If you owe back taxes, you may have wondered if declaring bankruptcy can provide a lifeline. The truth is that bankruptcy definitely helps clear some types of tax debt.
You may have already gone through bankruptcy and received a discharge and were surprised to find a tax form in the mailbox. Fortunately, this document doesn’t always mean you have to claim this money on your next income tax filing.
How Does Bankruptcy Affect Taxes?
Earning a discharge from your tax debt provides renewed financial freedom and a lot more flexibility to pay the other debts you may be behind on. Chapter 7 Bankruptcy usually provides the fastest route to relief from back taxes. Unfortunately, bankruptcy can only help you with certain types of tax debt.
State or Federal income tax debt is generally the only type of arrears a Chapter 7 bankruptcy wipes clean or “discharges.” Payroll taxes and fraud penalties aren’t eligible for discharge at the end of the Chapter 7 process.
There are other limitations on seeking tax debt relief through bankruptcy:
- Your income tax debt must be at least three years old.
- You must have filed a tax return on the debt in question at least two years before filing for bankruptcy. Any debt you didn’t file a return on or filed late may not be eligible.
- You must pass the “240-Day Rule.” The IRS must have assessed the tax debt at least 240 days prior to filing for bankruptcy.
You also can’t have filed a fraudulent tax return or used evasion to avoid paying taxes. If you engaged in this behavior you won’t be allowed to discharge your tax debt through bankruptcy. You’ll also want to steer clear of committing fraud when you file for bankruptcy.
Tax Debt and Tax Liens in Bankruptcy
It’s important to note that you won’t be able to clear debt from any tax liens the IRS has placed on your property. This applies to any liens enacted before you filed for bankruptcy.
Chapter 13 Bankruptcy also can’t erase tax liens, but it can buy you some time to use to pay it off.
Chapter 13 Bankruptcy to Discharge Tax Debt
Chapter 13 Bankruptcy takes a longer approach to solving your debt needs. However, it does allow you to hang on to certain property and possessions. It’s also used by people who earn too much income to qualify for Chapter 7 filing. Chapter 13 depends on a three to five-year plan to pay off a portion of your total debt. At the end of the payment plan, some qualifying debt is also discharged.
For tax debt, your income taxes in arrears are eligible for discharge once the payment plan is completed. Any income tax debt that doesn’t meet the criteria above, would not be eligible for discharge. For any tax debt not eligible for discharge, including penalties, you would have to pay it back in full. However, you would enjoy the extra time to repay it over three to five years.
If the IRS has a tax lien on any of your property, you’ll have this span of years to work towards removing it.
Exploring how filing for bankruptcy can help you should include a consultation with a bankruptcy legal professional. You should call The Law Offices of Steers & Associates of Los Angeles to set up a free case evaluation to find out if filing for bankruptcy is right for your situation.
Bankruptcy can play out differently if you are married and filing bankruptcy with your spouse. You’ll want to learn more about the advantages of filing with a spouse and under what circumstances you should leave your spouse out of a filing.
What to Do After Receiving a 1099-C Tax Form After Bankruptcy?
After a bankruptcy is complete, you could be shocked to find a tax form has been delivered to your address. A 1099-C form is known as a “Cancellation of Debt” tax document. Generally, the debt forgiven through bankruptcy is not taxed, but receiving a 1099-C form, understandably, causes doubt and worry.
Financial institutions must send out 1099-C forms any time $600 dollars or more in debt is forgiven or written-off. It’s mailed out whether you were forgiven through bankruptcy or through other means. This doesn’t mean you have to pay income taxes on the amount, but you’ll likely need to show the IRS that the debt was cleared through bankruptcy.
You’ll need to fill out the appropriate forms to alert the IRS of debt forgiveness through bankruptcy. Otherwise, the IRS would see the 1099 report and wonder why income tax wasn’t paid on it.
Income Tax Reporting Issues With Secured Property
Property like a house or vehicle is considered secured property. The mortgage debt you owe on a home is secured by the property itself.
When a home is foreclosed upon or a car is repossessed, the IRS will have questions about what happened. They consider a foreclosure or seizure as if you sold the property. In particular, they’ll want to know if a home was auctioned off for more than you paid for it or if it went for more than your tax basis.
Your tax basis is the value of your home or car when comparing the purchase price to depreciation. No matter the results, the IRS will need the appropriate forms filed to see if you are responsible for a taxable gain on the property.
Contact a Bankruptcy Lawyer Helping Those With Tax Debt in Los Angeles
Has your tax debt left you wondering if bankruptcy is the solution? When you have questions about bankruptcy, review our Ultimate Guide to California Bankruptcy or contact the attorneys with the Law Offices of Steers & Associates in Los Angeles. We offer a free consultation to anyone who is considering filing for bankruptcy.
We have helped hundreds of clients across Southern California facing similar situations and assisted them in earning debt resolution with the IRS.
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.