Discharging Tax Debts in Bankruptcy
Table of Contents
1. Income Taxes (Federal and State). An “income tax” is any tax (federal or state) measured by gross income or gross receipts. Income tax debts can be discharged in bankruptcy, but only if the tax is more than 3 years old and satisfies several other legal requirements. You must analyze the liability for each tax year in question to determine whether an income tax debt is dischargeable. The tax debt is dischargeable only if all of the following requirements are met with respect to each tax year. Index
1.1. Three Year Age Rule. More than 3 years must elapse between the bankruptcy filing date and the date the income tax return was last due, including all extensions. Index
Example #1. Assuming that the Taxpayer does not request an extension of the due date to file his income tax return, any tax owed for the 2007 federal income tax year can not be discharged in bankruptcy unless the bankruptcy petition is filed on or after April 16, 2011.
1.1.1. Return Filing Extensions. The 3 year time period does not expire until the due date for filing the tax return. For federal income taxes, if no extension is requested, the 3 year time period will elapse on April 15 of the 3rd year following the tax year in question. If an automatic extension is requested, the 3 year time period will not expire until the last date of the extension period (October 15). Index
Example #2. On April 15, 2007, Taxpayer requests a 6 month automatic extension of time to file his 2007 federal income tax return. He prepares and files the return on or before the due date (October 16, 2008), but does not pay any portion of the unpaid taxes due for the 2007 tax year. The 2007 income taxes can not be discharged in bankruptcy unless the bankruptcy petition is filed on or after October 16, 2011.
1.1.2. Due Date Controls – Not Filing Date. The last due date for filing the return is the proper date for determining if the 3 year age rule has been satisfied The date the taxpayer actually files the return is irrelevant. Index
Example #3. On April 15, 2008, Taxpayer requests an automatic extension of time to file his 2007 federal income tax return, which makes the return due on October 15, 2006. It is irrelevant to the 3 year age rule whether Taxpayer actually files the return early (prior to October 15, 2008) or late (after October 15, 2008). The taxes will be discharged only if the bankruptcy petition is filed on or after October 16, 2008.
1.2. Two Year Filing Rule. To discharge a tax debt in a Chapter 7 case, the taxpayer must file the return for the tax year in question more than 2 years before he files for bankruptcy. Although the 3 year rule considers the age of the tax, the 2 year rule only deals with the filing of any required tax return. Index
1.2.1. IRS Filed Returns Do Not Qualify. The Internal Revenue Code authorizes IRS to prepare and file a substitute return for a taxpayer if he fails to prepare and file the return. If IRS prepares a return for the taxpayer, the taxpayer can consent to the return by signing it, or the IRS can file the return without the taxpayer’s consent. If the taxpayer does not sign or otherwise agree to an IRS filed return, the IRS return does not count as a filed tax return for purposes of the 2 year filing rule. However, if the taxpayer signs the return, the IRS return will count as a filed return for purposes of the 2 year filing rule. Index
Example #4. Taxpayer never filed a 2003 federal income tax return. On January 2, 2006, IRS files a substitute tax return on behalf of Taxpayer. The substitute return indicates a $500,000 tax liability. IRS assesses the tax on the same day. Taxpayer does not sign or otherwise consent to the filing of the return. If Taxpayer files for Chapter 7 bankruptcy on January 2, 2010, he can not discharge the 2003 tax debt because he never satisfied the 2 year filing rule. In fact, the 2003 taxes can never be discharged in a Chapter 7 case because Taxpayer never filed and signed a tax return.
1.2.2. Filing Date for Purposes of 2 Year Rule. Federal tax returns filed before the due date are not considered filed until the due date. Returns filed after the due date are considered filed on the date IRS actually receives the return. If the taxpayer files the return before the due date, the 2 year time period starts to run on the tax return due date, not the actual filing date. If the taxpayer files the return late (after the last due date), the 2 year time period starts to run on the date that IRS actually receives the return. Index
Example #5. Taxpayer ignores the April 15, 2008 deadline for filing his 2007 income tax return. He waits until May 1, 2009 (one year and 15 days after the due date) to mail the return. IRS does not receive the return until May 15, 2009. IRS immediately assesses the tax after it receives the return. The 2007 taxes will not be dischargeable in a Chapter 7 bankruptcy unless Taxpayer files for bankruptcy on or after May 16, 2011.
