Does Bankruptcy Clear Tax Debt in Australia?

by | Oct 17, 2022

Filing for bankruptcy is often the last option you have if you are unable to repay your debts. When you declare bankruptcy, you are absolved from repaying most of your debts, allowing you to make a fresh start and manage your finances in a better way. Bankruptcy is an important financial decision, which must be taken after knowing its effects on different aspects of your life.

While bankruptcy covers most of your unsecured debts, such as your personal loans, credit card loans, and utility bills, you should know about the debts that are not covered by bankruptcy. Many people ask whether unpaid taxes are covered by bankruptcy. In this post, we will answer questions focused on the effects of bankruptcy on your taxes.

What to expect after bankruptcy

You can file for voluntary bankruptcy by filling out a Bankruptcy Form, or your creditor can also declare you bankrupt by getting a sequestration order from a court. After you become bankrupt, a trustee selected by you or the Australian Financial Security Authority (AFSA) will be appointed to oversee your financial matters. The trustee can legally seize some of your assets to recover the dues of your creditors. If you are employed and earn an income above the base threshold amount, you’ll have to make regular contributions to the trustee as repayments to your creditors.

The Australian Financial Security Authority (AFSA) maintains a list of various threshold amounts for the protected property for different assets, including your income, which you can check here. The amounts change regularly with the Consumer Price Index.

You should also note that the bankruptcy period will last for three years and one day.

Effects of bankruptcy on your taxes

You are not relieved from filing your tax returns after you become bankrupt. This means that you’ll have to file your tax returns like before despite being bankrupt. If you did not file your tax returns for several periods before the date of bankruptcy, the Australian Taxation Office (ATO) usually instructs trustees to prepare all previously unfiled tax returns to ascertain your tax liability. If you owe income tax to the ATO, you need to list the ATO as a creditor on the bankruptcy form with the estimated amount of tax debt. You’ll have to lodge your overdue tax returns, and your bankruptcy won’t absolve you from filing unfiled returns.

ATO can also use different available information sources to estimate your income tax debt if you are unable to file the due tax returns. The estimated tax debt calculated by the ATO can be higher than the actual, so we recommend that you cooperate with the trustee in preparing correct income tax returns. The tax agency can also sue you for not filing your tax returns, and the court can impose a penalty or fine on you, which you’ll have to pay even during your bankruptcy.

What happens to your tax refunds if you’re bankrupt?

When you are bankrupt, you need to inform your trustee about any tax refunds you receive from the ATO. You also need to provide the trustee with a copy of your notice of assessment from the ATO. The trustee will examine the refund and will inform you whether you can keep it or the trustee can claim it for recovery of debts.

In case you get an income tax return for the income you earned before becoming bankrupt, the refund will be considered your asset and can be claimed by the estate trustee. The period in which you receive the refund does not matter in this case.

In contrast, if you get an income tax refund for the income earned after your bankruptcy, the refund is considered income. You will be required to make contributions to the trustee if the income exceeds the base threshold amount mentioned above. However, you are allowed to keep the income tax refunds after your bankruptcy period ends.

The ATO can keep your refunds to settle any outstanding amount you owe to the tax agency or any other Commonwealth agency, such as Family Assistance or Child Support. You won’t be exempted from repaying the ATO or agency debts even if you list them in your bankruptcy form. After your bankruptcy is discharged, the ATO cannot keep any refunds to satisfy tax debts owed before the bankruptcy date.

Does bankruptcy cover your tax debts?

Barring some, most of your tax debts are covered by bankruptcy. This means they do not have to be repaid (except in certain circumstances). However, the ATO would still legally be your creditor, and can recover its dues if the amount becomes available. Any income tax you accrue after the start date of your bankruptcy won’t be covered by bankruptcy, and you’ll have to pay it to the ATO.

Can the ATO make you bankrupt for unpaid tax debts?

The ATO can make you bankrupt, provided they obtain a court judgment against you and you owe them a tax debt of more than $5,000. After obtaining the judgment against you, the ATO will give you a Bankruptcy Notice for paying off the tax debt within 21 days from the date the notice is served. If you don’t pay the due tax within the period, the agency can apply to court for declaring you bankrupt.

Final Thoughts

To sum up, all your outstanding tax debts at the date of bankruptcy are covered by your bankruptcy, irrespective of whether you have filed your tax returns or not. You can lodge your tax returns after the start of your bankruptcy. After you lodge your past outstanding returns, the ATO will usually waive off your previous unpaid tax debts until the start date of your bankruptcy.

However, tax debt that arises from income earned after the start date of your bankruptcy is not covered by bankruptcy, and you’ll have to pay it to the ATO. You must remember that bankruptcy does not exempt you from filing your outstanding tax returns.

B M Peachey

B M Peachey, has over 15 years of experience investing in property and the stock market, in both New Zealand and Australia. She has a post-graduate degree, with qualifications in Finance and Mortgage Broking and in Accounting and Bookkeeping. She is passionate about ensuring people have access to credible, reliable, and easy to understand information to help them get in control of the life they REALLY want to live.

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    Disclaimer: The information in this article is general in nature as it has been prepared without taking account of your specific objectives, financial situation or needs. Therefore, you should consider whether the information is appropriate to your circumstance before acting on it, and where appropriate, seek professional advice from a finance professional such as an adviser.