Are Tax Penalties Dischargeable in Bankruptcy?

Are Tax Penalties Dischargeable in Bankruptcy?

When tax penalties and other debts force you to consider filing for bankruptcy protection in Indiana, it is important to understand the bankruptcy laws so you can proceed in a manner that most effectively and completely relieves your debts. One of the common questions asked of the Indianapolis bankruptcy lawyers at Camden & Meridew, P.C. is, are tax penalties dischargeable in bankruptcy? As explained below, the answer is sometimes “yes.”

Understanding Bankruptcy: Are Tax Penalties Dischargeable?

Many Hoosiers attempting to deal with unmanageable debt start by looking for information on the Indiana bankruptcy laws. While federal law governs bankruptcy proceedings, Indiana bankruptcy laws dictate what property is exempt from bankruptcy.

Federal regulations and Indiana bankruptcy laws exist to protect an individual’s constitutional right to be absolved of debts when extreme circumstances result in an inability to pay those debts. While bankruptcy discharge in Indiana is a reasonable solution in some cases, those considering Chapter 7 bankruptcy in Indiana, or other forms of bankruptcy, should consult with a trusted and experienced attorney to evaluate the specific circumstances and determine the best course of action.

Indianapolis Bankruptcy Lawyers Address the Question, Are Tax Penalties Dischargeable?

Julie A. Camden, one of the Indianapolis bankruptcy lawyers at Camden & Meridew, P.C., prevailed on an issue of first impression on behalf of a husband and wife (the debtors) in a tax and bankruptcy dispute pending before the United States Bankruptcy Court for the Southern District of Indiana and the United States District Court for the Southern District of Indiana, Indianapolis Division, regarding the dischargeability of tax penalties imposed by the Internal Revenue Service (IRS) for three years of tax deficiencies.

After asserting tax deficiencies and tax penalties against the debtors, the IRS challenged the dischargeability of tax penalties sought by the debtors, which totaled more than $80,000, in the debtors’ subsequently filed petition for Chapter 7 bankruptcy in Indiana.

Indiana Bankruptcy Laws and Dischargeability of Tax Penalties

At issue was the interpretation of 11 U.S.C. § 523(a)(7)(A) of the United States Bankruptcy Code and the precedential effect of Cassidy v. Commissioner (Cassidy I). In Cassidy I, the United States Court of Appeals for the Seventh Circuit stated that tax penalties are non-dischargeable in bankruptcy if the underlying tax with respect to which the penalty was imposed is also non-dischargeable.

Unfortunately, in the case of the debtors, their underlying taxes for three years of income were owed and non-dischargeable. Relying upon the Seventh Circuit’s language in Matter of Cassidy (Cassidy II), however, the bankruptcy court in the debtors’ case held that the Seventh Circuit’s statement in Cassidy I regarding the dischargeability of tax penalties in bankruptcy was dicta, or, in other words, not binding, and therefore, had no preclusive impact on the debtors’ claim for tax penalty bankruptcy discharge in Indiana.

Statute and Precedent: Bankruptcy Discharge in Indiana

The bankruptcy court then examined the statutory plain-meaning of 11 U.S.C. § 523(a)(7)(A) and (B), which provides, in relevant part, that a bankruptcy discharge does not include a debt for “a fine, penalty, or forfeiture payable to and for the benefit of the government,” except for a tax penalty relating to a kind of tax not specified in § 523(a)(1) or a tax penalty “imposed with respect to a transaction or event that occurred before three years before the date of the filing of the [bankruptcy] petition.”

While the interpretation of § 523(a)(7)(A) and (B) was an “open question,” which had not yet been resolved in the Seventh Circuit, the bankruptcy court adopted the majority view of other courts interpreting the same language and held that a tax penalty is dischargeable if the penalty is described by either § 523(a)(7)(A) or § 523(a)(7)(B).

Are Tax Penalties Dischargeable in Indiana Bankruptcy Cases?

Fortunately for the debtors, two out of the three years of tax deficiencies asserted by the IRS fell outside the three-year window from the filing of their bankruptcy petition, and, therefore, their tax penalties for those two years were determined to be dischargeable pursuant to § 523(a)(7)(B).

While the IRS appealed the bankruptcy court’s decision, the district court affirmed and adopted the bankruptcy court’s reasoning and opinion in its entirety. The IRS then sought to appeal the issue to the Seventh Circuit, but later withdrew that appeal.

Are tax penalties dischargeable in Chapter 7 bankruptcy in Indiana? The Indianapolis bankruptcy lawyers at Camden & Meridew, P.C. can help answer that and other questions related to your specific legal and financial situation. We practice in the areas of civil litigation, civil torts, family law, bankruptcy law, and tax law. You can learn more about Julie A. Camden and the attorneys at Camden & Meridew, P.C. by calling 317-770-0000 or by completing our online contact form today.

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