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Debts Incurred to Pay Non-Dischargeable Taxes

Any debt incurred to pay a non dischargeable federal, state or local tax is likewise not dischargeable in a Chapter 7 or 11 bankruptcy case. If a debtor obtains a loan to pay off a non-dischargeable tax debt, the loan is not dischargeable in a Chapter 7 or 11 case. Note: These debts are dischargeable in Chapter 13 cases. See the discussion of the Chapter 13 “super” discharge below (15. Chapter 13 – Super Discharge).

Example. Taxpayer files his federal income tax returns for the 2009 and 2013 tax years in a timely manner. He owes $10,000 for each of these tax years. He obtains a $20,000 unsecured loan from ABC Bank during January 2015 for the express purpose of paying the taxes.  He pays off all prior taxes with the proceeds of the loan. Taxpayer files for Chapter 7 bankruptcy during August, 2015. The bankruptcy filing will discharge $10,000 of the $20,000 debt owed to ABC Bank because the 2009 income taxes were dischargeable in bankruptcy. The bankruptcy filing will not discharge the remaining $10,000 debt owed to ABC Bank because the 2013 income taxes were not dischargeable in bankruptcy.

The fact that Taxpayer actually used the proceeds to pay the taxes is irrelevant to the result so long as the creditor can prove that the debtor obtained the loan for the express purpose of paying the taxes.  The statute makes the debt non-dischargeable merely if it was “incurred” for the purpose of paying a non-dischargeable tax, regardless of whether the loan proceeds were actually used for that purpose.