Is it possible to discharge tax debts in a small business bankruptcy?

Small company owners who declare bankruptcy are not immediately relieved of their IRS tax liabilities. Find out more about tax debt and bankruptcy here.

What you’ll discover:

Can I discharge taxes if my company has declared bankruptcy?
How are unpaid taxes and unfiled tax returns handled in a corporate bankruptcy filing?
Would I still be penalized if my company is overdue on taxes at the time I file for bankruptcy?
Is there any other method to lower my company’s tax responsibilities while it is in bankruptcy?

Most entrepreneurs start out with the goal of creating a profitable company. Yet, one out of every five enterprises will fail during the first year. Half of all small firms will fail over the next five years. Small company closures are often the result of events beyond the control of the business owner. As a consequence of the COVID-19 outbreak, many small enterprises closed. Simply stated, when it becomes difficult to go on with business as normal owing to cashflow concerns, it may become essential to declare bankruptcy. In many circumstances, working with federal and state tax authorities within the framework of bankruptcy legislation may help to reduce the tax burden after declaring bankruptcy.

Can I discharge taxes if my company has declared bankruptcy?

The simple answer is that small company owners are liable for paying taxes owing upon declaring bankruptcy. Yet, under some cases, debtors may discharge or cancel their tax liabilities during bankruptcy proceedings.

There are many sorts of bankruptcies called after various provisions of the tax law. Regardless of the form of bankruptcy you have filed, you cannot submit your tax return and then immediately declare bankruptcy and seek discharge of your tax arrears. The regulations governing tax debt discharge allow for the discharge of taxes if they were due at least three years before filing for bankruptcy and if it has been at least two years since you filed a tax return for your firm. Also, at least 240 days must have passed since the IRS assessed the taxes.

Before a discharge is granted, you must have submitted the most current four tax returns for the company with the IRS no later than the first creditors conference for the bankruptcy case.

How are unpaid taxes and unfiled tax returns handled in a corporate bankruptcy filing?

When you declare company bankruptcy, you may be entitled to erase some of your outstanding taxes. You cannot, however, discharge or cancel taxes owing for tax periods in which no tax returns were submitted.

If your firm has not filed taxes for the prior three tax years, the IRS may eliminate your obligation for the previous tax periods. The procedure is complicated. Therefore, this respite is not automatic nor assured. Working with an attorney who can apply for it and negotiate on your behalf might be beneficial. The three-year rule applies when taxes were due, not when they were filed.

Would I still be penalized if my company is overdue on taxes at the time I file for bankruptcy?

Even if the tax liability does not match the time criteria for discharge described above, you may be able to obtain late payment penalties erased, or canceled, by the IRS in a company bankruptcy action.

Tax penalties that have been accrued for more than three years are normally dischargeable. Penalties associated with a tax obligation for which the IRS or another tax authority has secured a tax lien, on the other hand, may be more difficult to discharge. Moreover, interest on tax debt is generally dischargeable if the tax obligation itself is dischargeable.

Penalties on tax bills that are not dischargeable under the tax law are dealt differently depending on the kind of bankruptcy filed. Penalties and interest on such tax obligations are not dischargeable under Chapter 7, although they may be dischargeable under other laws. Depending on your circumstances, a bankruptcy attorney may assist you in weighing the benefits and drawbacks of different procedures.

Is there any other method to lower my company’s tax responsibilities while it is in bankruptcy?

You may not be able to discharge all of your business’s tax obligations, but if you are behind on taxes when you declare bankruptcy, you may have other choices for dealing with your debt. Sometimes working out monthly payment arrangements with the IRS or entering into an agreement to pay a lesser amount, known as an Offer in Compromise, makes sense.

Some small firms may be able to file for Chapter 11 bankruptcy. A reorganization plan is created under Chapter 11, and company owners may be allowed to prolong their timeline for paying unsecured tax bills for up to five years.

Filing bankruptcy for a small firm in which you have put your time and energy is never an easy choice, but it is sometimes the wisest alternative. Knowing how different sorts of debts, including tax liabilities, will be handled might help you choose which form of bankruptcy filing makes the most sense. Bankruptcy may not be the end of the world, but rather a fresh beginning.

Please keep in mind that the information presented above only applies to real federal income tax obligations. Payroll taxes, as well as taxes connected to false tax filings or deliberate tax evasion, are not dischargeable in a bankruptcy action.