income tax debt

Income tax debt and personal bankruptcy

Income tax debt. Despite beliefs to the contrary, personal income tax debt is treated no differently than most other types of debt under Canadian bankruptcy law. However, this statement comes with a caveat, which we’ll examine later later in this post.

Here is a typical scenario that occurs across frequently:

  • The debtor is self-employed and for one reason or another, has not filed personal income tax returns for a number of years;
  • She eventually has her earnings garnished by the Canada Revenue Agency. She calls CRA to find out what’s going on, and is told that they performed an arbitrary assessment of the income taxes that she owes, since she never filed her tax returns.

Here are the steps you should take:

  • Get your income tax returns filed. Once CRA assesses your income tax returns as filed, you may actually owe a lot less income tax than what CRA initially assessed. If that’s the case, you may be able to pay off your income tax obligations on your own;
  • However, if the actual amount assessed is still unmanageable, you should contact a bankruptcy trustee to determine what your options are to deal with your income tax (and other) debts.

Two formal options under the Bankruptcy and Insolvency Act are to file for personal bankruptcy or alternatively, make a settlement with CRA by way of a consumer proposal.

In contemplating filing for personal bankruptcy, you should be mindful of the following:

  • New amendments to the Bankruptcy and Insolvency Act came into force on 18 September 2009. An individual who filed bankruptcy prior to that date would be eligible for an “automatic” discharge; that is, she would be discharged automatically after fulfilling certain financial and counselling obligations without having to go to court to obtain her discharge;
  • If you file for personal bankruptcy on or after 18 September 2009 and you have: (1) at least $200,000 in personal income tax debt; and (2) the tax debt comprises 75% or more of your total debt, then you will be required to attend a discharge hearing with the bankruptcy court. The court will review your bankruptcy file and you may be required to pay more money to your bankruptcy estate as a condition of your discharge;
  • For example, as a rule of thumb, the Toronto bankruptcy court requires a bankrupt to pay between 10-15 percent of the principal balance of her personal income tax debts as a condition of her discharge. If the circumstances that led to her bankruptcy are particularly egregious (e.g., this is her second bankruptcy and her first bankruptcy was also income tax driven), she may be required to pay an even higher amount.

If you are contemplating filing a proposal to CRA, you should be mindful of the following:

  • If your total debts (defined as all debts excluding your mortgage on a principal residence) are less than $250,000, you will be eligible to file a consumer proposal. This is a streamlined approach of getting your proposal approved and your proposal can be automatically approved by your creditors within 45 days after being filed by a trustee;
  • If your total debts (defined as all debts excluding your mortgage on a principal residence) are more than $250,000, you will be required to file a Division I proposal. This requires a formal meeting of creditors and an application to the bankruptcy court to get your proposal approved. If your proposal is not approved by either the creditors or the court, you are deemed to have filed for bankruptcy at the creditors meeting or at the motion application, as the case may be;
  • Put your best foot forward. That is, offer the very best settlement you can afford when dealing with the CRA. CRA is very sophisticated in dealing with tax debtors who’ve undertaken formal insolvency proceedings, so it is best to deal with them in a straightforward manner.

This post should not be interpreted as legal advice or a legal opinion. Please consult your local Canadian Licensed Insolvency Trustee to review your own particular circumstances.

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