For a business struggling to stay afloat, bankruptcy is often the best option to achieve a clean slate. But, what happens when part of your debt is past-due federal taxes? Despite what you may have heard before, businesses can eliminate a portion of their federal tax debt through bankruptcy if they meet certain conditions.
A partnership or corporation can file for bankruptcy under Chapter 7 or Chapter 11. Below are the ways each type of bankruptcy can help discharge tax debts.
Discharging tax debts through Chapter 7
Bankruptcy can only eliminate income tax debts. Payroll taxes or other business-related taxes will remain after going through bankruptcy. Business owners can discharge income tax debts in Chapter 7 if they meet the following criteria:
- There is no evidence of fraud or tax evasion
- The debt was originally due at least three years ago
- They filed a tax return for the debt they seek to discharge at least two years before filing for bankruptcy
- The IRS assessed their tax debt at least 240 days before the bankruptcy filing
These factors should be applied to each year’s tax debt separately to determine whether Chapter 7 can eliminate the debt. Furthermore, the second and third requirements include any extensions a business owner filed for their taxes. So, a tax debt for 2016 that received an extension until 2017 would not be eligible for bankruptcy until 2020.
Tax debts under Chapter 11 reorganization
According to the IRS, Chapter 11 reorganization can discharge some tax debts, depending on the unique facts and circumstances of the case. A reorganized business can receive tax refunds during bankruptcy; however, the IRS might use these refunds to pay down a business’s tax debts. An experienced bankruptcy attorney can help you determine which debts might qualify for discharge under Chapter 11.