HMRC used to have a special status as a creditor, which means they would get paid back before other people when their debtor went bankrupt. But since 2013, tax debts are treated the same as any other debt. This means they are wiped out by the bankruptcy. However, there are a few complications to consider, which this article looks at in detail. This article will discuss how the different types of taxes are treated when someone goes bankrupt.
What Happens to Income Tax in a Bankruptcy?
If you file for bankruptcy, all income tax from previous tax years and any income tax you are liable for in the current tax year will be wiped. To stop any more income tax being taken from your salary, change your PAYE tax code to NT.
It’s important to note, changing the tax code to stop income tax deductions doesn’t make you any better off because that ‘saved’ money will be taken by the Official Receiver (OR) in an Income Payments Agreement (IPA) as the Insolvency Service uses this money to cover some of its costs.
Your PAYE tax code will revert to normal at the end of the tax year or if you change jobs during the tax year – which means you will have to pay income tax again. Your IPA will be reduced to accommodate paying the income tax. If you can no longer afford the IPA (due to paying income tax), the IPA will be stopped. Once your bankruptcy ends, the IPA cannot be reimposed even if you earn enough to be eligible for one.
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 for the change to take effect.
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.
What Happens to Council Tax in a Bankruptcy?
When you file for bankruptcy, all council tax debt from previous years and anything you would owe in the present year are wiped – even if the council has summoned you for them.
Important points to note:
- If you are living with someone else eligible to be responsible for paying the council tax (e.g. not a child or a student) then you are likely to be jointly liable for paying that council tax, so the council will seek to recover the whole amount from the other party, such as your partner.
- As with income tax, if your bankruptcy exempts you to pay council tax for the rest of the tax year, once again, any money ‘saved’ will go towards the IPA.
What Happens if I Move House During Bankruptcy?
Only the council tax for the house you were living in when you went bankrupt is included in the bankruptcy.
If you move into a new house, you have to start paying council tax on that new house. You didn’t owe this money when you went bankrupt, so it’s not included in the bankruptcy.
The higher IPA you’re paying because you’re exempt from paying the council tax debt on your previous property (because it’s included in the bankruptcy) should be lowered to accommodate the council tax you need to pay on the new property. Your OR will sort this out for you – make sure you contact them.
What Happens to Other Taxes in a Bankruptcy?
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.
I am Self-Employed, What Happens to the Taxes I Need to Pay?
Businesses with assets will be closed. If your business has no assets, you might be allowed to continue. Debt from the following tax groups is included in your bankruptcy (both from previous tax years and the current tax year):
- Income tax
- Value Added Tax (VAT)
- National Insurance (NI) debt
What Happens if I Start a New Business?
You are free to start a new business but any debts from that new business are not included in the bankruptcy – except the income tax for the current year. If you were VAT registered before, you have to re-register and use the new registration number.
Learning Lessons From the Past
If business related tax debts were the reason you went bankrupt, please make sure you leave money aside every month to pay your tax bills. 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.
Can I Keep Any Tax Refunds?
Any refunds of tax from previous years are going to go to the OR, not you.
Bankruptcy and Tax, A Summary
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 its taxes.
There are some complications about what happens to income tax and council tax during the current year, but do not assume you can use the complications to save a bit of money. All extra cash is going to go to your OR.
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