1.3. 240 Day Assessment Rule. A taxpayer can not discharge a tax in bankruptcy unless the taxing authority assesses the tax more than 240 days before the taxpayer files for bankruptcy. If the taxpayer makes any offer in compromise, the 240 day time period is extended by the number of days the offer in compromise is pending, plus an additional 30 days. The 240 day rule normally comes into play only if the taxing authority audits a prior return and assesses additional tax as a result of the audit. Index
Example #6. On April 15, 2008, Taxpayer files his 2007 federal income tax return. On November 1, 2010, IRS commences an audit of the 2007 return. On April 16, 2011, as a result of the audit, IRS assesses $100,000 of additional tax. Taxpayer has satisfied both the 3 year age and 2 year filing rules, but the 240 day assessment rule will not be satisfied until after December 13, 2011; 240 days after IRS assessed the additional tax. To discharge the $100,000 of additional tax, Taxpayer can not file bankruptcy until on or after December 13, 2011.
1.4. Post Bankruptcy Tax Assessments. A taxpayer can not discharge a tax debt which is lawfully assessed after he files for bankruptcy. A taxing authority is legally permitted to start or continue a tax audit, and assess additional tax, after a taxpayer files for bankruptcy, if the time period for assessing additional tax has not already expired. This rule is intended to force a person to pay, and prevent discharge of additional taxes assessed after a bankruptcy filing. Index
The general rule is that IRS has only three years from the return filing date to audit a return and assess additional tax. If the taxpayer has satisfied the 3 year age rule (a requirement for discharging the tax in bankruptcy), IRS can not legally assess any additional tax, with three important but rare exceptions. First, if the return omits gross income by more than 25 percent, IRS has 6 years from the return filing date to assess the additional tax. Second, IRS can assess additional tax at any time (forever) if the taxpayer files a fraudulent return or is guilty of tax evasion. Third, the tax assessment deadline can be extended if the taxpayer signs a written agreement extending the deadline. Therefore, the rule preventing a bankruptcy discharge of taxes assessed after the bankruptcy filing will rarely come into play, and will pose a problem only if: (1) IRS can prove that the taxpayer under reported income by more than 25 percent; (2) IRS can prove that the taxpayer is guilty of tax evasion or filed a fraudulent return; or (3) the taxpayer agrees to an extension of the assessment period.
Example #7. Taxpayer files his 2003 federal income tax return on April 15, 2004. The return reports $100,000 of gross income and a $10,000 tax obligation. Taxpayer never pays any of the tax. Taxpayer files for Chapter 7 bankruptcy on March 15, 2010, 5 years and 11 months after Taxpayer filed the 2003 return. On April 14, 2010, IRS discovers that Taxpayer under reported $30,000 of gross income on his 2001 return. IRS assesses $9,000 of additional income tax. IRS was legally authorized to assess the additional tax because: (1) post bankruptcy assessments are legally permitted; (2) gross income was under reported by more than 25 percent; and (3) less than 6 years elapsed between the return filing date and assessment of the additional tax. The bankruptcy filing will discharge the $10,000 of unpaid tax reported on the original return. However, the bankruptcy filing will not discharge the $9,000 assessment made on April 14, 2010 because the additional tax was legally assessable after Taxpayer filed for bankruptcy. Index
1.5. Tax Fraud and Willful Evasion. A tax debt is not dischargeable in a Chapter 7 case if the taxpayer files a fraudulent return. A return is fraudulent if the taxpayer intentionally fails to report income or makes misrepresentations on the return. Likewise, a taxpayer can not discharge a tax in a Chapter 7 case if he willfully attempts to defeat or evade payment of the tax. The following conduct could qualify as tax evasion: (1) the taxpayer has the ability to pay the tax but uses the funds for other purposes; or (2) the taxpayer evidences a pattern of failing to file returns, failing to pay taxes, or attempting to hide income and assets. The tax fraud issue can be raised after the bankruptcy case is filed and closed. However, a taxpayer might be able to discharge a tax debt in a Chapter 13 case, even if he is guilty of willfully evading payment of the tax, and possibly without paying any portion of the tax. See 14. Chapter 13 Cases for a discussion of debts excepted from discharge in Chapter 13 cases. Index
