A reader has asked which year’s income taxes are included in bankruptcy? HMRC used to have a special status as a preferred creditor, but since 2003 tax debts are treated the same as other debts and are wiped out by bankruptcy. There are however a few complications, so this article looks at all the different types of taxes and what happens to each of them when you go bankrupt. In particular, there has been a change this month (April 2014) in how the current year’s council tax is handled in bankruptcy.
All income tax debts from previous tax years are included in your bankruptcy. The income that you would have been due to pay in current tax year is also included. In order to stop any further payment of income tax, your PAYE tax code will be set to NT so no tax will be deducted from your salary.
However, you are not going to be any better off because of not paying income tax this year. Instead of paying tax to the Inland Revenue, the extra money you are now getting in your pay packet will be taken by the Official Receiver (OR) in an Income Payments Agreement (IPA). It is effectively a way the Insolvency Service covering some of its costs.
At the end of the tax year or if you change jobs during the tax year this all ends. Your PAYE tax code will revert to normal. Your IPA will be reduced by the equivalent amount, which may for some people mean that their IPA ends. If this happens, an IPA cannot later be imposed after your discharge even if your income rises.
If you go bankrupt towards the end of the tax year, you may well find that your tax code never changes as it takes a while to sort out.
If you are unclear about how much “tax” money you need to pay to the OR, or who to pay it to, then phone up and ask. If in any doubt, put the extra money aside, as it is going to be claimed by the OR at some point.
All council tax debts from previous years are included in bankruptcy, whether or not the council has issued a summons for them.
n.b. if you are living with someone else who is liable to pay council tax (eg not a child or a student) then you are probably jointly liable for the council tax, so the council will seek to recover the whole amount from your partner.
There was a court decision in December 2013 which implies that all council tax for the current year should be included in bankruptcy. As a result, the Insolvency Service has amended its Technical Manual to say: “All outstanding liabilities (that is, all arrears and future instalment payments) for council tax for the year in which the insolvency commences are provable debts [note 42] [note 43]. This applies whether or not the company/bankrupt was in arrears at the date of insolvency.”
As with income tax, if your liability to pay council tax stops for the rest of the tax year, you are likely to have to pay a higher IPA as a result for the remainder of the tax year.
If you later move house
The council tax for the house you were living in when you went bankrupt went into your bankruptcy as you owe all that amount at the point you went bankrupt.
If you move into a new house, you have to start paying council tax on that. You didn’t owe this money when you went bankrupt so it isn’t wiped out by your bankruptcy.
If you are paying a higher IPA because of the council tax on your previous property, this should now stop. Contact your OR and ask them to sort this. So you won’t be “paying double” – before you move you will pay a higher IPA, after you move your IPA will drop but you have to pay the new council tax.
Unless you are running a business, it is pretty unlikely that you will have any other tax debts from previous years. National Insurance will continue to be deducted from your salary as normal in the year after you go bankrupt.
Business Debtline is your best source of information about all the practicalities of going bankrupt when you are self-employed – the following is only a rough guide. If your business has any assets it is usually closed, if it has no assets it may be allowed to continue. Any tax debts such as income tax, VAT and NI debts from previous years and for the current year to the point of closure will be included in your bankruptcy.
You can then start a new business, in which case you are responsible for paying all the debts which then arise from that business (except for income tax in the current tax year, see above). If you were VAT registered before, you have to re-register and use the new registration number.
If the accumulation of tax debts was one of the main causes of your bankruptcy and you are planning on carrying on with your business, then you should take the opportunity of a fresh start to begin to put aside sufficient money for taxes each month. This future tax money is not ‘income’ from your business that you can use for your personal expenses. You are allowed to have a savings account when you are bankrupt and you should consider setting aside any tax money into this account each month.
Any refunds of tax from previous years are going to go to the Official Receiver, not you.
As a broad summary, all tax debts are extinguished when you go bankrupt. If you are self-employed, then you need to take advice on the impact on your business, including taxes.
There are some complications about what happens to income tax and council tax during the current year, but you should assume that you will not be any better off because of these. If you are considering going bankrupt, then you can probably ignore all these complications, because it is very unlikely that they would make a difference to your decision.