Bankruptcy is among the last stops for a client in money trouble, and one that entails a lot of decisions regarding taxes.

Bankruptcy filings fell slightly for the year ended March 31, according to the Administrative Office of the U.S. Courts. Bankruptcies filed in March alone were mixed, as non-business filings, which includes consumer filings, fell sharply as new business bankruptcies increased.

Both trends will likely rise, experts predict, amid a surge of business and personal bankruptcies as the pandemic continues to ravage the economy.

The most common categories of bankruptcy are Chapter 7 and Chapter 13.

“Chapter 7 bankruptcy is a debt-forgiveness plan,” said Gregory Wade, bankruptcy attorney at the law firm Wade, Grimes, Friedman, Meinken and Leischner in Alexandria, Va. “It involves asking the bankruptcy court to dismiss the majority of debts with exceptions, such as taxes, alimony and child support.” Chapter 13 offers both a debt-forgiveness plan and a debt-repayment plan, establishing a repayment percentage based on assets, income and the size of debts.

All tax returns must be filed before you file for bankruptcy; this determines your tax liability. But you may not have to pay those taxes immediately.

“The bankruptcy relief that you can get is not dependent on you having the funds to pay your taxes, but you do have to file so that anybody can have disclosure on your financial life,” Wade said, adding, “if you have an extension to file through October and you decide that you’re going to file for bankruptcy in June, that tax deadline disappears. You have to file your taxes before you file bankruptcy.”

According to the IRS, during a bankruptcy case you should pay all taxes that come due. Failure to file returns or pay current taxes during your bankruptcy may result in a tax case being dismissed.

Indeed, taxes are a different category of debt. “Many people think that taxes aren’t dischargeable by bankruptcy. That’s false,” Wade said. “Taxes can be discharged and forgiven in bankruptcy, but there are limits. The most common limit is that taxes have to be more than three years old and you have to have filed your tax returns more than three years before you file bankruptcy.”

When to file for bankruptcy matters, especially if a client owes a lot in taxes. “Let’s say it’s July and you know those taxes are not three years old,” Wade said. “You have to make a strategic decision whether to file the bankruptcy now, knowing it’s premature to get taxes discharged. But there may be other benefits from the bankruptcy that overweigh paying the taxes.”

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