Example #8. Assume the same situation described in Example #7, except IRS does not discover the under reported income until April 15, 2010, 8 years after Taxpayer filed the tax return. If IRS can prove that Taxpayer filed a fraudulent return or was guilty of tax evasion, IRS can assess the additional tax at any time. The prior bankruptcy filing will not prevent IRS from assessing or collecting the additional tax. Index
2. Employment Taxes. There are two parts to every employment tax: the employee portion and the employer portion. Index
2.1. Employee Portion (Trust Fund Taxes). Index
2.1.1. Defined. The employee portion is the portion of the tax which the employer is required to withhold from an employee’s pay check and remit to IRS. The employee portion includes the federal withholding tax, 6.2 percent social security tax and 1.45 percent medicare tax. The employee portion is typically referred to as a “trust fund” tax because the employer is required to hold the money in trust, on behalf of the employee, for payment to IRS. Index
2.1.2. Employee Portion Not Dischargeable. The rule relating to any “trust fund” taxes is very simple: a trust fund tax is never dischargeable in a Chapter 7 case, regardless of the age of the tax. Even trust fund taxes which are over 10 years old can not be discharged in a Chapter 7 case. In a Chapter 13 case, the bankruptcy plan must offer to pay 100 percent of all trust fund taxes owed, including all accrued interest and penalties due through the date the case was filed. You can never escape from paying trust fund taxes by filing for bankruptcy, regardless of whether the case is filed under Chapter 7 or 13. Index
However, if the 10 year statute of limitations expires, the tax will become uncollectible regardless of whether a bankruptcy case is ever filed. See “8. Statute of Limitations” for a discussion of the 10 year time limit on the collection of federal tax debts.
2.2. Employer Portion Index
2.2.1. Defined. The employer portion is the tax which the employer owes directly to the government. The employer portion includes the employer’s obligation to pay an additional 6.2 percent of social security tax and an additional 1.45 percent of medicare tax. Index
2.2.2. Employer Portion May be Dischargeable. A taxpayer can discharge the employer portion of the tax in a case filed under wither Chapter 7 or 13 if he can satisfy the 3 year age and 2 year filing rules, and the failure to pay was not the result of tax evasion. In other words, the employee portion of the tax is dischargeable if: Index
(a) more than 3 years pass between the bankruptcy filing date and the date the 941 tax return was last due, including all extensions;
(b) less than 2 years elapse between the date the 941 tax return was filed and the date the bankruptcy is filed; and
(c) the taxpayer did not willfully evade payment of the tax.
There is no similar 240 day assessment rule for employment taxes. If the 3 year, 2 year and tax evasion rules are all satisfied, it is irrelevant when IRS assesses the tax.
3. Sales Taxes. A sales tax is a tax collected from a customer by a seller of goods or services. Index
3.1. Sales Taxes are Trust Funds. In Texas, sales taxes are classified as “trust fund” taxes. The taxes are “trust fund” taxes because the employer is obligated to collect the tax from the customer and hold the funds in trust for payment to the Texas Comptroller’s office. Index
3.2. Sales Taxes Not Dischargeable. Trust fund taxes can not discharged in a Chapter 7 case, regardless of the age of the tax. In a Chapter 13 case, the bankruptcy plan must offer to pay 100 percent of all trust fund taxes owed, plus all accrued interest and penalties due through the date the case was filed. You can never escape from paying trust fund taxes by filing for bankruptcy, regardless of whether the case is filed under Chapter 7 or 13. Index
3.3. Personal Liability for Non-Payment. An individual is personally liable for nonpayment of a sales tax if he: Index
(a)(1) controls or supervises the collection of the tax from a customer; or
(2) supervises the accounting and payment of the tax to the state; and
(b) willfully fails to pay the funds to the state.
Any owner or employee of a business who either collects or supervises the collection of the tax, or who is responsible for paying the bills, will be personally liable for the tax if they are not paid.
