Discharging Tax Debts in Chapter 7 Bankruptcy
May 22, 2010
Did you know some tax debts can be discharged in bankruptcy?
Bankruptcy filers can sometimes discharge (wipe out) debts for federal income taxes in Chapter 7 bankruptcy. But, all of the following conditions must be met:
Tax return DUE at least three years ago.
To be dischargeable, the tax return must have been originally due at least three years before your bankruptcy filing date.
Tax return FILED at least two years ago.
At least two years prior to your bankruptcy filing date, you must have filed a tax return for the debt you are trying to discharge.
Tax ASSESSED at least 240 days prior to filing date, or not assessed yet.
The IRS must have assessed the debt at least 240 days prior to your bankruptcy filing date. Or, the tax must remain unassessed (by the IRS) as of your bankruptcy filing date.
In other words, you can’t discharge a tax liability during the 8 month period after the IRS assesses the tax. But, you can discharge the tax before the assessment happens and 8 months after the assessment.
Income taxes only.
Other kinds of taxes (such as payroll taxes or penalties for fraud) cannot be discharged in bankruptcy.
No fraud.
If you filed a fraudulent tax return, bankruptcy can’t discharge your tax liability.
You Can’t Discharge a Federal Tax Lien.
A Chapter 7 bankruptcy may be able to wipe out your personal liability for the tax debt. But, if the IRS has recorded a tax lien on your property, the lien will remain even after the bankruptcy. This means you’ll have to pay off the tax lien in order to sell the property.
The good news is discharging the tax liability will keep the IRS from being able to garnish your bank account or wages.
Discharge of Indebtedness (DOI) Income and 1099-C Tax Forms
August 20, 2008
Many consumers filed for an extension in order to complete their 2007 income taxes because they needed more time to resolve discharge of indebtedness questions.
October 15 is fast approaching…and our office has received many discharge of indebtedness (DOI) questions.
Please see below for some of the most common questions we’ve received in the past few weeks.
What is “DOI income”?
Debt that is canceled, forgiven, or discharged is often called “discharge of indebtedness” (DOI) income. Consumers are sometimes taxed on DOI income.
Many debt collectors and creditors will send consumers a tax form 1099-C showing DOI income. Creditors send this tax form when they settle an account for less than the amount originally demanded.
I received a 1099-C tax form showing DOI income. Do I owe taxes?
A debt collector or creditor’s filing a form 1099-C does not automatically mean you owe taxes. There are several exceptions to the rule that discharge of indebtedness (DOI) income is taxable.
But, a creditor or debt collector is unlikely to research a particular consumer’s situation. It will generate the tax form and leave it to the consumer to prove to the IRS that an exception applies.
So, upon receiving a 1099-C tax form, the consumer and his or her attorney and / or tax professional must evaluate whether the consumer should be taxed on the DOI income or not.
If you should not be taxed, your attorney or tax professional can document your exception to the IRS.
There are many exceptions, but some of the most common are listed below. If you meet certain criteria, you should NOT be taxed on DOI income, even if you have received a tax form.
Even if you do not meet these criteria, other exceptions may apply. You should discuss your situation with an attorney or tax professional if you receive a 1099-C from a debt collector or creditor.
Common situations in which DOI income may not be taxable:
- The debt was discharged as part of a bankruptcy.
- The debt was discharged while the debtor was “insolvent.”
- The debt was disputed by the consumer.
- Forgiveness of interest and fees is often NOT taxable.
Tax Forms and Continued Collections
Once a debt collector has sent you a 1099-C tax form, it means it has forgiven or written off the debt. The debt collector should not continue to collect on the remainder of the debt.
If the debt collector (1) continues to try to collect on the remainder of your debt and / or (2) sells the remainder to another debt collector, it may have violated applicable federal and state laws.
Deliberate use of inaccurate tax forms as collection technique
Our office has heard several accounts of debt collectors’ continuing illegal collection activity through indirect means.
One such technique involves debt collectors’ filing inaccurate tax forms or threatening to file such forms.
If this has happened to you, contact an attorney.
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