A debtor will typically file for bankruptcy in order to seek the protection of the bankruptcy laws against debts that cannot be paid in full, and it is not uncommon that such debts will include federal tax debts owed to the Internal Revenue Service (IRS). Typically, federal tax debt is not dischargeable in bankruptcy. That said, discharge of these debts is possible under certain circumstances, and the rules for the discharge of federal tax debts depend upon which chapter of the bankruptcy code a debtor files under.
Generally speaking, Chapter 7 debtors are not entitled to complete discharge of debts, and creditors are entitled to object to a debtor’s attempt to discharge debts owed to those creditors. With respect to federal tax debts, a Chapter 7 debtor will not be able to discharge the following tax debts by order of the court: “taxes entitled to eighth priority, taxes for which no return was filed, taxes for which a return was filed late after 2 years before the bankruptcy petition was filed, taxes for which a fraudulent return was filed, and taxes that the debtor willfully attempted to evade or defeat.” See Internal Revenue Service, Bankruptcy Tax Guide, Publication 908,
https://www.irs.gov/publications/p908/ar02.html#en_US_2012_publink1000137390. Of these non-dischargeable federal tax debts, the “eighth priority” taxes are perhaps the most difficult to understand for those unfamiliar with bankruptcy or tax law. Taxes are generally assigned priorities, and those taxes owed prior to the date of the bankruptcy filing (“pre-petition”) are usually deemed “eighth priority” debts by the bankruptcy court, and include pre-petition income tax, certain income taxes that could have been assessed by the IRS as of the bankruptcy filing date but for some reason were not, withholding taxes, an employer’s share of employment taxes on wages, salaries, or commissions, and excise taxes on pre-petition transactions. Id.
Chapter 13 debtors, on the other hand, are generally able to discharge all federal tax debts in bankruptcy provided that they have adhered to the terms of the payment plan approved by the bankruptcy court. Id. That said, the repayment plan might require those federal tax debts to be paid in full; as a result, a Chapter 7 filing may be a better choice for avoiding federal tax debts through a bankruptcy discharge, though one should consult an attorney experienced in bankruptcy matters before reaching that determination.
Though an individual Chapter 11 debtor is treated similarly to a Chapter 7 debtor when it comes to what federal tax debts can and cannot be discharged in bankruptcy, there are some broader exceptions for corporations that file for Chapter 11 bankruptcy protection.
Please keep in mind the information and advice presented in this blog is not intended to be used as formal legal advice. Contact a tax professional for personalized tax advice pertaining to your specific situation. While we try and answer all parts of the question when we write our blogs, sometimes there may be some left unanswered. If you have any questions about your problems with the IRS, SBOE, FTB, or BOE, or tax law in general, call RJS Law at (619) 595-1655.