Many people declare bankruptcy after experiencing a variety of financial hardships. Loss of income, high credit card bills, collections and judgments, unexpected taxes and liens combine to create an unmanageable financial situation. Bankruptcy discharge can eliminate responsibility for many debts, but certain debts, such as taxes, are not always included in that relief.
Federal bankruptcy laws exempt certain debts from discharge. Child support and alimony, most student loans, bankruptcy fees, criminal fines and restitution, and judgments related to drunken driving and driving under the influence are all exempt from bankruptcy discharge. Certain taxes are exempt as well. These taxes include property taxes due within a year before the filing date, taxes on income or gross receipts for the three years prior to the filing date, unpaid state and federal taxes, and unpaid employer taxes due for the three years prior to the filing date.
Since all debts that are included in a Chapter 7 bankruptcy are subject to discharge, exempt taxes may not be included in a Chapter 7 bankruptcy. They must be paid in full directly to the creditor. The debtor may also deal directly with the creditor and negotiate a settlement for a reduced amount or a repayment plan.
In a Chapter 13 bankruptcy, debts are restructured into a court-ordered repayment plan that lasts for three to five years. Taxes may be included in the Chapter 13 repayment plan, which may include a negotiated amount that is less than the original amount owed. This allows the debtor to repay the tax debt over an extended period through the monthly debt payment made to the court. The court will then pay toward the tax debt as a priority debt according to the agreement. After the repayment period is over, the court discharges any remaining outstanding debt, with the exception of exempt items. Any remaining balance on exempt taxes survives the bankruptcy, and the debtor must either repay it or make arrangements with the creditor. Taxes are not eligible for a hardship discharge.
Taxes During Bankruptcy
Chapter 13 bankruptcies can last for three to five years due to the length of the repayment period. The court can dismiss the bankruptcy at any time if the debtor fails to meet certain obligations during the bankruptcy proceedings. One of these is the failure to file and pay any taxes. Dismissal stops the proceedings and voids any court-ordered settlement, leaving the debtor liable for all included debts in full. In addition, the court can seize any tax refunds or credits received during the bankruptcy and use them to repay creditors.
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