That said, it is true that Federal and Michigan tax liabilities are dischargeable only under very specific circumstances.
This Article will explain when you can discharge taxes in bankruptcy. It will also discuss how Chapter 13 bankruptcy in particular can help you deal with overwhelming tax debt when it is not dischargeable.
First, however, this Article will address the most immediate benefit of discharging taxes in bankruptcy: the halting of all ongoing tax collection.
Yes, Filing Bankruptcy Stops Tax Collection
The moment that you file a Chapter 7 or Chapter 13 bankruptcy in Michigan, a Federal injunction known as the Automatic Stay Against Collections is activated.
The Automatic Stay requires that all collections activity cease immediately and for the duration of the bankruptcy case.
There are very few debts which are excepted from the Automatic Stay’s reach. These include:
- Child support collections;
- Criminal penalties;
- Court-ordered fines and sanctions payable to the court;
- … not much else!
Even if the tax debt is not dischargeable in bankruptcy, collection of that debt is still halted by the Automatic Stay.
Thus, when a tax lien is about to threaten your home, your wages, or your personal property, you should immediately contact a Metro Detroit bankruptcy attorney to discuss your options.
Okay. Back to the subject at hand.
When You Can Discharge Taxes in Bankruptcy
You can discharge tax debt in bankruptcy if the debt satisfies all of several requirements for dischargeability.
Hey, What Taxes Are We Talking About?
First, it is worth remembering that each tax years constitutes a single tax debt. Likewise, the debt owed to each taxing authority (the Internal Revenue Service vs. the Michigan Department of Treasury) for each, individual tax year is a separate debt from those owed for the same tax year to another tax authority.
These other taxing authorities include municipal tax authorities such as the City of Detroit and the City of Pontiac. They also include debts owed to the treasury departments of other states, other than Michigan, if you formerly resided or worked in those states.
Potential clients that we speak to often conflate tax debts into one, big, scary number. However, these debts must be parsed out from one another. It may be that the “big tax debt” you owe to the IRS for the year 2007 is totally dischargeable whereas the smaller tax debt owed to the State of Michigan for 2021 is not.
Each year is its own debt, in short. And each tax agency’s claim is its own debt.
It is also worth noting that this Article is discussing income tax debt, primarily.
Property taxes owed to Wayne County, Oakland County, Macomb County, Washtenaw County, Genesee County, Bay County, Ingham County, or any other in Michigan are separate topic unto themselves.
So When Can You Discharge Taxes, Exactly?
Okay, back to the rules regarding the eligibility of tax debts for bankruptcy discharge.
There are 7 rules determining when you can discharge taxes in Chapter 7 or Chapter 13 bankruptcy in Michigan and elsewhere in the U.S.
1. 3 Years Have Passed Since the Tax Became Due (The 3-Year Rule)
You cannot discharge taxes in bankruptcy if the tax debt is too new or has been too recently incurred.
The first “rule” regarding the discharge of taxes in bankruptcy is that 3 years must have passed since the tax became due.
When was that date, you ask?
Contrary to instinct, the taxes you owed for a given year did not become due on December 31st of that year. Instead, they became due on April 15th (or thereabout) in the following year.
April 15th is the deadline for the filing of tax returns each year (unless it is adjusted this way or that by a few days, as happened a year or two ago).
It is the date that the tax debt you owe for the just-completed tax year becomes “due” and is “owed” to the IRS or Michigan Treasury.
3 years + 1 day from this date, a tax debt incurred in that completed year will be potentially dischargeable in bankruptcy.
2. The Tax Return Must Have Been Filed Within the Past 2 Years (The 2-Year Rule)
The IRS and Michigan Treasury will accept a late-filed or amended return. Even if the tax debt is very old.
You can discharge taxes in bankruptcy if the tax debt is old enough—but so must be the return that you filed.
If you filed your return late, within the prior 2 years, it will not be dischargeable in bankruptcy until it has achieved that vintage.
Your tax debt may have become due 19 years ago, but, if you only got around to filing your return last year, you will not discharge those taxes in bankruptcy.
At least, not for another year or two.
3. The Tax Cannot Have Been Assessed Within the Prior 240 Days (The 240-Day Rule)
You may or may not have filed a timely tax return. Your tax debt may or may not be sufficiently elderly to allow you to discharge taxes in bankruptcy.
Whatever the case, an occurrence of which you may not be aware is the assessment or reassessment of your tax debt by the IRS or Michigan Treasury.
That is, you don’t know what these taxing authorities are doing in the background, while you sleep, and while you plan your Chapter 7 or Chapter 13 filing.
At intervals, tax authorities will recalculate the amount of tax debt you owe for a given year, including any and all new interest, late fees, and other penalties.
You will not be aware that this has happened. You will not be notified, usually, of an assessment, unless you receive a paper invoice from the IRS or Michigan Treasury. And receive it at your current mailing address. And read it.
Most of the time, you will discover that an assessment has occurred in the prior 240 days when your Livonia Michigan bankruptcy lawyer requests that you obtain what is called a tax transcript from the IRS. This document will note any recent assessments.
If you want to discharge taxes in bankruptcy, it will be vital that you obtain tax transcripts from the IRS or Michigan Treasury for all pertinent tax years.
4. Was Fraud Involved?
If the IRS or Michigan Treasury is of the opinion that you incurred the tax liability through fraud, you will have to fight to discharge taxes in your bankruptcy case.
