Can Tax Debt Help In Bankruptcy?

by Kent Anderson, Esq.

May 17, 2013

http://www.dreamstime.com/royalty-free-stock-photo-mature-businessman-knockout-punch-image21150255Overwhelming consumer debt and unpaid tax debt can feel like a one-two  punch. To recover from the consumer debt hit, some consumer debtors must pass a means test and prove they are poor enough to qualify for bankruptcy relief. This can be a problem if household income is above median for the state. But, the jab of unpaid tax debt is a hit that can really lay a debtor low. Believe it or not, sometimes taking the blow from tax debt can help a debtor to dodge the means test.

How can going a few rounds with the IRS help a debtor file for bankruptcy? To answer this question, we need to step out of the ring for now and examine the fight.

Consumer debtors can face budget problems if their current monthly income exceeds median income for the state in which they live. Higher income debtors must take the “means test“. This insidious device is a somewhat illogical mathematical calculation of just how broke a debtor is. Failure to pass the means test could result in disqualification for abuse of the bankruptcy system.

In 2005, Congress decided to sock it to consumers and made substantial changes to the bankruptcy code. The resulting law made filing for bankruptcy much more difficult for consumers. Fortunately, only consumer debtors are required to take the means test. Bankruptcy is much less complicated for an individual who is not a consumer debtor.

To be a consumer debtor, the debts owed must be primarily consumer debt. Consumer debt is debt that was incurred by an individual primarily for a personal, family or household purposes. It is usually incurred as a voluntary obligation. Tax debt is owed to a government and is an obligation incurred by law. Tax debt is not considered to be consumer debt.

So, if a great big whopping tax debt is more than the total of all consumer debt, the bankrupt debtor can sock it to them and avoid the means test no matter how great the family income. An above median income debtor who has $50,000 in credit card and other consumer debt but $50,001 in tax debt would not be a consumer debtor. The best thing about this is that most common individual tax debt can be discharged in bankruptcy if it meets certain criteria.

No means test and you can get rid of the tax debt with a bankruptcy discharge. That would be a TKO for the debtor wouldn’t it?

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I was admitted to practice in 1978. I am certified as a Consumer Bankruptcy Specialist by the American Board of Certification. I regularly speak on tax and bankruptcy issues at state, regional and national conferences. Years of experience in practice before the Internal Revenue Service and Oregon Department of Revenue have given me the background to resolve a large variety of consumer tax issues.

Last modified: May 16, 2013