Bankruptcy Relief

Most people, including many tax professionals, mistakenly believe that federal income taxes can never be forgiven (“discharged”) in a bankruptcy.  Fortunately, they are wrong in many cases.

Although the intersection of the United States Bankruptcy Code, the Internal Revenue Code, and IRS lien and levy laws is complicated, bankruptcy relief is often the best way to solve a serious tax problem.  The filing of a bankruptcy case automatically and immediately stops IRS bank account and wage levies  and enables the taxpayer to either obtain a discharge (forgiveness of the income tax debt), or receive a court-ordered payment arrangement with the IRS.

“…with improper planning it is entirely possible to complete a bankruptcy case  and yet not benefit from any forgiveness of the tax debt.

Many people come to us after this has happened and it saddens us to see how they wasted valuable time, money and a one-time opportunity to solve their tax problem, simply due to improper advice and planning by bankruptcy attorneys who did not coordinate their work with a tax adviser.”  John Balian, J.D., M.S. Tax –  Principal

Bankruptcy-Tax Guidelines

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) enacted by Congress and signed by the president in 2005, essentially applied more uniform rules to the discharges of tax obligations under Chapter 7, Chapter 13 and Chapter 11 bankruptcies.

These rules are complex, and their specific application to a taxpayer depends on the individual facts and circumstances of a case.

QUALIFICATION OF TAX DEBTS FOR DISCHARGE

To over-simplify, most “older” income tax debts can be forgiven (“discharged”), while “newer” tax liabilities are non-dischargeable.

The ability to discharge income tax in bankruptcy, and the selection of the proper bankruptcy chapter, is primarily determined by four dates:

(1) the last date on which the taxpayer’s return was due for the year of the delinquent tax;

(2) the date the taxpayer actually filed the applicable return;

(3) the date the tax in question was assessed by the IRS; and

(4) the proximity of the foregoing dates to the taxpayer’s bankruptcy case filing date.

Additionally, the taxpayer must not have filed a fraudulent tax return, nor engaged in tax fraud or evasion in order to obtain a discharge of his/her tax liabilities.

THREE DIFFERENT TIME PERIODS MUST BE REVIEWED

In plain language, the bankruptcy discharge of a personal income tax liability is primarily governed by the lapse of different time periods from the tax return due date, the actual return filing date and the tax assessment date, relative to the date of a taxpayer’s bankruptcy filing date.  These periods must expire over the different time frames.

Once all of these time periods have expired, an income tax liability will change from a non-dischargeable “priority tax” into a “non-priority tax” that, in most cases, will be dischargeable in a bankruptcy case.

Unfortunately, calculation of the beginning and end of the various time periods is not simple, and often requires experience in reviewing and interpreting IRS internal computer records, as well as the client’s records.

Moreover, the running of these time periods can be extended (or tolled) by many different events, such as:

1)   a prior bankruptcy — stops the clock, or tolls, the running of two of the three time periods; and

2)   an innocent spouse claim — will toll the running of one of the time periods;

3)   an offer in compromise — will toll the running of one of the time periods;

4)   a Collection Due Process Appeal — will toll the commencement, and hence the running of one of the time periods.

In sum, any action a taxpayer takes that delays the IRS’ ability to take collection action, will suspend one or more of the three time periods.

The various time and limitation periods for tax collection and bankruptcy discharge, and the possible occurrence of events that may toll the running of these “limitations” periods, are among the most important considerations in planning for the forgiveness of tax obligations.

EFFECT OF THE TAX LIEN

Lastly, the availability and benefits of a bankruptcy discharge of income tax liabilities may also be negatively impacted by the existence of a filed Notice of Federal Tax Lien encumbering the taxpayer’s property.

A filed federal tax lien attaches to a taxpayer’s real estate and personal property; it must be taken into account in any bankruptcy filing or other delinquent tax solution considered by the taxpayer or the taxpayer’s attorney.

If you are contemplating bankruptcy and have tax obligations, it is imperative that you seek experienced and knowledgeable counsel in both the tax and bankruptcy fields.