A bankruptcy case is initiated by filing a petition with the clerk of the Bankruptcy Court. Filing the bankruptcy petition creates a separate bankruptcy estate and also initiates an automatic stay, which stops all IRS collection efforts against the debtor/taxpayer and his or her property.

Types of Bankruptcy

"Chapter 7, Liquidation" bankruptcy is available to individuals, partnerships, and corporations. Its basic purpose is to collect the debtor's assets, distribute the assets, and determine the relief from creditor claims the debtor will receive. The discharge of debts in these types of cases is available only to individual debtors and only for certain debts.

In "Chapter 11, Reorganization" bankruptcy cases, the debtor attempts to satisfy some or all of the outstanding debts by extending the time for paying the amount owed through a plan of reorganization, and is also available to individuals, partnerships, and corporations.

A "Chapter 13, Adjustment of Debts of an Individual with Regular Income" case is limited to debtors who owe secured debt of $922,975 or less and unsecured debt of $307,675 or less. The debtor prepares the plan, which should provide for full payment to the secured and priority creditors in three years or less, although the court has the authority to extend the repayment for up to five years.

Effects of Filing a Bankruptcy Petition

Keep in mind that filing a bankruptcy petition temporarily stops the running of the statute of limitations for assessment and collection of tax. However, it also provides an automatic stay on collection of outstanding debts, the terms of which depend on the type of bankruptcy petition filed.

The general rule is that the automatic stay continues until the earliest of the following: (a) the bankruptcy case is closed or dismissed; (b) a discharge is granted or denied; or (c) the court grants relief from the stay.

Purpose of Bankruptcy and Potential Discharge of Tax Liabilities

To enable the debtor to receive a fresh start, the Bankruptcy Code discharges the debtor from continued liability for many types of prepetition debts, including, in some cases, prepetition tax liabilities. If the taxes are discharged, IRS collection efforts generally will be limited to any payments received through the bankruptcy plan plus any property subject to a prepetition filed tax lien.

Generally, non-dischargeable taxes include taxes in the second and eighth priorities. Therefore, the second-priority gap taxes (comprised of taxes that accrue after an involuntary bankruptcy petition is filed and before an order for relief is entered or a trustee is appointed) and the various types of eighth-priority prepetition taxes (e.g., income taxes for which the due date of the return, including extensions, was within three years of the filing of the petition) will not be discharged by the Bankruptcy Court.

If possible, the filing of the bankruptcy petition should be postponed where taxes have been assessed within the prior 240 days or where, by waiting awhile, the three-year period for the filing of returns will expire.

Under Bankruptcy Code Section 523(a), taxes are non-dischargeable if the debtor:

• did not file a tax return;
• filed the tax return late, taking into account extensions granted (but only if the return was filed within two years before the bankruptcy petition was filed);
• having knowledge of the federal tax claim, filed a fraudulent return or otherwise willfully attemped to evade or defeat payment of the tax; or
• having knowledge of the federal tax claim, failed to list the IRS as a creditor or failed to schedule the tax liability in time for the IRS to timely file a proof of claim (unless the IRA has actual knowledge of the bankruptcy case).

Dischargeable Taxes in Chapter 7 Cases

In an individual's Chapter 7 case, taxes are dischargeable if the following requirements are met:

• The debtor must be an individual and the tax must be a prepetition tax.
• The tax liability must have been known to the taxpayer and must have been scheduled in time to permit the IRS to timely file a proof of claim.
• The return due date, with extensions, must have been at least three years prior to the filing of the bankruptcy petition.
• The liability must not be for withheld or collected tax for which the taxpayer is liable in any capacity.
• The return must have been filed on time (or, if filed late, filed at least two years prior to the date of the bankruptcy petition), and must not have been a fraudulent return.
• The taxpayer must not have willfully attempted to evade or defeat payment of the tax.
• If the tax is an income tax, it must meet the following additional requirement:
  (1) The tax must not have been assessed within 240 days of the bankruptcy petition filing date (and if applicable, the time an offer in compromise was pending plus 30 days).
  (2) If the tax was not assessed, it must not have been assessable at the time of the filing of the bankruptcy petition, such as when a Notice of Deficiency has been issued or when the taxpayer executed a waiver extending the statutory period for assessment.

Dischargeable Taxes in Chapter 11 Cases

Discharge is granted for all dischargeable taxes arising before confirmation of the reorganization plan. Generally, payment of all non-dischargeable tax claims is required for confirmation of the plan, although the IRS can collect the unpaid portion of the non-discharged taxes from exempt property once the automatic stay is lifted. Specifically, taxes are dischargeable if the following requirements are met:

• The taxpayer must have made all payments to the IRS requires by the Chapter 11 plan.
• The tax must be a pre-confirmation debt (i.e., arose before confirmation of the plan).
• If the taxpayer is an individual, the requirements for dischargeability under Chapter 7 have been met.
• If the taxpayer is not an individual, the Chapter 11 plan must be a non-liquidating one.

Dischargeable Taxes in Chapter 13 Cases

In most Chapter 13 cases, all tax claims that are disallowed or provided for by the Chapter 13 plan are discharged following completion of the plan payments. However, a debtor in Chapter 13 will not receive a discharge of taxes for which no return was filed or the return was untimely filed.

Likewise, a discharge will be denied if a fraudulent return was filed, or the debtor attempted to willfully evade the law. Taxes due within three years of the bankruptcy filing or assessed within 240 days of the filing are also non-dischargeable.

Dischargeable Taxes for Partnerships and Corporations

A partnership or corporation cannot receive a discharge in a Chapter 7 liquidation case. Furthermore, partnerships and corporations cannot file a bankruptcy petition under Chapter 13. Therefore, a partnership or corporation can receive a discharge of tax debts only upon confirmation of a Chapter 11 reorganization plan.