If you're struggling with overwhelming debt in Canada, you may be considering bankruptcy as a potential solution. However, one question that often arises is whether or not bankruptcy can help eliminate tax debt. The short answer is: it depends. Bankruptcy can provide relief from some types of tax debt, but there are several important factors and exceptions to consider. In this blog post, we'll explore the relationship between bankruptcy and tax debt in Canada.

 

Bankruptcy in Canada

Before diving into the specifics of how bankruptcy affects tax debt, it's essential to understand the basics of bankruptcy in Canada. Bankruptcy is a legal process that allows individuals or businesses to be discharged from most of their unsecured debts, providing them with a fresh financial start. However, not all debts are automatically discharged through bankruptcy.

 

In Canada, there are two main types of bankruptcy proceedings: consumer bankruptcy and commercial bankruptcy. Consumer bankruptcy is intended for individuals, while commercial bankruptcy is designed for businesses. The processes and requirements for each type differ slightly, but the underlying principles remain the same.

 

Tax Debt and Bankruptcy in Canada

When it comes to tax debt, the rules surrounding its treatment in bankruptcy can be complex. The Canada Revenue Agency (CRA) is considered a preferred creditor, meaning that it has priority over most other unsecured creditors when it comes to collecting debts owed to the government.

 

Generally speaking, bankruptcy can potentially discharge certain types of tax debt, but there are specific criteria that must be met. 

 

1. Source Deductions and GST/HST

Tax debts related to source deductions (such as income tax, Employment Insurance premiums, and Canada Pension Plan contributions) and Goods and Services Tax/Harmonized Sales Tax (GST/HST) are typically not dischargeable through bankruptcy. These debts are considered "trust fund" debts, meaning that the money was collected from employees or customers on behalf of the government, and the debtor acted as a trustee. Failing to remit these funds is considered a breach of trust, and therefore, they cannot be discharged through bankruptcy.

 

2. Income Tax Debt

Income tax debts owed to the CRA may be dischargeable through bankruptcy, but only if certain conditions are met:

 

- The tax debt must be from a tax year that ended more than three years before the date of bankruptcy.

- The tax return for that year must have been filed on time, or within two years of the date of bankruptcy.

- The CRA must have been notified of the tax debt at least three years before the date of bankruptcy.

 

If these conditions are not met, the income tax debt will likely survive bankruptcy and remain payable after the discharge.

 

3. Pre-Bankruptcy Tax Debt

Any tax debt that was incurred before the date of bankruptcy and meets the criteria mentioned above may be discharged through the bankruptcy process. However, it's important to note that any tax debt incurred after the date of bankruptcy will remain payable and will not be discharged.

 

4. Student Loan-Related Tax Debt

In some cases, individuals may owe tax debt related to the repayment of student loans. If the tax debt arises from the reassessment of student loan-related tax credits or benefits, it may be dischargeable through bankruptcy if it meets the same criteria as income tax debt.

 

The Role of a Licensed Insolvency Trustee

When considering bankruptcy as a solution for tax debt, it's crucial to seek the guidance of a Licensed Insolvency Trustee (LIT). LITs are federally recognized professionals that administer bankruptcy and insolvency processes. They can provide valuable advice and assistance in managing the tax debt and bankruptcy.

 

An LIT will review your financial situation, including your tax debt, and determine whether bankruptcy is an appropriate course of action. They will also communicate with the CRA on your behalf and ensure that all necessary steps are taken to properly address your tax debt within the bankruptcy process.

 

Alternatives to Bankruptcy for Tax Debt

While bankruptcy can provide relief from certain types of tax debt, it's important to consider alternative solutions as well. Depending on your specific circumstances, you may be able to negotiate a payment arrangement with the CRA or explore other debt relief options, such as a consumer proposal.

 

A consumer proposal is a legally binding process that allows you to negotiate a settlement with your creditors, including the CRA, to pay a portion of your outstanding debt over a specific period. This option can be particularly beneficial if you have significant tax debt that may not be dischargeable through bankruptcy.

 

Seek Professional Advice

Management of tax debt and bankruptcy can be challenging, and it's crucial to seek professional advice to ensure you make informed decisions. A Licensed Insolvency Trustee or a tax professional can provide valuable guidance tailored to your unique financial situation.

 

Remember, bankruptcy should be considered a last resort, as it can have long-lasting consequences on your credit rating and financial future. Before making any decisions, it's essential to explore all available options and weigh the pros and cons carefully.

 

In conclusion, while bankruptcy can provide relief from certain types of tax debt in Canada, the rules and criteria are complex. By understanding the nuances of tax debt and bankruptcy, and seeking professional guidance from a Licensed Insolvency Trustee or tax professional, you can make informed decisions and take the necessary steps towards financial recovery.

 

You can also check the information regarding Difference between Bankruptcy and Consumer Proposal 

 

FAQs:

1. What types of tax debt can be discharged in bankruptcy?

Income tax debt that meets specific criteria (age of debt, timely filing, no fraud/evasion) may be dischargeable in Chapter 7 or Chapter 13 bankruptcy. Other taxes like payroll/trust fund taxes are generally not dischargeable.

 

2. How old does income tax debt have to be to qualify for discharge?

For income taxes to be discharged, the tax return must have been originally due at least 3 years before filing bankruptcy, the return must have been filed at least 2 years before bankruptcy, and the tax debt must have been assessed by the IRS at least 240 days before filing.  

 

3. Can tax penalties and interest be eliminated in bankruptcy? 

If the underlying income tax debt qualifies for discharge, the associated penalties and interest can also potentially be discharged along with the tax debt itself.

 

4. Are unpaid payroll/trust fund taxes dischargeable?

No, payroll taxes that employers withhold from employees for things like Social Security and Medicare are considered non-dischargeable "trust fund" taxes in bankruptcy.

 

5. How does bankruptcy affect state income tax debt?

State income tax debt may be dischargeable if it meets the same criteria as for federal income taxes. But bankruptcy laws can vary somewhat by state.

 

6. If tax debt can't be discharged, can bankruptcy still help?

Even for non-dischargeable tax debt, bankruptcy can allow you to restructure payments on taxes through a Chapter 13 repayment plan over 3-5 years.

 

7. Does bankruptcy stop IRS/state tax collections temporarily? 

Yes, the automatic stay in bankruptcy immediately stops most tax collection efforts like garnishments, levies and liens temporarily.

 

8. Will bankruptcy impact future tax refunds?

After bankruptcy, future tax refunds may potentially be taken by the bankruptcy trustee or taxing authorities to pay remaining non-discharged tax debt.

 

9. How long does tax debt remain on your credit report after bankruptcy?

Most tax liens are released after being discharged in bankruptcy, but can remain on your credit report for up to 10 years from the filing date.

 

10. Is bankruptcy the best solution for tax debt relief?

Bankruptcy may help in some cases, but alternatives like IRS installment plans, offers in compromise or current non-collectible status should also be explored with a tax professional.