Last week we discussed tax liens and how they work in bankruptcy. This week I will discuss the types of taxes that are not discharged in bankruptcy even if you pass the basic requirements. These types of taxes generally come up if you are a business owner. Essentially, if you are collecting taxes in a trust capacity, such as payroll taxes or sales taxes, and the taxing authority has assessed these taxes to you personally, you cannot discharge them in bankruptcy. Typically, this occurs when a business you own or for a business you have the responsibility to collect and pay these taxes over for has failed to pay them and the taxing authority assesses the tax against you personally.
Setting aside the underlying tax issues in these types of cases, the bankruptcy code specifically exempts these types of taxes from discharge under 11 U.S.C. §§ 523(a)(1)(A) & 507(a)(8)(C). In the federal tax setting this tax is often referred to as the trust fund recovery penalty and is usually assessed on the individual after the company has failed to pay over payroll withholdings from employee pay checks. This is usually federal income tax, Medicare, and Social Security withholdings. State sales tax that has not been paid over will also fall into this category. As a basic rule, if you are withholding tax it is held by your company in trust for the government, if it is assessed against you personally you will not be able to discharge it in bankruptcy. Under these circumstances you will most likely need to make some payment arrangement with the taxing authority.
Next week, in the final part of this series, I will discuss whether you need a special kind of bankruptcy proceeding, called an adversary proceeding, to discharge your tax debt.