Example #9. Bill and Sandy are both owners of Bill’s Widgets, Inc., a Texas corporation engaged in the retail sale of widgets. Sandy, the President, is responsible for selling the widgets and pays all of the bills. Bill is Vice-President. He is also a lawyer, operates a law firm, and does not participate to any significant degree in Bill’s Widgets. Bill does not write any checks against the Bill’s Widgets corporate bank account. Bill’s Widgets suffers slow widget sales. The business only generates enough income to pay either employee salaries or state sales tax, but not both. Sandy decides to pay her loyal employees instead of the state sales tax. Bill’s Widgets goes out of business. Bill and Sandy are both forced to file for personal bankruptcy. Bill is not personally liable for any of the sales taxes since he did not control nor supervise the collection or payment of the tax. Sandy is personally liable since she controlled and supervised the collection and payment of the tax. Sandy can not discharge the sales tax debt in a Chapter 7 case. In a Chapter 13 case, Sandy’s bankruptcy plan must offer to pay 100 percent of all sales taxes due, plus all accrued interest and penalties due through the date the case is filed, unless the Texas Comptroller agrees to accept less than full payment (an unlikely result). Index
4. Property Taxes. Index
(a) real estate taxes levied against land owners by local municipalities; and Index
(b) personal property taxes (sometimes called “ad valorem” taxes) levied against business owners for personal property used in connection with a business.
4.2. Dischargeability of Property Taxes. A person’s liability for any property tax is not dischargeable in a Chapter 7 case unless the tax was last payable without penalty more than one year before he files for bankruptcy. In other words, all property taxes more than 1 year old on the bankruptcy filing date are dischargeable. Index
In Chapter 13 cases, the bankruptcy plan must offer to pay 100 percent of all property taxes (including all accrued interest and penalties) last payable within one year before the case is filed. The bankruptcy plan could legally pay nothing on older property taxes.
4.3. Two Year Filing Rule Not Applicable. In Texas, the 2 year filing rule does not apply to property taxes because the taxpayer is not legally required to file a tax return. The taxing authority will assess a property value and the tax amount without receiving any return from the taxpayer. Index
5. Penalties and Interest. Index
5.1. Interest. For federal tax debts, the interest follows the tax. If the tax is dischargeable in bankruptcy, the interest is dischargeable. If the tax is not dischargeable, the interest is likewise not dischargeable. Index
5.2. Penalties. Index
5.2.1. Tax Dischargeable – Penalty Dischargeable. If a federal tax is dischargeable in bankruptcy, the penalty is also dischargeable. Index
5.2.2. Non-Dischargeable Taxes. The reverse of the previous rule is not necessarily true. In some cases, the penalties related to non-dischargeable taxes are likewise not dischargeable. However, in other cases, the penalty is dischargeable even if the underlying tax is not dischargeable. Index
(a) Non-Dischargeable Taxes Less than 3 Years Old. In a Chapter 7 case, if the tax is not dischargeable because it relates to a tax year less than 3 years old, any penalty relating to the unpaid tax will also be non-dischargeable. Index
(b) Non-Dischargeable Taxes More than 3 Years Old. Tax penalties are dischargeable in a Chapter 7 bankruptcy case if the events giving rise to the penalty occurred more than 3 years before the taxpayer files for bankruptcy, even if the related tax is not dischargeable. Recall that there are at least three types of tax claims that are not dischargeable in bankruptcy even if they are more than 3 years old: Index
► trust fund taxes;
► taxes assessed within 6 years after a tax return is filed because income was under reported by more than 25 percent; and
► taxes owed because the taxpayer is guilty of tax evasion or the filing of a fraudulent return.
All penalties relating to these types of taxes can be discharged in a Chapter 7 case, although the underlying tax is not dischargeable, if the events giving rise to the penalty occur more than 3 years before the taxpayer files for bankruptcy. Index
Example #11. Assume the same facts as Example #7. The additional $9,000 tax assessed by IRS on April 14, 2008 (5 years, 11 months and 30 days after the tax return was filed) is not dischargeable in bankruptcy. However, any penalty relating to the additional $9,000 tax will be discharged in bankruptcy because the events leading to the penalty (the under reported income on the 2000 return) occurred more than three years before the bankruptcy case was filed.
