One misconception about bankruptcy is that tax debts cannot be discharged. While it is true that some tax debts cannot be discharged, it is not true that all tax debts cannot be discharged. In fact, for many individuals, bankruptcy can offer taxpayers tax debt relief to years-old federal and state tax liabilities that they otherwise would never be able to pay in full.
There are three time periods that must be examined to determine whether tax due for a particular tax year can be discharged in a bankruptcy: (1) the date the return was due; (2) the date the return was filed; and (3) the date the tax was assessed.
Not only is it important to make sure the particular tax seeking to be discharged meets the three-pronged test above, but the taxpayer must also be careful that any tolling (stopping) of these periods are met as well. For example, if you filed an extension for a particular year, then the date in item #1 above, the date the return was due, would be in October of the following year, not April. Also, if you’ve been in a prior bankruptcy during these times, which was ultimately dismissed, discharged or otherwise terminated, the time you’re in that prior bankruptcy also tolls the time periods above. In short, if you file bankruptcy too soon, you will eliminate your ability to discharge the tax.
Despite the relief the bankruptcy code offers for individuals owing taxes, the code is not quite as forgiving for those who owe other types of taxes. For those who are liable for trust fund taxes – such as payroll tax withholding, sales tax, and the like – the rules detailed herein do not apply. Generally speaking, absolute relief cannot be afforded for trust fund taxes, although partial relief can be had via the Trust Fund Tax Penalty. This details of this type of tax liability relief is not covered by this article. It is important to contact a qualified tax and bankruptcy professional for help in your particular situation.