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Treatment of Tax Obligations in Bankruptcy

The treatment of tax obligations in bankruptcy is quite complex under the Bankruptcy Code and will require an in-depth analysis of tax claims, debtor’s returns and the timing of the filing of the return. A debtor’s ability to discharge any tax debt is based upon the classification of the tax debt. For purpose of bankruptcy, a tax claim can be either a trust fund tax (sales taxes or employee withholding taxes), a secured claim (filed and recorded tax liens), an administrative tax claim (tax claims arising after the filing of the bankruptcy petition), a priority tax claim (taxes are due within a certain time before the filing of the bankruptcy petition), a general unsecured claim, or a penalty claim.

The first inquiry is whether or not a tax return was filed by the debtor on time. A taxpayer must file his/her tax return on time before a determination of whether or not such tax claim is dischargeable in bankruptcy. If the tax payer fails to file the required tax return, the tax obligation in general will not be dischargeable. If the tax payer files the return late, then other factors must be considered for the determination of the dischargeability of the late file tax obligation.

Trust Fund Taxes

Trust Fund taxes are taxes which have been collected by the debtor from third parties. Sales taxes and income tax withholdings are examples of trust fund taxes and these funds are held in trust by the debtor for the taxing authority. If the debtor fails to collect trust fund taxes and/or fails to pay over these funds to the taxing authority, then such taxes are considered priority, will not be dischargeable in bankruptcy and must be paid in full.

Secured Tax Claims

Once the taxing authority files a tax lien in the county where the real estate of debtor is located or where the debtor resides, a secured tax claim may arise. The tax claim is secured to the extent that there is equity or value in the real estate or personal assets of the debtor. For example, if the filed tax lien is $30,000, the debtor’s real estate is worth $100,000, the first mortgage payoff is $80,000, the tax claim will be secured up to $20,000, and $10,000 of the tax claim is considered unsecured. The discharge in bankruptcy will not automatically eliminate the tax lien even if the tax obligation itself is unsecured and dischargeable. Secured tax liens must be paid to the extent there is value of the secured tax lien

Administrative Tax Claims

Administrative tax claims are generally taxes that have accrued after the bankruptcy petition is filed. There are a few exceptions under the bankruptcy code, but in general, administrative tax claims, together with interest and penalties, must be paid in full and are not subject to discharge.

Priority Tax Claims

Certain tax claims are considered priority and must be paid in full and not subject to discharges. There are several categories of priority tax claims. A careful examination of the tax return and the filing date is required to determine the priority status of a tax claim.

The within statements are general in nature and this information is not intended as a substitute for legal advice regarding your specific case, nor is an attorney-client relationship established between Mina Nami Khorrami, LLC and any person reading this information. Mina Nami Khorrami is an experienced bankruptcy and debt attorney based in Columbus, Ohio.

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