You are about to learn the short version of how to file bankruptcy on Income Taxes.  You can bankrupt income taxes in a 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
  • wait the proper amount of time until they are dischargeable (3 years).

You may need to enter into a payment agreement to age the taxes. A very useful tool to determine when the taxes can be discharged is available for a very reasonable price at Taxes other than income, such as payroll and sales taxes are trust taxes and are generally not dischargeable. However only the trust portion of the tax is non dischargeable.  Sales taxes in some states are not held in trust and may be dischargeable state taxes. Tax and other administrative liens such as property taxes are not strippable in bankruptcy but property can be valued and crammed down in a Chapter 13 and released if paid for.

Bankruptcy discharge tax exceptions

If the debt is priority or secured it must be repaid for the secured or priority portion of that debt.  If it is unsecured it is discharged with other unsecured dischargeable debt.  Part of the trust tax you are billed for may be unsecured debt which can be discharged.

Priority and secured debt must repay interest but collections stop.  But appropriate language should be in the plan to insure discharge. The Income Taxes 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.

The three major rules if there is no fraud or willful evasion

First you have to file the tax return.

The income tax return must be filed at least two years prior to filing bankruptcy on taxes.

Second 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). 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.

Third 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 a Chapter 13 will amend it’s claim to the amount you state your property is worth so use liquidation not replacement value for property. After 10 years the tax lien expires automatically. Here is the form to release the lien.

Look at the tax codes

Here are the internal tax codes to determine when the tax was assessed or filed but you must have an account transcript to read them Tax Transcript Codes. 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 a 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. The Mortgage Forgiveness Debt Relief and Debt Cancellation Actoff. 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 taxes cases. There is a calculator to help you determine the exact date you can file Bankruptcy on Income Taxes .

Please like us on Facebook, Google Plus, Twitter or LinkedIn and help spread the word. You may also want to download our book, stop by the office for an autographed hard copy or get it on Amazon and Barnes and Noble. We only take cases in Kentucky and Southern Indiana. We were one of the first attorneys asked to be licensed in the US Tax Court with license #51.

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