Most tax issues in bankruptcy involve whether or not a tax is discharged, how to properly handle tax refunds, and delinquent real estate taxes. Dischargeability of taxes typically involves income and income type taxes and withholding taxes. Income type taxes include employment and unemployment taxes assessed directly upon the debtor.
Income and income type taxes are dischargeable in bankruptcy if three conditions are met. First, the tax in question must be three years old or older. This is calculated from the required filing date of the tax or the extension date, if an extension was filed. Offers in compromise and previous bankruptcies extend the time frame of this calculation. Second, two years must have passed since the debtor actually filed the tax return. Finally, any new assessments of the tax within the previous 240 days may not be affected by a bankruptcy discharge unless paid in full as part of a plan of reorganization in a Chapter 11, 12, or 13.
Withholding taxes are those taxes imposed upon another that the debtor has the responsibility of withholding and then turning over to the government. Sales tax is included in this group. Simply stated, withholding taxes are never discharged in bankruptcy unless paid in full as part of the plan of reorganization in a Chapter 11, 12, or 13.
In a Chapter 7, tax refunds are property of the estate and may need to be surrendered to the trustee depending on a debtor’s available exemptions. Tax refunds accumulate month by month. So if a case is filed on June 30th of a given year, then one half of any tax refund for that year has already accumulated and is subject to administration by the trustee. If a debtor is likely to have a tax refund, then it is advisable to consider changing the rate of withholding with the debtor’s employer to reduce the tax refund by the end of the year.
In a Chapter 13, a debtor not only has the above listed concerns but also has to consider that a Chapter 13 trustee might require turnover of the tax refund every year during the life of a Chapter 13 case as it represents additional income in the year received. Not all Chapter 13 trustees and Judges have this point of view, but it needs to be considered and appropriate steps need to be taken to reduce or eliminate tax refunds during a Chapter 13 case.
A delinquent real estate tax may be paid as part of the plan of reorganization in a Chapter 11, 12, or 13. Real estate taxes have a priority position under state law and are not displaced by a mortgage and must be dealt with or could result in a tax sale of the property. A holder of a tax certificate can request a tax sale of the property two years after purchase of the tax certificate unless the tax is dealt with in a plan of reorganization.