6. Tolling Events (Clock Stoppers). Index
6.1. Time periods in Bankruptcy. The 3 year age rule and the 240 day assessment rule will be suspended or “tolled” for 90 days, plus any additional time periods during which the government is prevented from collecting the tax as a result of either of the following events:
(a) Prior Bankruptcy Case. A pending bankruptcy case; or Index
(b) Request for Hearing or Appeal of Collection Action. A request for a hearing and appeal of any collection action proposed or taken against the debtor.
In other words, the clock on the 3 year age rule and 240 day rule is tolled for for all time periods during which the taxpayer had a pending bankruptcy case, or a prior pending appeal of a tax collection action proposed or taken against the debtor, plus an additional 90 days. The clock on the 3 year rule and 240 day rules start to run again after these event have been concluded. Index
Example #12. Taxpayer files his 2009 tax return in a timely fashion on or before April 15, 2010, but never pays the tax. On April 15, 2011, 2 years before expiration of the 3 year age rule, Taxpayer files a Chapter 13 bankruptcy petition. The bankruptcy case is dismissed for non-payment on April 14, 2012 (exactly 2 years after it was filed). Taxpayer can not file a second bankruptcy case to discharge the 2009 income tax debt unless the second case is filed on or after July 14, 2015 (the normal 3 year time period, plus the amount of time in bankruptcy [2 years], plus 90 days).
6.2. Offers in Compromise. An offer in compromise is an alternative method of settling a tax debt by offering to pay IRS less than the full amount due. The submission of an offer in compromise will suspend the running of (stop the clock on) the 240 assessment time period. If the taxpayer makes an offer in compromise within 240 days of filing for bankruptcy, the 240 day time period will be suspended for the time during which the offer in compromise is pending, plus an additional 30 days. Index
Example #13. Taxpayer files his 2009 federal income tax return in a timely fashion on or before April 15, 2010. On April 13, 2013, as a result of an audit, IRS assesses additional tax for the 2009 tax year (the amount of additional tax is unimportant). On June 15, 2013, Taxpayer submits an offer in compromise to IRS offering to pay 1/5th of the additional tax. IRS rejects the offer on September 14, 2013. The additional tax assessed on April 14, 2013, can not be discharged in bankruptcy unless Taxpayer files for bankruptcy on or after April 9, 2014 [361 days after the additional tax was assessed on April 13, 20013 – 240 days, plus 90 days (the time period during which the offer in compromise was pending), plus an additional 30 days.
6.3. Litigation. A taxpayer has the option of preventing IRS from assessing additional tax by filing a lawsuit in Tax Court to contest a proposed assessment. The filing of such a lawsuit will prevent IRS from assessing the additional tax until after the Tax Court resolves the matter. If the taxpayer files such a lawsuit and losses, the 240 day time period will not start until IRS assesses the additional tax, which can only occur after the lawsuit is over. Index
7. Tax Liens. Tax debts can become “secured” debts if the taxing authority takes the steps necessary to obtain a lien against the taxpayer’s property before he files for bankruptcy. If the taxing authority obtains a pre-bankruptcy tax lien, the attachment of the lien can drastically impair a taxpayer’s ability to avoid payment of the tax through a bankruptcy filing. Index
7.1. Federal Tax Liens – Attachment of Lien. To obtain a federal tax lien valid in bankruptcy, IRS must file a “Notice of Federal Tax Lien” in the real property records of the Texas county clerk before the taxpayer files for bankruptcy. Index
7.1.1. Real Property (Land & Improvements). To assert a valid tax lien against real property (land and improvements to land), IRS must file the tax lien notice in the county where the land is located. Index
7.1.2. Personal Property. To assert a valid tax lien against personal property (everything other than land and improvements to land), IRS must file the tax lien notice in the county where the taxpayer resides on the date the tax lien notice is filed. It is irrelevant whether the property is located in a county different from the taxpayer’s residence or whether the taxpayer moves to a different county after IRS files the tax lien notice. If the tax lien is properly secured, the taxpayer can not defeat the lien by moving his residence or property to a different county. Index
7.2. Property Exempt from Federal Tax Collection. The following property is the only property that is exempt from a federal tax levy (i.e. can not be taken to satisfy a federal tax debt): Index
(1) wearing apparel and school books;
(2) fuel, provisions, household furniture, personal effects, arms (guns) for personal use, livestock, and poultry (maximum value – $6,250);
(3) books and tools of a trade (maximum value – $3,125);
(4) unemployment benefits;
(5) undelivered mail;
(6) railroad workers and U.S. Armed Services annuity and pension benefits (other retirement plans not covered);
(7) workmen’s compensation benefits;
(8) wages in the following amounts; Index
(a) amounts required to pay court ordered child support; plus;
(b) the standard tax deduction ($4,750 in 2003) plus the number of personal tax exemptions allowed ($3,050 per exemption in 2003). For an individual, the amount in 2003 would be $650 per month ($4,750 + $3,050 divided by 12);
(9) service-connected disability benefit (as defined by 38 U.S. Code 101(16);
(10) public assistance benefits under the payments. the Social Security Act, or state welfare programs; Index
(11) Job Training Partnership Act payments;
(12) residences in cases where the amount of the levy does not exceed $5,000.
