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Discharging Tax Debts in Bankruptcy

There are two parts to every employment tax: the employee portion and the employer portion.

1. Employee Portion (Trust Fund Taxes).        Index

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

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 "Statute of Limitations" for a discussion of the 10 year time limit on the collection of federal tax debts.

2.2. Employer Portion        Index

2.1. 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. 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.

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