Most tax debt is not dischargeable in bankruptcy. Bankruptcy will not discharge taxes that are (1) secured by a lien, (2) came due within three years of the bankruptcy filing, (3) where a tax return was not filed, (4) when the return was filed within the two years prior to filing bankruptcy, and (5) when the return was fraudulent. Taxes that fall into the forgoing categories are considered non-dischargeable tax debts.
Priority Tax Debt is not dischargeable and may be paid back by the Trustee ahead of general unsecured claims. A Priority Tax Debt claim is one where the tax debt came due in the three years prior to filing the bankruptcy or the tax debt was assessed within the past 240 days prior to filing bankruptcy.
In bankruptcy, you would normally want your non-dischargeable tax debt to also be a Priority Tax debt because, at least then, the Trustee could pay it ahead of other general unsecured creditors.
It is possible to have a non-dischargeable tax debt that is also a non-priority tax debt. For example. A tax debt on an unfiled return, or a fraudulent return could be both non-dischargeable and non-priority. This is a problem for the debtor because he will still owe the taxes after bankruptcy and any monies distributed to his creditors by the Trustee would not first go toward tax debt.
A debtor would typically prefer for tax debt to be paid ahead of general unsecured claims because general unsecured claims are going to be discharged whether they are paid back or not. If you must pay back debt in bankruptcy, it might as well be a debt that was not going to be discharged.
Also, if you file your tax return late, then the taxes will likely become non-dischargeable in bankruptcy. Several jurisdictions have ruled that taxes owed on a tax return that was filed late can never be discharged in bankruptcy. Other jurisdictions have ruled that if the return was filed a few days late, before the governmental agency assessed a tax, then the tax debt may still be dischargeable in bankruptcy.
Even if you live in one of the jurisdictions that allow a discharge if the return was filed before the tax was assessed, you still must wait at least two years to file bankruptcy if you are hoping to have the tax debt discharged.
If you fail to file your tax return then the IRS, or other governmental agency, will file a Substitute for Return (SFR), assess a tax, and send you a deficiency notice. The SFR that they file will be based on the information provided to them from your employers, but not include any deductions you may have been entitled to. Therefore, the assessment will likely be for more than you should owe. This SFR or assessment does not count as you having filed a return.
Once the IRS goes through this process, the assessed tax debt will become non-dischargeable in bankruptcy. Even in this circumstance, it is usually better to go ahead and file your tax return late to get credit for your allowable deductions.
When it comes to bankruptcy, filing your tax return late is always a bad idea. In most cases, a late tax return, especially a very late tax return, will cause the tax debt to be non-dischargeable in bankruptcy. If you file a No-Asset Chapter 7 bankruptcy, one where there is nothing for the trustee to sell for the benefit of your creditors, non-dischargeable tax debt will just follow you after your case is over. However, if your non-dischargeable tax debt is also non-priority because it is over three years old, then it will cause problems in your Chapter 13 case because the Trustee will not pay it ahead of general unsecured creditors. In a Chapter 13 repayment plan, the only way to have the non-priority, non-dischargeable taxes paid in full is by being in a plan that repays all creditors 100% of the debts owed.
Even if your tax debt was filed timely and is sufficiently aged, you still may have a problem getting a discharge if the required waiting period had been tolled. Even if your tax obligations fall outside of the three-year and two-year periods, they still may be non-dischargeable if the waiting periods had been tolled. Tolling occurs when you do an offer-and-compromise, have filed a previous bankruptcy, or obtained a Taxpayer Assistance Order (TAO). Merely entering a payment plan to repay your tax debt does not toll the time periods.
