It’s my annual “Taxes from A to Z” series! If you’re wondering whether you can claim home office expenses or whether to deduct a capital loss, you won’t want to miss a single letter.
V is for Voluntary Bankruptcy.
When you realize that you will not be able to pay off your debts, and you can find no other solution, you may consider bankruptcy. A voluntary bankruptcy is a bankruptcy that you initiate; in contrast, an involuntary bankruptcy is a bankruptcy initiated by one or more creditors.
There are a number of factors to consider when weighing whether to claim bankruptcy. Often, debtors believe that declaring bankruptcy will eliminate all existing debts, including all outstanding tax debts. This is not true. What kinds of debts may be eliminated depends on the kind of bankruptcy and the kind of debt.
The most common bankruptcies for individuals are Chapter 7 and Chapter 13 (so named because of the chapters in the Bankruptcy Code). With a Chapter 7 bankruptcy, all allowable debts may be discharged. With a Chapter 13 bankruptcy, some debts will be repaid under a payment plan while others may be discharged.
No matter the kind of bankruptcy, not all tax debts may be discharged. This is important to understand: Often, taxpayers wrongly believe that declaring bankruptcy will clear all outstanding tax liabilities.
Generally, to be dischargeable, a tax debt must:
- be associated with a tax return that was due at least three years before you filed for bankruptcy;
- be associated with a tax return that was filed at least two years before you filed for bankruptcy;
- be assessed at least 240 days before you filed for bankruptcy;
- not be associated with a tax return which is fraudulent or frivolous; and
- not be the result of an intentional act to evade tax laws.
You typically cannot discharge tax debts which are:
- withholding (trust fund) taxes for which you are liable;
- taxes for which no return was filed;
- taxes for which a late return was filed within two years of the date you filed for bankruptcy;
- taxes for which a fraudulent or frivolous return was filed; and
- taxes that you willfully attempted to evade.
These are not meant to be exhaustive lists: It’s more of a quick peek. Additional rules apply to penalties, as well as other kinds of taxes like property taxes and excises taxes. The priority of your claims may make a difference, as well as whether you have any tax liens in place. The rules can also be different in an involuntary bankruptcy. For more on taxes and bankruptcy, check out IRS Pub 908, Bankruptcy Tax Guide (downloads as a pdf).
One more thing. You’ve probably figured out that, like taxes, bankruptcy rules can be complicated. And just as there’s an entire section of the U.S. Code devoted to taxes (good ol’ Title 26), there’s also an entire section devoted to bankruptcy (Title 11). The rules are numerous – as are the caveats, exceptions, and specific exemptions. I highly recommend that you consult with a bankruptcy lawyer about whether you qualify and which debts might be dischargeable, including your taxes. And before you jump in, make sure your bankruptcy lawyer understands the underlying tax consequences of your bankruptcy petition – or has a good tax professional on speed dial.
For your taxes from A to Z, here’s the rest of the series:
- A is for Annual Contribution Limits
- B is for Bonus
- C is for Choate
- D is for Direct Deposit
- E is for Enrolled Agent
- F is for Found Money
- G is for Ghost Preparer
- H is for Hobby Loss Rules
- I is for Installment Agreement
- J is for Joint Accounts
- K is for Kin (Crypto)
- L is for Line of Credit
- M is for Mileage
- N is for NIIT
- O is for Organ Donations
- P is for Private and Parochial Schools
- Q is for Qualifying Relative
- R is for Relief Funds
- S is for Surviving Spouse
- T is for Taxpayer Bill of Rights
- U is for Unused Sick Leave