by Adam Mack, J.D.
Meeting tax obligations can be a major financial obstacle for many families. To make matters worse, the Internal Revenue Service is unquestionably the most powerful debt collector in existence. The IRS has the legal authority to reach assets that no other debt collector can. As a result, tax debt is often a major factor in driving a person to consider bankruptcy.
DISCHARGEABLE INCOME TAX DEBT
It is important to understand that just as the IRS has special treatment in the collection of debt, it also has some additional protection in bankruptcy. However, this does not mean tax debt cannot be discharged. Federal income tax debt can be discharged, but the debts have to meet five stringent requirements.
FIRST: The taxes must be income taxes. This means that this rule does NOT apply to other taxes such as real estate tax, personal property tax, payroll tax, etc.
SECOND: The tax must have been due three years prior to the date you file your bankruptcy. If you filed for an extension on any given year, then the three years will start counting from the time of the latest extension granted.
THIRD: A tax return for the tax debt you are trying to discharge must have been filed. Further, that tax return had to have been filed at least two years prior to filing bankruptcy. And for the sake of clarity, by “tax return”, I mean the tax return that you filed. If the IRS determined your tax liability for you (sometimes referred to as a ‘substitute tax return’), then it is as if you have not filed a return for purposes of the bankruptcy discharge. The three year deadline does not begin to run until you file a return for the tax year at issue.
FOURTH: You cannot have ever willfully evaded paying your taxes or committed tax fraud. If you have ever even been accused of tax evasion or fraud, let your attorney know. This is a critical issue and can drastically change the outcome of your case.
FIFTH: The IRS must have either (1) assessed the taxes at least 240 days prior to you filing your bankruptcy or (2) the IRS must not have assessed the taxes at all. It is also important to note that if you have made an offer in compromise to the IRS, and in response the IRS ceased attempts to collect the debt, then this time limit may be extended. The assessment date is the date the tax liability is recorded by the IRS on its records.
TAX LIENS SECURED BY REAL ESTATE
If the IRS has filed a tax lien on your house (or other property for that matter) and the tax debt is otherwise dischargeable, then the good news is that you may be able to file a Chapter 7 Bankruptcy to discharge your personal obligation to pay that debt. The bad news is that the lien will follow the property it is secured by rather than following you. In other words, you will not have to pay the money to the IRS, but if and when you sell your home, the IRS will get their money from the sale of the house before you receive anything.
On the other hand, if you want to resolve your tax issues once and for all, a Chapter 13 Bankruptcy may be right for you. A Chapter 13 Bankruptcy has a payment plan built into it which allows you to repay your tax debt over a space of three to five years. However, one important restriction in a Chapter 13 Bankruptcy is that if you do have any non-dischargeable tax debts, then you will be required to pay 100% of that tax debt in no more than five years. Thus, the amount of tax debt may create feasibility issues in the bankruptcy which may result in the court not confirming your proposed Chapter 13 plan.
Bankruptcy law is complicated and interpreting the tax code can be a daunting. So, at the intersection of bankruptcy and tax law exists a host of intricate and complex nuances. To fully understand the impact of your tax debt in bankruptcy, speak with a qualified and experience bankruptcy attorney.