Is Income Tax Debt Dischargeable in Bankruptcy?

Income tax debt is, under some circumstances, dischargeable in Chapter 7 bankruptcy. Even outside of those circumstances, it is at least “treatable” in a Chapter 13 bankruptcy in a manner that can be a much better deal for the taxpayer than any of the payment schemes offered by the IRS.

Income tax debt, whether Federal or state income tax debt, is, for starters, classified as a “priority” claim by the Bankruptcy Code. In a Chapter 7 bankruptcy context, that means that, unless the debt meets certain criteria, it is non-dischargeable and the bankruptcy will not affect the filing debtor’s obligation to pay it. In a Chapter 13 bankruptcy context, “priority” classification means that the debt must be paid in its entirety within the Chapter 13 bankruptcy payment plan (60 months maximum).

The criteria for determining whether a tax debt is dischargeable in Chapter 7 and classifiable as non-priority and therefore eligible for at least partial discharge in Chapter 13 are :

• The age of the debt. The debt must be more than 3 years old dating back to the tax deadline of the year in which it was due (April 15th). Likewise, if the return was filed within 2 years, even if the debt itself is more than three years old, it cannot be discharged.
• The quality of the debt. The taxpayer must have filed a non-fraudulent, timely tax return in the year that it was due.
• The assessment of the debt. There cannot have been an assessment of the debt within 240 days for the debt to be dischargeable.

Depending upon the state that you reside in, there may be other considerations as well. If these criteria are met, an income tax debt may well be dischargeable in a Chapter 7.

In a Chapter 13, as mentioned above, the tax debt would then likewise be eligible for classification as a low-priority unsecured debt. In a Chapter 13, unsecured debts are paid last in priority in the payment plan and receive only whatever is left remaining after the plan term has expired, after all higher priority debts are paid.

Even if a tax debt is NOT dischargeable, in a Chapter 13, the debt can be paid off at 0% interest over the life of the Chapter 13 payment plan. That is, if you owe $10,000 to the IRS and would otherwise be required to pay it off at a cost of several hundred dollars per month at at least 2% interest directly to the IRS, the Chapter 13 can give you a better deal: you will pay the debt off in a maximum period of 5 years with no interest whatsoever. That $10,000, divided by 60 months in a 5-year plan, would then be paid off at only $166.66 per month. Depending upon the size of the debt, this can be an ideal reason to consider a Chapter 13 bankruptcy rather than either a Chapter 7 bankruptcy or a straight payment plan if the taxing authority is requiring more than you can afford to pay.

If you are a resident of southeast Michigan and are considering filing for bankruptcy or have unmanageable tax debt, please contact me at (248) 977-4182 or jhilla@aronofflinnell.com to schedule a free, initial consultation.