Tax Law Insights

If an individual or business owes unpaid income taxes to the IRS, or to a state, federal bankruptcy laws may provide relief for some, if not all, of these taxes. Generally applicable to "older" federal and state income taxes, if a taxpayer has filed timely tax returns for a tax period, the due date of which, including extensions, is more than 3 years from the date a bankruptcy petition is filed; if the tax return is filed late, at least 2 years have elapsed since the filing of the late return and the filing of the bankruptcy petition; and, where the IRS has made an "assessment" of the tax owed, at least 240 days have passed since the assessment and the bankruptcy petition date, these older taxes, including any associated penalties and interest, may all generally be "discharged" or released through a federal bankruptcy filing. Taxes that are for more current tax periods, generally for the 3 years before the bankruptcy, are not dischargeable. There are also exceptions to the discharge rules for fraudulent returns, where the taxpayer has not filed tax returns, and, judicially-developed, where the taxpayer has filed late tax returns otherwise dischargeable but where the taxpayer had sufficient income and other resources to pay the taxes when due but simply didn't.

Penalties and interest associated with income taxes are discharged to the same extent of the underlying taxes, except there is a special rule also discharging penalties if they related to a penalty imposed on a transaction or event occurring more than 3 years prior to filing the bankruptcy.

Where an individual or business owes federal or state income taxes, a lien arises against the individual or business and against all his/its assets in favor of the IRS or state taxing authority. The IRS and state tax authority "perfects" this lien by filing notice of the lien against the tax debtor, typically with the county in the state where the tax debtor's assets are located. If a tax lien has been filed prior to bankruptcy, the IRS or state tax authority is treated as a "secured" creditor in the bankruptcy, with the tax claim now secured to the extent of the tax debtor's assets. This secured status in the tax debtor's assets is given to the IRS or state tax authority even if the underlying tax debt is otherwise discharged in the bankruptcy.

Income taxes that are considered "dischargeable" tax debts in a bankruptcy are treated as unsecured debts in the bankruptcy and paid together with other unsecured creditors.