You may have heard that filing for bankruptcy won’t help you with the back taxes you owe California. That’s not always true. In certain circumstances, the bankruptcy process can provide major relief from your tax problems.
Can I File Bankruptcy Over Back Taxes?
Yes. Filing for bankruptcy when you owe unpaid federal and state taxes can be a complicated process, but it’s also a lifesaver for hundreds of California residents each year.
With the help of an experienced, local bankruptcy attorney, the discharge of tax debt is an obtainable goal.
Conditions for Filing Bankruptcy with Tax Debt
You will need a good understanding of your current tax situation before you file for bankruptcy. There are five conditions you must meet before you should count on income tax relief from a bankruptcy court.
- The Type of Taxes You Owe: If you owe income taxes or property taxes you are in luck. Those debts are eligible for discharge in Chapter 7 Bankruptcy and a partial discharge in Chapter 13 Bankruptcy. There are other types of tax debt you won’t be able to shed. You cannot discharge payroll and employment taxes, sales tax, and many tax penalties.
- How Long You’ve Had the Tax Debt: Debt that is from three years ago or older has a better chance of being included in a bankruptcy discharge. This is three years from the date your taxes were originally due. If your taxes were due two years ago or even more recently, you aren’t permitted to erase them by submitting a bankruptcy petition.
- If You Filed Your Annual Return Correctly: Tax fraud will shut down your bankruptcy attempt. For your income tax debt to qualify for discharge, you must have filed a tax return correctly. Falsifying your return or evading payment means bankruptcy won’t be an option.
- When You Filed Your Tax Return: You must have filed your tax return in question two years prior to filing for bankruptcy. It’s also important that you filed on time. Some courts will discharge tax debt if it was part of a late return, some courts won’t.
- When the Tax Debt Was Assessed: The “240-day rule” enforced by the IRS comes into play. The IRS must have assessed the income tax debt at least 240 days before you file Chapter 7 Bankruptcy, or not at all. Some exceptions can earn you leeway if the IRS stopped collection activity due to an offer of compromise or a previous bankruptcy filing.
What Happens to Tax Debt When You File Bankruptcy?
After meeting the strict requirements listed above for state or federal tax debt, you can then proceed with a bankruptcy filing. Whether that filing is of the Chapter 7 or a Chapter 13 variety will depend on what you qualify for and what you and your attorney feel is best for your situation.
Tax Debt in Chapter 7 Bankruptcy
If you didn’t meet the five conditions above, you can still file for bankruptcy to help with your other debt, but you’ll still be responsible for paying your back taxes.
If you’ve met the five conditions, there should be no obstacles left to filing a Chapter 7 petition. You’ll go through the process to earn a Chapter 7 discharge including credit counseling and working with your bankruptcy trustee. A discharge is hopefully the result. Your discharge also frees you from the penalties and interest generated by your back taxes.
Tax Debt in Chapter 13 Bankruptcy
In a Chapter 13 bankruptcy, you agree to a plan to repay part of your debt over a period of three to five years. When you clear all of the five tax debt requirements above, your back taxes are included in this plan as “nonpriority debt.” It gets treated like credit card debt. You’ll pay an agreed-upon portion of what you owe the IRS or the state and the rest will get discharged when you complete your payment plan.
If you don’t meet the five requirements above, your income tax bill becomes “nonpriority debt.” Under this designation, the tax debt is paid in full over the course of your payment schedule.
How an Automatic Stay Affects Tax Debt
When you file for bankruptcy, you receive an “automatic stay” that protects you from most of the creditors you owe. They are barred from contacting you and taking other punitive actions while your bankruptcy is sorted out.
The IRS and California’s Franchise Tax Board (FTB) are also subject to this automatic stay. To get full protection, you’ll list them among your creditors on your petition. This prompts the bankruptcy court to notify them of your filing.
With an automatic stay, the IRS and FTB are prevented from taking many of the collection actions they usually employ. This includes sending you collection letters and late payment notices. The IRS is blocked from garnishing your wages and levying your bank accounts. They are also restricted from taking a current tax refund from you.
The IRS and Franchise Tax Board must keep their hands off your property for the time being. However, if you’re filing for bankruptcy just before the IRS is scheduled to sell off some of your property, you’ll want to personally notify them immediately of your “automatic stay” to prevent the loss of your assets.
Tax Liens & Bankruptcy
Tax debt relief in a Chapter 7 discharge is great news, but it does not include freedom from a tax lien. Tax debt and a tax lien are not the same things.
A discharge doesn’t dismiss a property lien if the IRS recorded a tax lien on your property before the bankruptcy filing. The lien will continue to limit the actions you can take with your property. You’ll have to pay off the tax lien before you can transfer the title to a new owner.
Frequently Asked Questions
How Are Property Taxes Handled in Bankruptcy?
There are differences when seeking relief from property taxes. Your property tax debt can be more recent and still be considered for discharge in a Chapter 7 Bankruptcy. The debt must simply be more than a year old to qualify.
In a Chapter 13 filing, property taxes over a year old fall under nonpriority debt and get paid off in your payment plan. Property taxes under a year old qualify as a priority debt and you’re required to pay them off completely.
Can State Taxes Be Discharged Through Bankruptcy?
Yes. The Bankruptcy Court has jurisdiction no matter if the back taxes are federal or state. This means the same five conditions are required for state taxes when hoping for help with back tax issues. Your state tax debt should be three years old or older in order for it to qualify for discharge.
Can Bankruptcy Help with Unfiled Taxes?
No. Your tax debts won’t earn a discharge if you did not file the tax return at least two years beforehand. An automatic stay can help delay the IRS’s or FTB’s debt collection although agents could ask the court to allow them to continue their attempts to collect.
Contact a Los Angeles Bankruptcy Lawyer
Are you struggling with the decision to file for bankruptcy? Your California or federal tax debt could be the determining factor. If you have bankruptcy questions, contact the attorneys with the Law Offices of Steers and Associates in Los Angeles. We have guided hundreds of clients across Southern California facing similar situations and have helped them earn their financial freedom.
Elena Steers is an expert in bankruptcy law and debt negotiation in California and has worked on both sides of the bankruptcy process for over 25 years. She uses her experience in the courtroom to give clients a voice in a process that can sometimes make them feel helpless. Take a moment and read about her extensive experience.
You may also find our online guide to bankruptcy helpful, The Ultimate Guide to California Bankruptcy.
Elena Steers is a highly experienced bankruptcy attorney, the founder of Law Offices of Steers & Associates, and previously worked as a Bankruptcy Trustee Assistant at the Office of the Chapter 13 Trustee in Los Angeles. Her current affiliations include the State Bar of California, National Association of Consumer Bankruptcy Attorneys, and Central District Consumer Bankruptcy Attorneys Association.