Taxes and bankruptcy: what you need to know.

It can happen to anyone. Just like any bill, taxes can be forgotten. Although the initial tax payment may have been manageable, forgotten taxes can become subject to hefty fees, interest and penalties. A once manageable debt can now be overwhelming. Those that find themselves in this situation may consider relief through a bankruptcy petition.

Bankruptcy can cover a variety of debts, including taxes. Although a petition for bankruptcy can help relieve some forms of tax debt, not all tax obligations qualify. Below are some basic rules and tips to help provide a basic understanding on how taxes are impacted by a bankruptcy petition.

  • Audits. A report by Fox Business recently addressed the issue of taxes and bankruptcy. One of the big takeaways: those who are under audit by the IRS are likely out of luck. Although bankruptcy's petition for relief will not stop the audit, it may stop any attempt by the IRS to collect fees, penalties or back taxes. Unfortunately, even this layer of protection can fail. A petitioner is protected by a court issued automatic stay. This court order requires anyone attempting to seek payment to cease and desist. It is important to note that the IRS can get around the automatic stay by filing a Relief of Stay motion with the court. If granted, the IRS can continue to pursue payment.
  • Personal income taxes. This type of tax is generally deductible if the applicant meets various qualifications. Some points of qualification include that the tax must be three years old and the person seeking relief must not have willfully committed tax evasion or tax fraud. In addition, the taxes must have been filed at least two years prior to filing for bankruptcy.
  • Priority debts. These debts are generally not dischargeable in bankruptcy. Examples of priority debts include child support and student loans as well as certain tax debts. These debts include trust fend penalties and fraud assessments.

The type of bankruptcy petition plays a role in the impact of bankruptcy on taxes. A Chapter 7 petition can lead to discharged debts. If granted, this removes any obligation to pay the debt. In contrast, a Chapter 13 petition results in a court supervised repayment plan. Generally, these plans span three to five years and grant the payer a manageable payment plan.

Navigating the laws of bankruptcy can be overwhelming. As a result, those who are considering bankruptcy should contact an experienced bankruptcy and tax liability attorney. This legal professional will be able to discuss your options and help better ensure you choose a plan that is best for your unique situation.