May I discharge taxes if my business has filed for bankruptcy protection?
The short answer is that small business owners are responsible for paying taxes owed when declaring bankruptcy. But there are certain circumstances under which debtors may discharge, or cancel, tax obligations during bankruptcy proceedings.
There are different types of bankruptcies that are named for different sections of the tax code. You cannot file your tax return and then immediately declare bankruptcy and request discharge of your tax debts, regardless of the type of bankruptcy you have filed. The rules regarding discharge of tax debts allow for the possible discharge of taxes when those taxes were due at least three years before filing for bankruptcy, and only if it has been at least two years since you filed a tax return for your business. In addition, at least 240 days must have elapsed since the time the IRS assessed the taxes.
You must have filed the business' most recent four tax returns with the IRS, no later than the first creditors meeting for the bankruptcy matter, before a discharge is granted.
How are back taxes and unfiled tax returns handled in a business bankruptcy filing?
You may be able to discharge some back taxes you owe when you declare business bankruptcy. However, you may not discharge, or cancel, taxes that are owed for tax periods in which tax returns were not filed.
If your business has not filed taxes for the past three tax years, the IRS may cancel your debt for the previous tax periods. The process is complex. Also, this relief is not automatic, nor guaranteed. It can be helpful to work with an attorney who can apply for it and negotiate on your behalf. The three-year rule applies to when taxes were due, not from the tax filing date.
Will I still be charged a penalty if my business is behind on taxes at the time of my bankruptcy filing?
You might be able to get late payment penalties discharged, or canceled, by the IRS in a business bankruptcy proceeding, even if the tax debt itself does not meet the time requirements for discharge outlined above.
Tax penalties that are more than three years old are generally dischargeable. However, it may not be as easy to discharge penalties that are tied to a tax debt for which the IRS or another tax authority has obtained a tax lien. Also, as a general rule, interest on tax debt is dischargeable if the tax debt itself is dischargeable.
Penalties on tax debts that are not eligible for discharge under the tax code get treated differently, depending on the type of bankruptcy you are filing. Penalties and interest on such tax debts are not dischargeable under a Chapter 7 bankruptcy, but might be under different chapters. A bankruptcy attorney can help you evaluate the pros and cons of various approaches, depending on your situation.
Are there other ways to limit my company's tax obligations during bankruptcy?
You might not be able to discharge all of your business' tax obligations, but you may have other options for dealing with your debt if you are behind on taxes when you decide to declare bankruptcy. Sometimes, it makes sense to work out installment payment plans with the IRS or enter into an agreement to pay a reduced amount, called an Offer in Compromise.
Some small businesses may qualify to declare Chapter 11 bankruptcy. Under Chapter 11, a reorganization plan is developed, and business owners may be able to extend their timeframe for payment of unsecured tax debts for up to five years.
Declaring bankruptcy for a small business you have invested your time and energy into is rarely an easy decision, but sometimes it is the best option. Understanding how various types of debts will be handled, including tax obligations, can help you evaluate which type of bankruptcy filing makes the most sense. Bankruptcy may not be an end, but rather, a new beginning.
Note that the information provided above relates solely to legitimate federal income tax obligations. Business owners may not discharge payroll taxes in a bankruptcy proceeding, nor may they discharge taxes related to fraudulent tax filings or willful tax evasion.
Business bankruptcies are often complex. Fortunately, help is available. Reach out to a Rocket Lawyer network attorney about how your company's tax debts may be handled in a bankruptcy proceeding.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.