State tax debts can sometimes be cleared or "discharged" by filing for bankruptcy. It depends on the type of tax debt that is owed. Many of the same rules apply to state income tax debt and tax debt owed to the Internal Revenue Service (IRS), but not all of them. In this article, you'll learn about state rules for wiping out tax debt, state taxes that aren't dischargeable in bankruptcy, and paying off nondischargeable tax in Chapter 13 bankruptcy.
Be aware that tax liability resulting from business ownership, such as sales, withholding, and franchise tax, have specific rules that vary between states. You’ll want to speak with an experienced attorney about your particular case.
Wiping Out State Tax in Bankruptcy
State taxes follow the same rules for dischargeability as federal income taxes. For instance, whether you can get rid of them will depend on when the taxes come due, when you file your return, and when the taxing agency assesses the tax. If the state income tax you owe meets the federal income tax discharge rules, the state income tax can also be discharged.
Learn about other nondischargeable debts in bankruptcy.
State Taxes That Won’t Go Away in Bankruptcy
Some state taxes never get discharged in bankruptcy. For instance, you’ll remain responsible for paying:
- income taxes less than three years old
- income taxes on a return filed less than two years before the bankruptcy
- fraudulently reported income taxes, and
- sales, payroll, and other business-related tax.
Business taxes such as sales and payroll taxes are known as “trust fund” taxes. A business must collect and hold them in trust for the taxing authority.
If you operate as a sole proprietorship, you’re automatically personally liable for sales and payroll taxes. If you are interested in a corporation, partnership, or limited liability company, you’ll be personally responsible for any tax the business doesn’t pay.
Taxing authorities tend to aggressively collect trust fund taxes. The period will depend on the state and is usually quite long. If you owe trust fund taxes, you should seek advice from an experienced attorney on how best to proceed.
Learn about the effects of small business bankruptcy.
How a Chapter 13 Bankruptcy Can Help
If your state tax obligation can't be discharged, Chapter 13 bankruptcy will let you spread the payments over three to five years. You’ll have the added benefit of potentially paying less on other debt, such as credit card balances, leaving you a larger percentage of your income to pay off the tax.
Consult a Bankruptcy Lawyer
Understand, however, that tax debt can be complicated. Before you explore this route, you’ll want to get an assessment with a bankruptcy attorney. Getting legal help isn't as expensive as you'd think, and most people believe hiring a bankruptcy lawyer is well worth the cost.