Federal tax liens are not subject to a taxpayer’s federal or state exemptions. In other words, except for the property listed above, a federal tax lien, if properly filed, will attach to all of the taxpayer’s property, even property that would be exempt from seizure for other debts under federal or state law. The filing of a bankruptcy case will not change that result, although IRS is usually never interested in taking essentially worthless personal property. After the bankruptcy court enters a discharge order, IRS will normally release a federal tax lien if the taxpayer owns nothing more than household furniture, clothing or other personal property of insignificant value. Index
Example #14. Taxpayer owes $35,000 of federal income taxes for the 2005 tax year. He files his 2005 federal income tax return prior on or before the April 15, 2006 deadline. Taxpayer owns and resides at a $35,000 home located in Harris County, Texas. On December 15, 2008, IRS files a “Notice of Federal Tax Lien” with the Harris County Clerk. Under both federal and Texas state exemption laws, the home would normally be completely exempt from seizure in bankruptcy. If Taxpayer files for bankruptcy on or after April 16, 2009, his personal liability for the 2005 taxes will be discharged. However, the tax lien will survive the bankruptcy. IRS can sell the home to satisfy the tax debt. Taxpayer will also not be able to sell the home free and clear of the lien. The bankruptcy filing will only help the taxpayer avoid payment of the tax debt if he is willing to walk away from (abandon) the home.
7.3. Pre-Bankruptcy Liens Survive Bankruptcy. A tax lien will continue to exist after the entry of a bankruptcy discharge with respect to all property the taxpayer owns on the date he files for bankruptcy. Although the tax lien survives bankruptcy, the taxpayer’s personal liability to pay the tax will be released if all other requirements for a bankruptcy discharge are satisfied. This means that after the entry of a discharge order, the taxing authority can never collect the tax as a personal obligation of the taxpayer, but can pursue collection by seizing and selling any property the taxpayer owned on the date he filed for bankruptcy. Index
7.4. Tax Liens Do Not Attach to Post Petition Property. Tax liens do not attach to property acquired by a taxpayer after he files for bankruptcy, unless he acquires the property with funds or property he owned before filing for bankruptcy. In other words, if the tax debt is dischargeable, and the taxpayer acquires any property after he files bankruptcy, with funds earned after the bankruptcy filing, the taxing authority will not be able to seize and sell the post petition property to pay the tax. For this reason, a tax lien will not affect a taxpayer with few assets on the day he files for bankruptcy. Index
8.1. Federal Taxes. IRS’ ability to collect any federal tax expires 10 years after it assesses the tax, unless it commences a lawsuit to collect the tax, obtains a favorable court judgment and periodically renews the judgment. The 10 year statute of limitations also applies to tax liens. A federal tax lien will expire 10 years after the tax is assessed, unless IRS begins a lawsuit to collect the tax, obtains a favorable court judgment, and periodically renews the judgment. The 10 year time period begins to run on the date IRS assesses the tax, not on the date it files a tax lien. A bankruptcy filing is unnecessary if the taxpayer’s primary goal is to avoid payment of a federal tax assessed more than 10 years ago. Index
Example #15. Taxpayer owes unpaid employment taxes (both the employer and employee portions) for the 2000 tax year. The unpaid tax was assessed on September 15, 2001. IRS files a tax lien five years later on September 15, 2006. Taxpayer can never discharge the employee portion of the tax in bankruptcy. However, the tax will become uncollectible, and the tax lien will expire, unless IRS files suit to collect the tax on or before September 15, 2011, 10 years after the tax was assessed.
