What Are Priority Taxes in Bankruptcy?

When facing financial distress, not all debts are treated equally in bankruptcy. Certain obligations, particularly tax debts owed to federal, state, and local governments, are designated as priority claims under U.S. bankruptcy law. This status means they receive special treatment and must be paid ahead of many other debts. Understanding which taxes are considered priority and how they are handled is an important part of navigating the bankruptcy system.

Defining Priority Tax Claims

When a person files for bankruptcy, their debts are categorized to determine the order of repayment from any available assets. This creates a payment hierarchy where priority claims hold a specific place, positioning them ahead of general unsecured debts. This elevated status is granted by the U.S. Bankruptcy Code to certain types of debts considered to be of public importance.

Secured claims, which are debts backed by collateral like a mortgage or car loan, are at the top of the hierarchy and are paid first from the proceeds of that collateral. After secured creditors are addressed, remaining assets are used to pay priority claims, which include specific tax debts. Only after all priority claims have been paid in full do any remaining funds get distributed to general unsecured creditors, such as those holding credit card debt or medical bills.

This structure means that a tax debt with priority status has a much higher likelihood of being paid than a general unsecured debt. This distinction is a matter of federal policy, which favors the payment of certain obligations to ensure public functions funded by these taxes can continue.

Taxes That Qualify as Priority Claims

Several types of tax debts are granted priority status, but they must meet specific criteria, many of which are time-sensitive. These rules determine whether a tax obligation is a general unsecured debt, which might be discharged, or a priority debt that must be paid. The most common forms of priority taxes include certain income, payroll, and property taxes.

Income Taxes

Recent income tax debts are among the most common priority claims if they satisfy strict timing rules. The “three-year rule” gives priority to income taxes for a tax year where the return was last due, including any extensions, within the three years before the bankruptcy petition was filed. For example, if a bankruptcy petition is filed on April 1, 2025, the tax debt for the 2021 tax year, with a return due date of April 15, 2022, would be a priority claim.

Another timing requirement is the “240-day rule.” This rule applies to taxes that have been formally assessed by a tax agency, such as the IRS. If the tax was assessed within the 240 days prior to the bankruptcy filing, it qualifies as a priority debt.

A separate rule applies when a tax return was filed late. If a tax return was filed after its due date and within the two years before the bankruptcy filing, the related tax debt is also treated as a priority claim.

Taxes related to fraudulent returns or cases where a taxpayer willfully attempted to evade their tax obligations do not have a time limit. They are always treated as priority debts that cannot be discharged in bankruptcy.

Trust Fund Taxes

Trust fund taxes are those that an employer is required to collect or withhold from an employee’s wages and then remit to the government. These include federal income tax withholding and the employee’s share of Social Security and Medicare taxes (FICA). These funds are considered to be held “in trust” by the employer for the government.

Because these funds belong to the government from the moment they are withheld, they are almost always given priority status in bankruptcy, regardless of how old the tax debt is. The time-based rules that apply to income taxes do not apply here, making trust fund taxes a durable form of priority debt.

Property Taxes

Property taxes can also be priority claims, but they are subject to a timing rule. For a property tax to qualify for priority status, it must have been assessed before the bankruptcy case was filed. Additionally, the tax must have been last payable without a penalty within one year of the date the bankruptcy petition was filed.

If a property tax debt is older than this one-year lookback period, it typically loses its priority status and is treated as a general unsecured debt. This rule ensures that only recent property tax obligations are given preferential treatment in the bankruptcy payment hierarchy.

Other Taxes

Beyond the more common tax types, the Bankruptcy Code grants priority status to other governmental claims. Certain excise taxes, which are taxes on the sale or use of specific goods or services, can be priority claims. The rules for excise taxes look at whether the transaction that triggered the tax occurred within the three years before the bankruptcy filing. Customs duties on imported goods can also be treated as priority claims under similar timing rules.

Treatment in Bankruptcy Proceedings

The classification of a tax debt as a priority claim has direct consequences for the debtor, which differ based on the type of bankruptcy filed. The treatment is markedly different in a Chapter 7 liquidation compared to a Chapter 13 reorganization. The priority status ensures the government’s claim is handled with a higher degree of importance than other unsecured debts.

In a Chapter 7 Bankruptcy

In a Chapter 7 bankruptcy, a trustee is appointed to sell the debtor’s non-exempt assets to pay creditors. The proceeds from this sale are distributed according to the payment hierarchy. Priority tax claims must be paid from these proceeds before any money is distributed to general unsecured creditors.

Priority taxes in Chapter 7 are non-dischargeable. This means that even after the bankruptcy case is over, the debtor remains personally liable for any portion of the priority tax debt that was not paid. If there were insufficient assets to pay the priority taxes in full, the taxing authority can resume collection actions after the bankruptcy case concludes.

In a Chapter 13 Bankruptcy

A Chapter 13 bankruptcy involves creating a repayment plan where the debtor makes monthly payments to a trustee over three to five years. A requirement for a court to confirm a Chapter 13 plan is that it must provide for the full payment of all priority claims. This means the entire amount of any priority tax debt must be paid through the plan.

Debtors must factor these full payments into their monthly budget when proposing a plan. Unlike general unsecured debts, which may be paid only a small percentage of what is owed, priority taxes cannot be negotiated down or partially paid. Failure to do so will prevent the bankruptcy plan from being approved by the court.