Debts and taxes: What bankruptcy does and does not do

As tax season approaches, one thing that people considering bankruptcy ask is how their bankruptcy will affect their taxes. Interestingly, your bankruptcy should not have much of an impact on your taxes. While the cancelation of your debts is considered taxable income in most circumstances, cancelled debts in bankruptcy may be excluded based on federal tax rules.

When you file your taxes, be aware that you cannot deduct fees associated with your bankruptcy. That means that you can’t deduct personal expenses such as your attorney’s fees or court costs. However, if you are filing bankruptcy for your business, you would be able to deduct those expenses as business expenses on your tax forms.

Can bankruptcy help eliminate tax debts?

If you are hoping that your bankruptcy will eliminate any taxes that you owe, you may be out of luck. In most cases, you cannot have tax debts eliminated through bankruptcy. However, you may be able to use bankruptcy as a way to modify payment plans with the Internal Revenue Service.

Certain kinds of taxes are not dischargeable. These include:

  • Tax penalties marked as unable to be discharged by the IRS
  • Debts from unfiled returns
  • Trust fund taxes
  • Withholding taxes

If you were hoping to discharge tax debts in bankruptcy but cannot, remember that your attorney may be able to help you with setting up an installment agreement with the IRS. An installment agreement allows you to pay what you owe over time.

If you have funds free thanks to your bankruptcy, you may also be able to negotiate by making an offer in compromise. This is a settlement of your debts for less than you owe.

Are there any IRS actions that won’t be stopped by choosing bankruptcy?

Tax debts are some of the trickiest debts to deal with. In some cases, the IRS’s actions will be unaffected by the bankruptcy. For example, if the IRS placed a federal tax lien on any of your property, then that lien will remain even after your bankruptcy. This is something to discuss with your attorney if you’re hoping to have a lien removed.