8.2. State Taxes. Index
8.2.1. Property Taxes. A lawsuit to collect delinquent property taxes may not be filed after the expiration of the following time periods after the tax becomes delinquent: Index
● 4 years – personal property taxes;
● 20 years – real property taxes.
8.2.2. Sales, Excise, Use and Franchise. Index
(a) Assessment. Index
(i) General Rule. Texas state sales, excise, use and franchise taxes can not be assessed more than 4 years after the tax is due and payable. The tax can not be collected if the Texas government office does not assess the tax within 4 years.
(ii) Exceptions. There are several exceptions to the 4 year statute of limitations on assessment of sales, excise, use and franchise taxes. The general rule does not apply if:
● Tax Evasion and Fraudulent Returns. The tax imposed relates to a fraudulent tax return or the taxpayer is guilty of tax fraud.
● No Return Filed. The Taxpayer never filed a required tax return for the tax in question.
● Gross Error on Return. The tax return contains a gross error. A gross error is any error which results in an increase of 25 percent or more in the tax due. Index
(b) Collection. The State of Texas must file suit to collect the tax within 3 years after the later of the date the: Index
(i) tax became due and payable; or
(ii) the tax lien was last recorded.
The tax becomes uncollectible and the tax lien will expire if the state does not file suit to collect the tax before expiration of the 3 year time period.
(i) any bankruptcy case;
(ii) a tax payment has been made under protest;
(iii) any lawsuit or administrative proceeding to determine the amount of the tax due.
9. Chapter 11 and 13 Cases – Claim Treatment. Chapter 11 and 13 cases normally require the court to approve a repayment plan which repays all or a portion of the debts owed to creditors. Tax claims (as well as all other debts) will be classified as secured, priority or general unsecured, depending on the facts and circumstances. The classification of a debt as secured, priority or general unsecured will usually determine whether the taxpayer must pay all or none of the tax, and whether interest and/or penalty must be paid. Index
9.1. Secured Tax Claims. The tax debt will be classified as a “secured” debt If the taxing authority follows the procedures required to obtain a tax lien. Index
9.1.1. Federal Tax Liens. Federal tax liens attach to a taxpayer’s equity in all of his property except for the very the limited amount of property exempt from seizure under federal tax laws. Almost no property is exempt from collection of federal tax debts except for wearing apparel and a limited amount of household furniture, personal effects and tools of trade. See 7.2 Property Exempt from Federal Tax Collection for a list of property exempt from collection of federal tax debts. Index
9.1.2. State Tax Liens. Index
(a) Property Taxes. Tax liens securing the payment of real or personal property taxes attach only to the taxable property. For example, a tax lien will attach against a taxpayer’s home with respect to unpaid taxes relating to the home, but will not attach to other land or personal property owned by the taxpayer. Index
Property tax liens take priority over all other liens and mortgages, including mortgage taken by banks before the tax was incurred, and all liens held by homeowner’s associations for unpaid dues or assessments.
Example #16. Owner buys a home for $100,000 on 1/1/06. Bank takes a mortgage for $80,000 of the purchase price on the same day. On 1/1/07, Owner fails to pay his $500 yearly dues to HOA. As a result, a lien attaches to the home to secure payment of the unpaid dues. Owner then fails to pay $3,000 in 2008 property taxes owed to County, City and School District on 12/1/08. As a result, County, City and School District have a lien against the home to secure payment of the property taxes. Per state law, the property tax lien relates back to 1/1/08. The priorities of the lien claims are set forth below:
Per both federal and state law, the lien for property taxes trumps (has priority over) all other mortgages and liens, regardless of the fact that the other liens came before the property tax lien.
