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Eliminating Income Taxes in Bankruptcy

Many people assume that you cannot file bankruptcy on taxes and go on for years paying taxes that they could have eliminated in bankruptcy. This notion may stem from the prevailing belief in the United States ever since Benjamin Franklin uttered the famous quote: “In this world nothing can be said to be certain, except death and taxes.”

Tax liability is often a very stressful issue, especially for business owners. Employees usually have their taxes taken out of the paychecks each pay period, so they are prepaid come April 15th. But when it comes business owners, they pay themselves and usually do not set aside the necessary savings to cover their anticipated liability. So tax time rolls around and they stress about how they will meet their obligations to Uncle Sam.

The good news, for many people, is that if you have gotten yourself into a situation where you incurred a tax liability that you cannot pay, you may be able to discharge your liability in bankruptcy. Generally speaking, you can file bankruptcy on taxes and eliminate your income tax liability if your taxes are more than 3 years old.

More specifically, if your taxes were (1) first due more than 3 years ago, and (2) two years has passed since you filed your return, and (3) if an assessment has been made then 240 days has passed since the assessment, you can file file bankruptcy on taxes and your tax liability to the IRS can be discharged in bankruptcy.

If the IRS has not made an assessment before you file bankruptcy, it may make an assessment after you file bankruptcy, in which case that may pose an obstacle to you eliminating your income tax liability depending on your particular circumstances.

If there is fraud alleged to be involved in connection with the filing of your returns (or possibly based on a total failure to file), then your income taxes may not be dischargeable even if you meet the above described test.

As part of the pre-bankruptcy planning process, an experienced bankruptcy lawyer can properly advise you as to whether your tax liability would be dischargeable in bankruptcy in light of your particular circumstances and when you should file in order to be able to discharge your tax liability.

Note: this article does not address cancellation of debt income attributed to you, for example, when a mortgage lender writes off a debt and issues you an IRS Form 1099-C. Income tax liability based on cancellation of debt income is beyond the scope of this article. Suffice it to say, such liability is generally dischargeable in bankruptcy regardless of the year the liability was incurred.

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