Taxes in Bankruptcy Proceeding

In Washington, you may retain any property that falls into one of the exemptions categories if you file bankruptcy. However, there are certain debts that you will not be able to discharge even in bankruptcy, among them are certain non-dischargeable taxes, as for example, back taxes are not dischargeable unless the tax meets discharge requirements.

The main question is whether one’s personal federal / state income taxes can be included in a bankruptcy claim? In order to be dischargeable, a tax return must have been due for at least three years. Once the first determination is made, you must have filed tax returns, at least, two years prior to filing bankruptcy. Finally, taxes must have been assessed at least 240 days prior to filing bankruptcy. However, these deadlines can be “tolled” (extended) due to various events, e.g. filing for an offer in compromise can extend some of these deadlines.

Although taxes can be dischargeable, IRS can retain a lien if it filed a notice of federal tax lien before you filed bankruptcy. It is certainly possible to communicate with IRS and try to remove a tax lien if the debtor does not have many assets.

Another question is whether you can retain tax refunds in bankruptcy. Generally, it is possible to retaim tax refunds in Chapter 7 bankruptcy, however for Chapter 13 debtors the amount is limited. In Chapter 7, the tax refunds are considered as assets, whether received or expected in the future. Therefore, as with all other assets, if tax refund is “exempt”, trustee will not be able to reach it. You need to carefully plan ahead in order to preserve a better chance of keeping this asset.

In Chapter 13 bankruptcy, however, your tax refunds will be closely scrutinized by trustee during the life of the plan. Trustee may have the discretion to retain your tax refund in case if you are in a plan that pays less than what you owe on your debt. Because Chapter 13 requires all disposable income to be paid into the plan, trustees generally classify tax refunds as disposable income.

We are generally are able to have our clients retain portion of the refund, and can motion to retain all during the plan. Dischargeability of taxes or keeping the tax refunds in bankruptcy is very rigorous and complicated issue, therefore, it is advised that you consult with a bankruptcy attorney.