(b) State Sales, Excise, Use and Franchise. Tax liens securing the payment of most Texas state taxes (sales and unemployment taxes) attach to a taxpayer’s equity in all property except for the property exempt from seizure under Texas state exemption law. See the Exemptions page for a list of property exempt from seizure under Texas state law. Texas state law provides for fairly liberal exemptions compared to the exemption laws of most other states. Index
9.1.3. Required Plan Payment of Secured Claims. Determining the required amount that must be paid on secured claims in a Chapter 11 or 13 plan is rather complicated. A comprehensive explanation is beyond the scope of this article. Only an experienced bankruptcy attorney can property analyze if you must pay a secured claim, and if so, how much. Index
The required plan treatment of secured claims depends on several factors:
● whether the debtor desires to retain or surrender possession of the property;
● whether the property is the debtor’s homestead (primary residence), or a rental or investment property;
● the value of the property;
● the payoff amount owed to each secured creditor;
● the priority of the various liens (if there is more than one lien against the property); and
● the interest rate specified by any applicable federal, state or local law. Index
(a) Surrender. If the debtor desires to surrender the property, the plan will not be required to pay any portion of the secured claim unless the debt can also be classified as a priority claim. It is important to note: many tax claims can be classified as either a secured or priority claim, or as partially secured or partially priority, depending on the value of the property and the payoff amount due on the debt. If the debtor elects to surrender the property, and the claim can be wholly or partially classified as a priority claim, the plan may need to pay all or a portion of the claim. Index
(b) Retain. If the property is debtor’s homestead, the plan will virtually always need to pay the full amount due on all state or local tax claims (and all other mortgages and liens). Federal tax liens may not need to be paid in full depending on the value of the property. The scenarios are so varied and complicated that it is probably more instructive to provide several examples. Index
Example #17. Taxpayer files for Chapter 13 bankruptcy on April 16, 2009. He owns a homestead worth $100,000. Assume the following tax and mortgage debts. The required bankruptcy plan treatment is specified in the right hand column. State and local tax liens will trump a pre-existing mortgage.
The IRS is last in priority but still must be paid in full because the value of the property is less than the full amount of all liens and mortgages.
The IRS is last in priority and can be partially stripped away because the value of the property is less than the full amount of all liens and mortgages.
The IRS is last in priority and can be fully stripped away because the value of the property is less than the full amount of all other liens and mortgages.
The IRS is last in priority and can be fully stripped away because the value of the property is less than the full amount of all other liens and mortgages. The 1st mortgage can never be either fully or partially stripped away, nor can any of the other terms of the mortgage be altered.
9.2. Priority Taxes. A “priority” tax is any income, employment, sales or property tax which can not be discharged in a Chapter 7 case. Index
9.2.1. Required Payment on Priority Tax Claims. A Chapter 11 or 13 repayment plan must propose full payment of all “priority” tax debts. The bankruptcy court may not approve a plan that fails to satisfy this requirement. Index
Example #18. Under the situation described in Example #10, the payment plan must propose full payment of any income taxes owed for the 2006, 2007 and 2008 tax years. The bankruptcy plan may propose no payment of the taxes owed for the 2005 tax year if Taxpayer’s budget shows that he can not afford to pay the older taxes.
9.2.2. Interest and Penalty on Priority Tax Claims. A priority tax claim includes all accrued interest though the bankruptcy filing date, but excludes all accrued penalties. The plan will not need to pay post filing interest on any priority claim, including priority tax claims. Index
Example #19. Taxpayer files for Chapter 13 bankruptcy on April 16, 2009. On that date he owes the following amounts for 2005 federal income taxes: principal: $10,000; interest: $1,000; penalty: $2,000. The amount of the “priority” claim is $11,000, which includes all principal and accrued interest. The $2,000 penalty is not part of the priority claim, but is instead a “general unsecured” claim. The Chapter 13 plan must provide for full payment of the $11,000 priority claim, without the payment of further interest. The Chapter 13 plan must pay the $2,000 general unsecured claim only if Taxpayer’s budget shows that he can afford to pay it.
9.3. Unsecured Tax Claims. All tax claims not classified as “secured” or “priority” claims are classified as “general unsecured” claims. All general unsecured claims must be treated equally, and will receive a pro rata share of any funds leftover after the payment of priority and secured claims. The plan must propose to pay general unsecured claims between 0 and 100 percent of the claim amount, depending on how much the debtor can afford to pay. If the budget shows that the debtor can’t afford to pay any portion of the general unsecured claim, the plan may propose a 0 percent payout. If the budget shows that the taxpayer can afford to pay some or all of the general unsecured claim, the plan must propose to pay the full amount the taxpayer can afford to pay. Index