How Do I Deal with Government Debts During Business Bankruptcy?

 Dealing with government debts during a business bankruptcy can be complex, as these debts are subject to specific legal provisions and often have different rules than debts owed to private creditors. Government debts can include taxes, fines, penalties, and other obligations to local, state, or federal authorities. Here’s a breakdown of how you may need to handle government debts during bankruptcy proceedings:

1. Understand the Types of Government Debts

Before addressing how government debts are handled during bankruptcy, it’s important to differentiate between the types of debts a business may owe to the government. These typically include:

• Taxes: Income taxes, payroll taxes (e.g., Social Security, Medicare), and sales taxes owed to local, state, or federal authorities.
• Penalties or fines: These may arise from regulatory violations, environmental issues, or other legal obligations.
• Other debts: This can include fees, licenses, or permits owed to the government.

2. Tax Debts in Bankruptcy

Tax debts are among the most complicated issues businesses face in bankruptcy proceedings. While some tax debts may be dischargeable in bankruptcy, others are not. Here’s a general breakdown based on the type of bankruptcy:

Chapter 7 Bankruptcy (Liquidation)

In a Chapter 7 bankruptcy, the business’s assets are liquidated to pay off creditors. When it comes to tax debts, they are generally treated as follows:

• Priority Tax Debts: Certain tax debts, such as payroll taxes (e.g., employee withholdings for Social Security or Medicare), excise taxes, and recent income taxes, are considered "priority" debts. Priority debts must be paid in full during the bankruptcy, and failure to do so may result in the tax authority continuing its collection actions.

• Non-priority Tax Debts: Older income taxes (typically taxes due more than three years ago) or taxes where the tax return was filed more than two years ago may be dischargeable in Chapter 7 bankruptcy. However, even if some income taxes are discharged, other government-related debts (like payroll taxes) are not.

Chapter 11 Bankruptcy (Reorganization)

In a Chapter 11 bankruptcy, businesses aim to reorganize their debts and continue operations. Here's how government debts are treated in this process:

• Payment Plan: In Chapter 11, tax debts may be included in the business’s reorganization plan. The business will need to propose a plan to repay priority tax debts over a specific period (typically within five years).

• Negotiation with Tax Authorities: Businesses filing for Chapter 11 may be able to negotiate more favorable terms for repaying tax debts, potentially reducing the total debt owed or extending the payment period.

• Treatment of Dischargeable Taxes: Like in Chapter 7, some older income taxes might be eligible for discharge if the conditions are met. The business may not have to pay those debts if the tax authority agrees.

Chapter 13 Bankruptcy (Debt Adjustment)

If a business is a sole proprietorship, it can file under Chapter 13 (which is typically for individuals). In Chapter 13, the debtor proposes a repayment plan to restructure debts, including government taxes.

• Payment Plan for Taxes: Similar to Chapter 11, tax debts in Chapter 13 will be included in the repayment plan. These taxes must be paid over a three to five-year period.

• Priority vs. Non-Priority Taxes: Priority tax debts (such as payroll taxes) are paid in full, while non-priority debts (like older income taxes) can often be paid over time.

3. Negotiating Tax Debt During Bankruptcy

In both Chapter 7 and Chapter 11 bankruptcy proceedings, it may be possible to negotiate with the government to settle tax debts. The IRS, state tax agencies, and local authorities may be willing to work out arrangements to collect the debt without forcing the business into liquidation. Negotiation may include:

• Installment Payment Plans: The business may be able to set up a payment plan to pay off the debt over time.
• Offer in Compromise: The business may be eligible for an Offer in Compromise (OIC), which allows the taxpayer to settle tax debts for less than the full amount owed, if the business can prove that it is unable to pay the full debt.
• Penalty Abatement: It may be possible to reduce or eliminate penalties associated with the tax debt, especially in cases where the business can demonstrate that the tax issues were due to circumstances beyond its control.

4. Payroll Taxes and Trust Fund Recovery Penalty

If your business has unpaid payroll taxes (e.g., Social Security, Medicare, and federal income tax withholding), these taxes are often treated as trust fund taxes. The IRS has strict rules about these taxes because they are considered “trust fund” money, meaning they are withheld from employees' wages and should be sent directly to the IRS.

• Trust Fund Recovery Penalty (TFRP): If the business fails to pay payroll taxes, the IRS may impose the Trust Fund Recovery Penalty (TFRP), which holds responsible individuals within the business personally liable for the unpaid taxes. This can include business owners, officers, or anyone responsible for managing payroll.

• Impact in Bankruptcy: Even in bankruptcy, payroll tax debts may not be dischargeable, and business owners may be personally liable for these debts. This can complicate the bankruptcy process, as the business owner may need to address these personal liabilities separately.

5. Other Government Debts (Fines, Penalties, and Fees)

• Dischargeability of Penalties and Fines: Penalties and fines imposed by the government may or may not be dischargeable in bankruptcy, depending on the nature of the debt. In general, fines and penalties for criminal conduct, environmental violations, and some regulatory fines may not be discharged.

• Government Fees and Licenses: Some business-related fees (such as licenses, permits, or other regulatory fees) may be considered part of the bankruptcy process and might be subject to negotiation for payment or relief.

6. Important Considerations for Government Debts in Bankruptcy

• Communication with Tax Authorities: It’s essential for the business to maintain communication with the IRS, state tax agencies, and other government authorities during bankruptcy proceedings. Failure to do so can result in the government taking actions to collect debts, even during the bankruptcy process.

• Consultation with a Bankruptcy Attorney: Government debts, especially tax debts, can be tricky to navigate in bankruptcy. It's vital to consult with an experienced bankruptcy attorney who can advise on how to handle specific tax issues, negotiate with authorities, and ensure that you comply with all legal requirements.

Conclusion

Government debts, especially taxes, can be one of the most complex aspects of business bankruptcy. Whether the business is filing for Chapter 7, Chapter 11, or Chapter 13 bankruptcy, it’s crucial to understand the treatment of different types of government debts. Priority taxes, such as payroll taxes, typically must be paid in full, while some older income taxes may be dischargeable. Businesses may also have the option to negotiate with tax authorities or restructure payments as part of their bankruptcy plan. The key is to work with an experienced bankruptcy attorney who can help navigate the rules surrounding government debts and ensure the best possible outcome for the business.