May I discharge taxes if my business has filed for bankruptcy protection?
The short answer is that small business owners are generally responsible for paying taxes owed when declaring bankruptcy. However, there are certain circumstances under which debtors may discharge, or cancel, tax obligations during bankruptcy proceedings.
There are different types of bankruptcies, named for sections of the U.S. Bankruptcy Code. You cannot file your tax return and then immediately declare bankruptcy and request discharge of your tax debts.
The rules regarding discharge of tax debts allow for possible discharge only when:
- The taxes were due at least three years before filing for bankruptcy.
- It has been at least two years since the tax return was filed.
- At least 240 days have passed since the IRS assessed the taxes.
You must also have filed your business’s most recent four tax returns with the IRS—no later than the first creditors’ meeting—before a discharge can be granted.
How are back taxes and unfiled tax returns handled in a business bankruptcy filing?
You may be able to discharge some back taxes owed when you declare bankruptcy. However, you cannot discharge taxes for periods in which returns were not filed.
If your business has not filed taxes for several years, the IRS may still assess or pursue those taxes, and any potential discharge is not automatic. The process is complex and depends on the type of bankruptcy and the timing of your filings.
In general, the three-year rule applies to when taxes were due, not to when they were actually filed. Filing accurate and timely returns is critical to preserving eligibility for potential tax debt discharge.
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.
Tax penalties that are more than three years old are generally dischargeable. However, penalties tied to a tax debt for which the IRS or another tax authority has already obtained a tax lien are much more difficult to discharge.
As a general rule, interest on tax debt is dischargeable only if the underlying tax debt itself is dischargeable.
Penalties and interest on tax debts that are not eligible for discharge are treated differently depending on the type of bankruptcy. For example, these are not dischargeable under Chapter 7, but may be treated differently in other chapters, such as Chapter 11 or Chapter 13.
Are there other ways to limit my company's tax obligations during bankruptcy?
Even if you cannot discharge all of your tax obligations, there are other options for addressing tax debt when you declare bankruptcy. These include:
- Installment agreements: You may be able to work out a payment plan with the IRS.
- Offer in Compromise (OIC): You might qualify to pay a reduced amount to settle your tax debt.
Some small businesses may also qualify for Chapter 11 bankruptcy, which allows reorganization and repayment of debts over time. Under Chapter 11, business owners may be able to extend the timeframe for paying 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—including tax obligations—will be handled can help you evaluate which type of bankruptcy filing makes the most sense. Bankruptcy may not be an end, but rather, a new beginning.
Important notes about tax debt and bankruptcy
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 Legal Pro about how your company's tax debts may be handled in a bankruptcy proceeding.
Please note: This page offers general legal information, not but not legal advice tailored for your specific legal situation. Rocket Lawyer Incorporated isn't a law firm or a substitute for one. For further information on this topic, you can Ask a Legal Pro.
