Bankruptcy and Taxes
Are tax liabilities dischargeable in a bankruptcy? How do I know if my taxes are dischargeable? What if I haven’t filed tax returns? Should I file bankruptcy if I owe taxes? These are some of the questions you need answered before you consider filing bankruptcy.
Filing bankruptcy is an important decision and should only be done after careful consideration and obtaining professional advice from both a bankruptcy attorney and a tax professional if you owe taxes or have not filed tax returns.
The following article is not intended as legal advice and is specifically written to help individuals understand what effect filing bankruptcy has on their tax liabilities. Bankruptcy laws, rules and procedures are extremely complex and you should seek legal advice from a bankruptcy attorney if you are considering filing bankruptcy.
Filing bankruptcy can prevent the Internal Revenue Service (IRS) and/or state tax agencies from levying your bank account, paycheck and/or prevent the seizure of assets. However, you should never file bankruptcy solely to prevent enforcement action. A tax professional can negotiate a resolution with the appropriate tax agency to prevent enforcement action and if you’ve already been levied, e.g. wages garnished, bank account attached, even if assets have been recently seized, a tax professional can usually negotiate a release of levy.
Discharge of taxes:
Individual taxes (form 1040 & state individual taxes) are dischargeable if certain criteria are met. The general rules that apply in Chapter 7 and Chapter 13 bankruptcy are:
1. The due date for filing a tax return is at least three years ago. The tax debt must be related to a tax return that was due at least three years prior to the bankruptcy petition date. The due date includes any extensions.
2. The tax return was filed at least two years ago. The tax debt must be related to a tax return that was filed at least two years before the bankruptcy petition date. The time is measured from the date the taxpayer filed the original tax return.
3. The tax assessment is at least 240 days old. The IRS must assess the tax at least 240 days before the taxpayer files for bankruptcy. The IRS assessment may arise from a self-reported balance due, an IRS final determination in an audit, or an IRS proposed examination assessment which has become final.
4. The tax return was not fraudulent. The tax return cannot be a fraudulent or frivolous return.
5. The taxpayer is not guilty of tax evasion. The taxpayer cannot be guilty of any intentional act of evading tax laws.
If the income tax debt meets these rules, then the tax debt is dischargeable in Chapter 7 and Chapter 13 bankruptcy petitions.
Substitute for Return (SFR) assessments are not dischargeable:
Tax debts that arise from unfiled tax returns are not dischargeable. The IRS routinely assesses tax on unfiled returns. These assessments are referred to as Substitute for Return (SFR) assessments. These tax liabilities cannot be discharged.
Other Tax Issues in Bankruptcy:
Before a Chapter 7 or Chapter 13 bankruptcy can be granted, the bankruptcy petitioner is required to prove that the four previous tax returns have been filed with the IRS. The four previous tax returns must be filed no later than the date of the first meeting of creditors in a bankruptcy case.
Additionally, bankruptcy petitioners are required to provide a copy of their most recent tax return to the bankruptcy court. Creditors can also request a copy of the tax return, and petitioners must provide a copy to them.
Collection by IRS after bankruptcy discharge granted:
1. The Internal Revenue Service (IRS) can collect non-dischargeable liabilities from the exempt, abandoned, non-administered and after-acquired property of an individual debtor.
2. Regarding dischargeable liabilities, if a Notice of Federal Tax Lien has been filed pre-petition, the IRS may collect on its lien from exempt or excluded property or property that has been abandoned or otherwise not administered by the trustee.
The fact that the Notice of Federal Tax Lien (NFTL) still exits after all of the taxes may have been discharged in bankruptcy and IRS can pursue collection is one of the most misunderstood aspects of taxes and bankruptcy. This is why it is important to consult with a bankruptcy attorney and a tax professional that specializes in collection tax matters prior to filing bankruptcy. Sometimes bankruptcy is not the solution that best fits your needs and submitting an Offer in Compromise (OIC) is a better solution.
I offer a FREE CONSULTATION. If I can be of assistance in deciding whether filing bankruptcy is the best solution for you, feel free to complete the FREE CONSULTATION form on my website.