessed or adjusted as a result of fraudulent claims are not forgivable. Of course, tax fraud will lead to far more serious consequences, which may include jail time. In addition, only taxes that are unsecured can be discharged in a bankruptcy. In other words, tax debt can only be forgiven if the IRS does not hold a lien against your unpaid back taxes. Such a situation can arise if you have reached an earlier settlement with the IRS to avoid litigation due to unpaid taxes and agreed to take out a lien on specific property as part of a settlement.
Each bankruptcy filing is unique and the final decision rests with the bankruptcy court. Therefore, your tax liability may not be forgiven even if all of the conditions are met.
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