Federal tax debt is a significant factor for many individuals filing for bankruptcy protection. Celebrities like Willie Nelson have experienced widely-publicized difficulties due to taxes owed to the Internal Revenue Service (IRS). Unlike many types of debts, bankruptcy generally can only wipe out an individuals federal tax debt if certain legal requirements are satisfied. An individual that wishes to discharge his or her tax debts through Chapter 7 or Chapter 13 bankruptcy must initially review those tax debts to determine how much, if any, would be dischargeable in bankruptcy.
Federal Tax Debt
Unpaid taxes may accrue unintentionally, as in one of the most famous cases of substantial tax debt, country singer Willie Nelson. Nelson had invested heavily in a tax shelter in the early 1980’s that the IRS disallowed as a deduction. This led to an assessment by the IRS of $6 million in unpaid taxes over a period of six years, from 1984 to 1990, with an additional $10 million in accrued interest.
Federal agents raided Nelson’s residence in November 1990 and seized most of his property, although he was able to keep his guitar. Instead of bankruptcy, he reached an agreement with the government that involved the sale of most of his assets and the release of an album. He would split the proceeds of the album, titled “The IRS Tapes: Who’ll Buy My Memories?” with the IRS. The government received $3 from the sale of each $19.95 album, and collected a total of $3.6 million from album sales. It used proceeds from the sale of many of Nelson’s assets to pay part of the debt, and Nelson was able to use money from a settlement with his accountant to pay the remainder of the debt. Unfortunately, most individuals may not have the clout to reach such an agreement with the IRS.
Discharge of Federal Tax Debt
Federal bankruptcy law allows the eventual discharge of federal tax debt in a Chapter 7 or Chapter 13 bankruptcy, but only under the following circumstances:
– The debt must be for federal income tax, not payroll or any other kind of tax. 11 U.S.C. § 507(a)(8)(A).
– The tax debt must be at least three years old at the time the debtor filed for bankruptcy. 11 U.S.C. § 507(a)(8)(A)(i).
– The debtor must have filed a return for the taxes sought to be discharged. 11 U.S.C. § 523(a)(1)(B)(i).
– The IRS must have either (1) assessed the tax debt at least 240 days before the debtor filed for bankruptcy, or (2) not assessed the tax debt yet. 11 U.S.C. § 507(a)(8)(A)(ii).
– The debtor must not have committed tax fraud or attempted to evade paying taxes prior to filing for bankruptcy. 11 U.S.C. § 523(a)(1)(C).
Nondischargeable Tax Debts and Liens
Other types of tax debt are not subject to discharge in bankruptcy at all. This includes FICA and Medicare taxes, commonly known as payroll taxes, which are often withheld from an individual’s paycheck and paid by the employer. Self-employed individuals, however, are responsible for paying these taxes themselves. Tax liens recorded by the IRS before a debtor files for bankruptcy are also not dischargeable, and may only be reduced or discharged in a settlement with the IRS. Many local taxes, such as property taxes attached to real property, are also not dischargeable.
Bankruptcy protection may offer relief to people in Los Angeles who have more debt than income, allowing individuals to restructure their bills or, in some cases, discharge debts entirely. Devin Sawdayi, a bankruptcy attorney, has represented clients in the Los Angeles area with dignity and respect for fifteen years, helping them to rebuild their finances and their lives. To schedule a free and confidential consultation, contact us today online or at (310) 475-9399.
Web Resources:
IRS Publication 908, Bankruptcy Tax Guide
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A Chapter 13 Bankruptcy Can Help You With Your Large Student Loan Debt, Los Angeles Bankruptcy Lawyer Blawg, May 21, 2013