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Bankruptcy and tax debt: opportunities and issues

Tax debt is a factor in many bankruptcies. In fact, bankruptcy filings tend to go up during tax season.

Keep in mind, however, that there are many specific rules that can affect the ability to discharge tax debt in bankruptcy. For example, business tax debt is never dischargeable. 

In this post, we'll outline some of the opportunities and limitations involved in seeking to resolve personal income tax debt through a bankruptcy petition.

The opportunity, of course, is that personal tax debt can, in some cases, be discharged in bankruptcy. Discharging this debt can be a significant part of an overall debt relief strategy.

But there are several limitations that must be taken into account when considering this approach. For one thing, much depends on how much time has passed. 

In general, the rule of thumb is that three years must have passed since the taxes in question should have been filed. And make no mistake: a return must be filed in order to have a chance at discharging tax debt in bankruptcy. Indeed, there are also rules about how much time must have passed since the returns were filed before someone can seek to discharge the tax debt associated with those returns.

Another limitation is that a bankruptcy filing will not stop a tax audit that is already in progress. It's true that a bankruptcy filing will stop collection proceedings by the IRS for as long as the bankruptcy is pending.

After all, one of the benefits of bankruptcy is the automatic stay it provides against collection proceedings of all types. But you cannot avoid an audit merely by declaring bankruptcy.

Source: Fox Business, "How Bankruptcy Impacts Your Taxes," Bonnie Lee, July 25, 2013

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