By John Lee
Tax debts are generally not dischargeable in bankruptcy. Tax debts that are almost never discharged include: (1) tax debt from unfiled returns, (2) tax debt from employers 941 withholdings and (3) certain tax penalties. Tax debts that may be dischargeable include personal income taxes where the debtor (1) filed the return over 2 years ago, (2) the tax debt is at least three years old, and (3) the IRS has not assessed the tax debt in the last 240 days prior to filing.
If you are guilty of any type of tax fraud or tax evasion then the debt may not be dischargeable in bankruptcy. Even if your tax debt is otherwise dischargeable, if you have entered in to a payment plan with the IRS then that acts to extend the time it takes before the tax would become dischargeable. In other words, a repayment plan acts to toll the waiting period before you are eligible to file and receive a discharge.
Other types of tax debts that may not be dischargeable would include State income taxes and sales taxes on a business or restaurant. If the IRS has placed a lien against your property, then that lien would not be dischargeable in bankruptcy. As you can see, in many cases, tax debt is not dischargeable in a Chapter 7 Bankruptcy.
A Chapter 13 Bankruptcy can help a debtor deal with tax debts. Even though your tax debts may not be dischargeable in a Chapter 7 Bankruptcy, you still may be able to find relief in the Chapter 13 Bankruptcy. The Chapter 13 Bankruptcy puts the debtor on a court ordered repayment plan that, in many cases, eliminates interest and penalties. The interest and penalties on tax debt can double and triple the original principle balance in a short period of time. The Chapter 13 Bankruptcy, once filed, can stop the rapid accruing of interest and penalties and give the debtor a chance to pay back the debt without additional charges. This can be a very powerful tool if the IRS is adding thousands of dollars a month to your tax bill in interest and penalties.
Clients always ask me if they can keep their tax refund; and the answer is . . . maybe. In Virginia, we have an exemption that is like a wildcard exemption to protect miscellaneous property. The only problem with this exemption is that it is limited to $5,000.00 per lifetime. That means if your tax refund is over $5,000.00; or, if you used the exemption in a previous bankruptcy, then you may not be able to protect your tax refund. If you are over 65, disabled or have minor children you may be eligible to protect a little more than $5,000.00. This exemption is referred to as the “Homestead Exemption.” Virginia is one of the worst States when it comes to allowing its most vulnerable citizens to use a homestead exemption to protect their home and valuables. Many other States have Homestead Exemptions that exceed $500,000.00. So if you are reading online about protecting assets, make sure that you take into consideration that Virginia is very different from most States.
Some of my clients decide to file bankruptcy after they have received and spent their tax refund money. Unfortunately, this does not protect the tax refund because the Chapter 7 Bankruptcy Trustee has a Look Back Period and he can undo transactions that occurred immediately prior to filing bankruptcy.
Often times a debtor will receive his tax refund and use it to pay back friends and family members that lent him money during the year. Other times a person will receive a tax refund and give a percentage of it to a non custodial parent, relative or guardian. In cases where the debtor gave a portion of his tax refund to a friend or family member (whether there be a loan or not), the Chapter 7 Bankruptcy Trustee can actually go after that friend or family member and demand that they turn over the funds received from the debtor’s tax refund. Debtors are not allowed to give away money or to pay back loans to “insiders” including friends and relatives prior to filing a bankruptcy.
A debtor may receive a tax refund and spend it prior to filing a bankruptcy. If a debtor is planning on filing bankruptcy shortly after receiving a tax refund he should (1) keep an itemized list of all the things he purchased with the funds; (2) he should not give any of the money to friends or family members; and (3) he should not pay any creditor (family member or not) over $600.00 with the money. The debtor can (1) make one car payment and/or rent payment with the tax refund; (2) pay his attorneys fees; (3) catch up on utilities; (4) buy groceries and clothing; and (5) buy normal household goods and electronic equipment. This is not an exhaustive list of what the debtor can spend his pre-bankruptcy tax refund money on, but it should help give some guidelines.
Another thing to consider when filing bankruptcy is that the Chapter 7 Bankruptcy Trustee can hold open your bankruptcy case until the following year to take your tax refund. If you filed bankruptcy in June and you normally receive a $6,000.00 tax refund, then you have “earned” half of that by your June bankruptcy filing date, or $3,000.00 of the future tax refund. The Chapter 7 Bankruptcy Trustee can hold your case open until the following tax season to take $3,000.00 of your $6,000.00 tax refund. In some cases an attorney can exempt this tax refund using your Homestead Deed, but only if you have enough homestead deed left over from previous bankruptcies.
Filing a bankruptcy without an attorney is a good way to have your next tax refund seized by the Bankruptcy Trustee. The attorneys at John W Lee, PC have helped thousands of people properly claim their exemptions in Bankruptcy Court. Our attorneys offer a free initial consultation to help you determine if your property is safe in bankruptcy.
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