Debts incurred through fraud are among the chief reasons why any debt, tax or otherwise, may not be discharged in bankruptcy.
However, some good news here: the creditor doesn’t get the final word on what is and what isn’t fraud. Not even the IRS.
However, there are some differences in how this fight plays out between the IRS and an ordinary commercial creditor.
An ordinary credit card or other commercial creditor who wants to argue that that the debt it holds should not be discharged because you racked the debt up through fraud must file a sort of lawsuit against you within your own bankruptcy case.
This sort of lawsuit is called an Adversary Proceeding. It does not seek entry of a money judgment, per se. The goal of a creditor’s non-dischargeability Adversary Proceeding is the granting of a judgment by your judge at the US Bankruptcy Court agreeing that the debt is non-dischargeable.
With such a judgment in place, the creditor can resume collections activity against you after your bankruptcy case is closed.
Adversary Proceedings must be filed within 60 days of the date of your 341 Meeting of Creditors hearing. (This hearing is usually held 20-40 days from the date of filing of the bankruptcy case.)
If the creditor misses this deadline, too bad, so sad. The debt is discharged no matter how much fraud it thinks you engaged in.
The IRS, on the other hand, will often ignore the need for an Adversary Proceeding, simply assert that the debt is fraudulent, and then resume collections activity when your cases closes as if nothing had happened at all.
Thus, if you owe a substantial amount of tax debt that would be dischargeable except for the suspicion that the IRS or Michigan Treasury will raise an unfounded fraud allegation, it may be best to take charge of the fight.
That is, work with a Michigan bankruptcy attorney experienced with non-dischargeability litigation and tax issues rather than a “bankruptcy mill” that is simply quotes the cheapest fee.
You get what you pay for.
It may be true that you can discharge taxes in Michigan bankruptcy—if you hire the right lawyer.
5. Was A Substitute Return Filed?
If you don’t file your own tax return for a long enough period of time, the IRS will do it for you.
This is known as a substitute return.
The IRS will always argue, based on existing case-law in some Federal Circuits, that tax debt is never dischargeable when a substitute return has been filed.
Bankruptcy Courts in some jurisdictions in the US have ruled that this is true. Others have agreed with this less often.
Again, you may have no idea whether or not a substitute return has been filed unless you retain an experienced Michigan bankruptcy attorney who will direct you to retrieve and then will expertly analyze your tax transcripts.
Chapter 13 Tax Payment
If you can’t discharge taxes in bankruptcy, can bankruptcy still help you?
Yes. A Chapter 13 bankruptcy will allow you to pay off your tax debt at 0% interest over as many as 5 years. Chapter 13 bankruptcy will allow you to restructure your debt so that “priority” tax debt is paid ahead of “non-priority” unsecured credit card and other such debt.
How does this work?
Chapter 13 bankruptcy is a “reorganization” bankruptcy. It is not a “liquidation” or “straight” bankruptcy as is Chapter 7.
Instead of discharging your debt entirely with no requirement of repayment, a Chapter 13 bankruptcy is a Federal Court-enforced payment plan.
It is not debt consolidation, however. In a Chapter 13 bankruptcy, you pay only what you can afford to pay.
In a Chapter 13 bankruptcy, the Automatic Stay stops all creditor collections as noted. Including tax debt, dischargeable or non-dischargeable.
For 3-5 years, you make a monthly payment to the Chapter 13 Trustee assigned to your case by the court. You do not pay your creditors anything directly (with exception).
That payment amount is roughly equivalent (in most cases) to your net monthly household income. That is, your take-home pay after your necessary household expenses are deducted. If you have $200 left over at the end of the month, that’s your Chapter 13 plan payment. (If it’s $2,000, well, that’s your Chapter 13 plan payment, too.)
The Chapter 13 Trustee takes that payment from you and disburses it out to your creditors in a priority order mandated by the US Bankruptcy Code and by the Chapter 13 plan that your Metro Detroit bankruptcy attorney files for you.
The Bankruptcy Code requires that unsecured priority debts like taxes be repaid ahead of non-priority debt. You are not required to pay any interest to the IRS or other tax creditors in a Chapter 13.
Thus, the Chapter 13 Plan allows you to repay your non-dischargeable tax debt in full at 0% interest while paying your low-priority unsecured creditors nothing.
If anything is left of your monthly Chapter 13 plan payment remittances after your secured and priority tax debts are repaid, that’s all your unsecured creditors get.
Even if it’s 2 cents.
The balance that you owe non-priority unsecured creditors “on paper” is then discharged just as in a Chapter 7 bankruptcy.
If you can’t discharge taxes entirely, it’s the best deal you’ll get under US law.
Let Us Help You Determine If You Can Discharge Taxes in Bankruptcy
If you want to discharge taxes in a Michigan bankruptcy proceeding, it is vital that you retain an experienced and aggressive Detroit Bankruptcy Attorney to represent.
Tax dischargeability in bankruptcy is a “sub-skill” of legal bankruptcy practice, one that newer attorneys or “filing mills” that offer to file your case fast for next to nothing may not possess.
The Hilla Law Firm has successfully represented hundreds of clients through Chapter 7 and Chapter 13 bankruptcy processes in Michigan.
Offering free, virtual consultations and friendly, one-on-one service from Livonia bankruptcy attorney John Hilla, we will ensure that your matter is handled properly, competently—and with kindness.