Not everyone wants to file bankruptcy just to get rid of a tax debt. Bankruptcy is the nuclear option to discharge income tax debts. You can bankrupt income taxes by aging an income tax debt that is not fraudulent. But you can also resolve your tax debt sometimes for pennies on the dollar if you have very little disposable income and no substantial assets with an offer in compromise. The problem is that income tax debt does not age while you are in an offer in compromise and an offer in compromise takes a year for approval. Also an offer in compromise often requires you to repay much more than a bankruptcy would have cost.
Income taxes do age while they are in payment agreements or in a currently uncollectible status. After 10 years income taxes age past their statute of limitations and become uncollectible. After 3 years they become bankruptable. If you have no assets or disposable income, you can apply for the currently uncollectible status. You can also age the tax debt with a repayment plan that may offer similar benefits as an offer in compromise. You can also apply to abate the penalties to help resolve the tax debt.
All these options have an application process that takes about a year, and you should use a qualified attorney or CPA to apply for them. The IRS and state tax departments often reject these applications. You often only have one shot at getting them approved. By the way I have license #51 and I have done this longer than any attorney I know in Kentucky ever since the first year the IRS had a tax court in 1988.
File Bankruptcy on Income Taxes the filing Exceptions
This page explains the short version of how to file bankruptcy on income taxes. You can bankrupt income taxes in Chapter 7 or 13 bankruptcy, but only if all of the rules are met. Basically, you want to:
- File your tax returns as soon as possible and
- Wait the proper amount of time until the tax debt is dischargeable (3 years).
You may need to enter into a payment agreement to age your taxes. A handy tool to determine when the taxes can be discharged is available for a very reasonable price at taxdischargedeterminator.com. Attorneys and CPAs often take hours reviewing the tax transcript to discover when the tax becomes dischargeable and usually charge 1600 or more for an opinion.
Taxes other than income taxes, such as payroll and sales taxes, are trust taxes and are generally not dischargeable. If a tax is a priority or secured debt, you must repay that debt’s secured or priority portion in any Chapter 13. If it is unsecured, then it is discharged with other unsecured dischargeable debt like a credit card. Aging the tax debt converts most income taxes into unsecured debts.
Some Sales taxes are not Priority tax debts
Not all sales taxes are trust taxes. Some states assign trust taxes as a trust tax making it a priority tax and non-dischargeable. Sales taxes in some states are not held in trust. Those taxes are not priority and are dischargeable taxes. It is not possible to strip tax and other administrative liens such as property taxes in bankruptcy. However, a property can be valued and crammed down in Chapter 13 forcing a tax department to be paid only the value of the property.
Priority and secured debt must repay interest, but collections and even property tax foreclosures stop in a Chapter 13 or 7. However, appropriate language should be in the plan to ensure you discharge the tax. The Income Tax Flowchart is meant to be used with your IRS account transcript to plan how to discharge income taxes under sections 507 and 523 of the bankruptcy code.
Three major rules for no fraud or willful evasion.
1. You have to file the tax return.
The income tax return must be filed at least two years prior to filing bankruptcy on taxes.
2. The tax must have become due at least three years ago.
An income tax debt does not become due until the return is due to be filed. As an example, if the 2002 year return was filed on January 15th, 2003 it still became due on April 15th, 2003, and was not dischargeable in bankruptcy until April 16th, 2006 at the earliest. October 15, is the due date when you ask for an extension. If the 15th falls on a holiday, Saturday or Sunday, the return wasn’t due until the next business day. Example Saturday is the 15th then the due date is Monday (unless Monday was also a holiday).
Furthermore, the IRS may file a substitute tax return for your tax return if you fail to file a return. In that case, the time never runs since the tax return was never properly filed and assessed. There is no good faith filing to an IRS generated return because the return must be both signed and filed or given to the IRS.
3. You have to wait 240 days after an assessment.
If an income tax was assessed within 240 days prior to filing your bankruptcy you may have to wait until 240 days have passed to discharge the debt. Income taxes that obey all 5 of the discharge rules and qualify for discharge are treated and discharged the same as any other unsecured debt. There is no discharge for fraudulent tax returns and willful evasion which are the last 3 rules.
In order to bankrupt your taxes and not lose property, the tax debt must be unsecured. The IRS lien is a statutory lien and cannot be avoided by a 522(f) motion to strip the lien like judicial liens. The IRS in Chapter 13 will amend its claim to the amount you state your property is worth so use liquidation not replacement value for the property. After 10 years the tax lien expires automatically. Here is the form to release the lien.
Look at the tax codes.
Here is the link to the Tax Transcript Codes to determine when the tax was assessed or filed. However, please note that you must have an account transcript to read them. You can get a copy of your return and your account transcript from the 1-800-829-1040 number for the IRS. They will fax the docs to you. Please stand at the fax machine to confirm transmission. Also, see our manual and the checklist of documents you will need.
Look at the tolling events.
The time allowed to the IRS to collect is extended by the non-filing of a return, requesting a due process hearing, an offer in compromise, or filing bankruptcy on taxes. These events “toll” (extend) the “3-Year Rule” and the “240-day rule”. The 3-Year, 2-Year, and 240-Day are extended by the period of bankruptcy plus an additional 6 months. If you file an offer in compromise, the 240-Day period is extended by the period it is under IRS consideration, plus 30 days. We compute the time periods all the time for clients we used to work for the Tax Department.
Charged off or forgiven debt problems.
Be especially careful about when a debt is charged off. Refer to the Mortgage Forgiveness Debt Relief and Debt Cancellation Act. For a time Homeowners were able to avoid the taxable income from a mortgage modification or a foreclosure. But now the failure to file a bankruptcy before a mortgage or debt is charged off will trigger a substantial tax debt that is not dischargeable in bankruptcy for at least 3 years.
We expect that this new development will be what triggers a new flood of Chapter 7 and Chapter 13 bankruptcy on tax cases. Here is a link to a calculator to help you determine the exact date you can file bankruptcy on income taxes.
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Helpful Links for This Article:
Resources for Bankruptcy
Other Related Information
IRS Transcript Codes for Bankrupting Taxes
Tax and Bankruptcy Lawyer for Business Trust and Income Tax
Chapter 13 and IRS Tax Returns and Refunds in Bankruptcy
File Bankruptcy on Income Taxes
If you are thinking about filing bankruptcy, don’t delay because timing is crucial. I am here to help you. So, contact my office right away to start the conversation. Nick C. Thompson, Bankruptcy Lawyer: 502-625-0905.