Income Tax Debt in Bankruptcy
When you’re filing for bankruptcy because of the inability to pay your debts, there is a likelihood you also have accumulated tax debts.
Filing for bankruptcy can be a solution for many suffering financially.
The initial consultation with a trustee is crucial to determine whether the type of debt burden you have can be cleared through bankruptcy.
A sort of debt that deserves special attention is income tax debt.
The income you earn is subject to taxation.
However, it is not collected automatically.
You have the responsibility to report your total income and calculate the amount of tax due.
When you file for bankruptcy, your trustee will complete a tax form for the period starting 1st of January until the date you file for bankruptcy.
Most often, the type of debt that benefit from bankruptcy are unsecured debt.
When you owe taxes when filing for bankruptcy, they are treated similarly to most unsecured debts.
This means, just like your credit card and other unsecured debt, your tax debt also gets eliminated when you are discharged provided that the total amount is not over $200,000 or that your bankruptcy is not made up more 75% in tax debt.
The treatment of tax debt during bankruptcy
Section 172.1 of the Bankruptcy and Insolvency Act define the treatment of unpaid income taxes during bankruptcy.
If the total amount of tax debt is more than $200,000 or your bankruptcy claim is made up of 75% income tax debt, then you will not obtain an automatic discharge after nine months as is the case with other unsecured debts when filing for the first time.
To obtain discharge, a court hearing is necessary.
Your trustee will seek an appointment for the hearing.
Often, court hearing for income tax bankruptcy discharge occurs between 9 and 36 months after the bankruptcy date.
When your bankruptcy consists of credit card unsecured debt or other such debt, the trustee will file along with the Statement of Affair outlining your financial situation, the income tax return from the start of the year until the date you file for bankruptcy.
However, if your bankruptcy is made up mostly of unpaid income tax, the trustee need to file all of your unfiled tax return of previous years.
Lien Against Income Tax Debt
The request for income tax bankruptcy is not possible when there is a lien placed against your income taxes.
A lien is a claim on a collateral.
For example, the Canada Revenue Agency (CRA) can place a lien against your property if it has been years you haven’t filed your tax return.
When there is a lien placed on your income tax, you have three options to have it removed.
- You negotiate with the CRA repayment of the income tax debt. If you come into an agreement, once you take care of your responsibilities, they’ll remove the lien;
- You can have the collateral placed as a lien and used the money to pay your debts;
- You can file for a Consumer Proposal. In the proposal, a clause must be entered noting that the liens should be removed once you take care of your responsibilities under the Consumer Proposal agreement.
Considering your income tax bankruptcy claim
When there is the need for a court hearing to settle your income tax debt, the court will give one of three verdicts taking into account:
1) your circumstances when you incurred the income tax debt;
2) The efforts you’ve made, if any, to repay the debt;
3) Whether you paid other debts and ignored the income tax debt, and;
4) Your future financial prospects.
Judging by these elements the court will rule either:
- Refused – The debts are not discharged by the bankruptcy, however, you can always reply in the future
- Suspended – You’re going to be granted discharge, but sometimes in the future at a date the court will specify.
- Conditional – The discharge will be granted provided you comply with certain conditions set by the court.
The role of the trustee is not to advocate on behalf of the bankrupt.
Instead, he/she must provide objective information regarding the cause of your bankruptcy.
However, you are entitled to seek a lawyer at your own expenses to represent you at the court hearing.
Hence, in Quebec, income tax debts are treated similarly to unsecured debt and are eliminated once you’re discharged of your bankruptcy.
However, if the bankruptcy is made up of 75% income tax debt or that your income tax debt exceed $200,000, discharge is not possible and a court hearing is essential for the final verdict.