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By Karen E. Klein
APRIL 27, 2000

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Smart Answers Archive

Q:  I had a small business that I had to close, and I'm currently in bankruptcy proceedings. Can one deduct Virginia sales taxes through bankruptcy?

-- I.S., Woodbridge, Va.

A:  I suspect that you mean to ask whether state sales taxes are dischargeable -- rather than deductible -- through bankruptcy proceedings. This is definitely a question for the attorney handling your case. Lawyers familiar with bankruptcy proceedings in Virginia say in general, sales tax liabilities are not dischargeable in bankruptcy.

"Sales taxes are treated like withholding taxes, which are withheld from an employee's wages. Like the employer in the withholding tax situation, the retailer is deemed to be holding the sales taxes in trust for payment to the state," and the obligation to pay those taxes is not alleviated by a bankruptcy filing, says Donald F. King, a principal in the Fairfax (Va.) law firm Odin, Feldman & Pittleman.

CHAPTERS 11,13. King, who has been appointed a bankruptcy trustee for the U.S. Bankruptcy Court's Eastern District of Virginia, says small businesses should consider negotiating with tax authorities to reschedule payments or ask for a reduction if they can clearly demonstrate their inability to pay the tax liability. "Any type of taxes can be restructured, and you can put them on a payment plan, but they are considered priority claims in a bankruptcy case and have to be paid within six years of the date of bankruptcy assessment," he says.

If you have filed under Chapter 13, the tax authority is not allowed to collect interest on back taxes while you are under a repayment plan, but if you filed under Chapter 11, interest on back taxes will still accrue, King says.

If your sales-tax liability is very high and you can submit personal financial statements and company cash-flow statements that show a clear inability to pay it in full, tax authorities may be amenable to a compromise, King says. "We always advise the taxpayer to consider an offer in compromise. If you make a good-faith effort to pay some portion of the liability, you may get some type of release on the balance. But working out a compromise can take a long time, and you should choose an attorney who has experience in tax-controversy work to represent you."

You should also be aware of liens, which also aren't discharged by bankruptcy petitions. If the State Board of Equalization or the Internal Revenue Service has attached a lien to your property or assets for nonpayment of taxes, it won't go away just because you file for bankruptcy.

"It's treated as a secured claim, and if the underlying debt is nondischargeable, that lien will continue to attach to any new property or new assets that the debtor acquires in the future," King says.

Check out the American Bankruptcy Institute's Web site. The professional organization offers bankruptcy news, statistics, legislative updates, and information on how to find bankruptcy professionals and instructions for filing in your state. At the Web site, you can search bankruptcy opinions, find links to bankruptcy courts and credit-counseling organizations throughout the country, and look up bankruptcy terminology.

Have a question about running your business? Ask our small-business experts. Send us an E-mail at, or write to Smart Answers, BW Online, 46th Floor, 1221 Avenue of the Americas, New York, NY 10020. Please include your real name and phone number in case we need more information; only your initials and city will be printed. Because of the volume of mail, we won't be able to respond to all questions personally.


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