Bankruptcy may provide relief from debt caused by taxes

In a well-publicized case, singer Dionne Warwick recently filed for Chapter 7 bankruptcy in United States Bankruptcy Court in New Jersey. Despite a monthly income of more than $20,000, Warwick has been unable to meet her monthly expenses. She also cannot repay a hefty debt of about $10 million she owes to the Internal Revenue Service and state tax board, according to the Huffington Post.

Tax debt piled up

Warwick, age 72, has income from a retirement plan, a contract with an entertainment production company and royalties from many hit songs. However, she claims that her financial managers handled accounts poorly, leading to late tax payments over a number of years, from 1991 through 1999.

Even though the singer eventually paid the original state and federal taxes that she owed, says her publicist, she has incurred millions of dollars in interest and penalties due to late payments. Attempts to negotiate a payment plan with the IRS and state tax board have not been successful.

With monthly expenses hovering at a little more than her income, Warwick has not been able to make a significant dent in the tax liabilities.

Tax debts and bankruptcy

While few people have income, expenses and debts at the level of Warwick's, many find themselves unable to keep up with their bills. Bankruptcy can sometimes be the best solution to get out from under a crushing debt burden.

Some kinds of debt can be completely wiped out, or discharged, in bankruptcy. Some cannot be entirely discharged, and some cannot be discharged at all. When it comes to tax liabilities, some can be discharged under the right circumstances.

When a person files for Chapter 7 bankruptcy, it may be possible to discharge federal income tax debt that was incurred at least three years previously. The debtor must have properly filed income tax returns at least two years before setting the bankruptcy in motion. A rule known as the 240-day rule will apply. Under this rule, the IRS must have actually assessed the tax debt no less than 240 days before the bankruptcy filing.

Specific conditions for discharging tax debt

In order to discharge tax debt, an important requirement is that the debtor did not intentionally try to evade paying taxes or to defraud the IRS. A bankruptcy judge will take a dim view when debtors employ tactics like attempting to conceal identity via a name change or Social Security number change. Debtors will also be regarded with suspicion if they remove cash from bank accounts and try to hide it. Tax evasion is also considered to be a likely possibility when a debtor repeatedly fails to pay taxes year after year.

If tax debts are discharged, penalties that have been imposed can also be discharged. However, if the IRS placed a federal tax lien on a debtor's property before the bankruptcy, that obligation will not be discharged. The debtor will have to pay off the lien before selling the property.

People who are interested in filing for bankruptcy will need to consult with an attorney to obtain the best advice and accurate information about their specific situations.