In a recent bankruptcy case (In Re Shin), a court questioned whether the recapture obligation of the first-time homebuyer credit constitutes a “tax” that can be applied to the non-discharge provision of the bankruptcy code. This credit refers to a tax credit established by the Housing and Economic Recovery Act of 2008. The credit, which was utilized for certain home purchases between 2008 to 2010, was between $7,500 to $8,000. For home purchases as well as accompanying creditos for the tax year of 2008, though, the credit must be repaid within 15 years. This repayment was effectuated as the result of taking the credit, divided by 15 (6⅔%), and then adding to the tax return over a 15-year period. Additional regulations found in the Recovery Act of 2008 states that if a credit is allowed to a taxpayer, the tax imposed as a result increases 6⅔% of the amount of such credit for each year taxable during the recapture period. 

Under bankruptcy code, some taxes are not subject to bankruptcy discharge. In this case, a motion was made to reopen a bankruptcy case to assess whether the repayment obligation was a tax capable of being discharged as a result of the underlying bankruptcy. The debtor argued that the repayment obligation was not a tax and as a result could not be discharged. The Internal Revenue Service, however, argued that its repayment obligation was a tax and not capable of being discharged. 

In arriving at its ruling, the court acknowledged that two other bankruptcy courts had analyzed the first-time homebuyer credit repayment obligation and come to differing conclusions. For example, in the In Re Bryan case, a California bankruptcy court held that the repayment obligation was a tax. The court expressed the perspective that while a home buyer tax credit is comparable to a loan in that both must be repaid, the obligation to repay is imposed as an increased tax instead of a general obligation. Coming to a contrary opinion, a Maryland court in the In Re Betancourt case held that the repayment obligation was discharged in bankruptcy because it was a pre-petition debt that did not fall within any exception. 

The court in this case also considered previous Supreme Court of the United States rulings, which found that “labels” are not dispositive in deciding whether something constitutes a “tax.” Instead, the Supreme Court had found that courts should assess the “actual effects” of exaction. Quoting the Supreme Court, the court here also noted that a tax constitutes a “pecuniary burden” placed on individuals or property for the purpose of supporting the government. Applying this perspective, the court concluded that the repayment obligation was a tax and denied the motion to reopen. 

Discharging Taxes in Bankruptcy

One of the most common myths that exists about taxes and bankruptcy is that it is impossible to discharge taxes during bankruptcy. In reality, taxes can be discharged during bankruptcy provided that certain requirements are met. 

Remember, there are six types of bankruptcy filings. Bankruptcy Chapters 7, 11, 12, and 13 are available for people in different situations. Bankruptcy chapters 9 and 15, however, do not apply to tax debts. Consider the following issues about tax debts and the various types of bankruptcy:

• Chapter 7 offers the possibility for full discharge of debts. Courts during Chapter 7 bankruptcy liquidate assets to pay off a person’s debts. If taxes are discharged through Chapter 7, a person will be deemed no longer responsible for these debts.
• Chapter 11 permits debt reorganization and is most commonly utilized by incorporated businesses or individuals with debt greater than the Chapter 13 limit. Taxes can be discharged through Chapter 11 as part of a reorganization plan.
• Chapter 12 was created for farmers and fishermen who face financial difficulties in connection to their business. Taxes under Chapter 12 can be discharged as part of a repayment plan.
• Chapter 13 bankruptcy involves a court-approved payment plan to repay a person’s debts. If a person pursues Chapter 13, a person might be required to repay a tax debt as part of a payment plan. 

In each of these types of bankruptcy, tax debts are often classified as priority debts. Consequently, tax debts are often paid first. Debtors are also often required to pay taxes in full. If a tax is classified as a “priority” debt, the tax is not capable of being discharged in Chapters 11, 12, or 13.

Five Rules to Remember about Discharging Tax Debts in Chapter 7 Bankruptcy

To discharge tax debts while pursuing Chapter 7 bankruptcy, five critical factors must be satisfied. The application of these criteria can result in some debts qualifying for discharge, while others will not qualify. These five factors include the following:

• The debtor must not be guilty of tax evasion. The act of tax evasion can occur in various ways, but requires intentional action on the part of the debtor.

• The due date for when a debtor was required to file the tax return occurred at least three years ago. A tax debt must be connected to a tax return that was due at least three years before the taxpayer filed for bankruptcy.

• The tax assessment must be at least 240 days old. The Internal Revenue Service’s assessment can be part of a self-reported balance due, a proposed assessment that has since been finalized, or a final determination in an audit.

• The tax return cannot be fraudulent. This means that a person cannot engage in any intentional acts of evading tax laws. Similarly, a tax return can be neither fraudulent nor frivolous.
• The tax return must have been filed at least two years ago. This period of time is measured from the date that the debtor filed the return.

Speak With an Experienced Bankruptcy Attorney

The bankruptcy process is often complex, which is why the assistance of a knowledgeable bankruptcy lawyer often proves critical. Contact attorney Melanie Tavare today to schedule a free case evaluation.