Understanding Why Some Tax Debts Are Excluded from Discharge in Bankruptcy

After tax season has come and gone, people with lingering tax debts may be wondering how to cope with repayment or they are searching for a source of relief from that debt. If you’re looking for relief from other debts on top of tax debts, you may be able to find positive, long-term relief through Chapter 7 bankruptcy. In many cases, income tax debts can be discharged if they are at least three years old and those tax debts have been assessed as being due and payable for at least two years. However, some types of tax debt cannot be discharged through the bankruptcy process. Depending on your tax debts, you may or may not be able to have them discharged in a Chapter 7 bankruptcy. With the help of Behm Law Group Ltd., you can determine if filing for chapter 7 bankruptcy in Mankato, MN, is right for you.


Chapter 7 bankruptcy works to discharge debts in exchange for the sale of non-exempt assets. Non-exempt assets are assets whose values exceed the applicable protective exemption amounts provided by the bankruptcy code.  However, tax debts can be complex and how they are treated in bankruptcy can be nuanced.


Generally speaking, the conditions for a tax debt to be discharged in bankruptcy are stringent. First, it must be an income tax type of debt.  Second, the debt must be at least three years old, and you must have filed the return for the tax year giving rise to the tax debt at least two years ago. Also, the tax debt must have been assessed (acknowledged as due and payable) by the taxing authority for at least 240 days before you file bankruptcy, and there must be no evidence that you have engaged in fraud or willful tax evasion. If the income tax debt meets these conditions, it can be considered hardship and proof that you were unable to pay that debt for reasons outside of your control and such tax debt can be discharged in a chapter 7 bankruptcy case.


Tax debts that are excluded from the bankruptcy process are typically non-dischargeable for good reason. Most of these debts directly impact another person, organization, business, or other third party.


With a few exceptions, the tax debts that will typically survive a chapter 7 bankruptcy case include:


  1. Property taxes: These affect your city, state, and federal government in many ways. Because property taxes typically impact a local government, they can have significant influences on housing costs, licensing, and other property requirements if they are left unpaid.  Usually, when a city or county is owed property taxes the city or county will be entitled to assert a secured lien against any subject real estate for the amount of the delinquent property tax debt.    For instance, if you owe $10,000.00 to a city for property taxes, the city will assert a secured lien against your home in the amount of $10,000.00.  Such liens are essentially like other secured liens, such as liens on motor vehicles.  In a chapter 7 bankruptcy proceeding, you could technically be relieved of such property tax debt but you would also have to surrender your house.  For example, presume that you own a house that is worth $100,000.00 and that there is a $90,000.00 secured mortgage on the home.  Presume further, that you are delinquent with property tax debt to the city in the amount of $10,000.00 and that the city has asserted a tax lien for that amount.  If you were to file for chapter 7 bankruptcy relief, both the $90,000.00 mortgage and the $10,000.00 property tax lien would be considered secured debts secured by the value of your home.  In a chapter 7 case, both the mortgage lender and the city would only have recourse/relief for such debts against the value of the house.  You could walk away from personal liability for those debts going forward but you also would have to accept that you would have to surrender or lose the home.
  2. Third-party taxes: These include taxes paid to trust fund parties such as FICA and Medicare. It also includes sales taxes paid to the debtor by customers.
  3. Tax liens: Some tax debts can be secured by a tax lien asserted by the Internal Revenue Service or the Minnesota Department of Revenue.  In this case, the lien filed by the taxing authority essentially becomes secured by pretty much everything you own, including 401(k) plans, IRA’s, checking/savings account deposits, furniture and appliances, etc.
  4. Employment taxes: These includes excise taxes and custom duties, depending on time periods.
  5. Tax return errors: If you were erroneously refunded more than you should have on a tax return, you owe that back as a debt to whatever government entity paid it to you. This can significantly affect local governments if you do not repay it.


If you are planning on filing for chapter 7 liquidation bankruptcy in Mankato, MN, and want to know how it will affect your tax debt, contact Behm Law Group Ltd. at (507) 387-7200 or stephen@mankatobankruptcy.com.