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Chapter 7 and Federal Taxes

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  • Chapter 7 and Federal Taxes

    Ok, time to give a "simple" rundown on taxes and bankruptcy. Note, even many BK attorney's don't know the ins-and-outs of taxes and BK.

    Context:

    I am discussing personal tax obligations which come in two varieties, 1040 Income Tax, or the Trust Fund Recovery Penalty ("TFRP"). You small business owners may run afoul of the TFRP if you didn't pay your Federal Tax Deposits relative to your employee withholding (Form 941) and therefore you get assessed personally for the withholding portion of your 941 Withholding. However, TFRP is easy in BK, the TFRP CANNOT BE DISCHARGED IN BK, EVER. But, there are some options with regard to personal income tax debt.

    Discharge Rules for Taxes

    So, the #1 questions, what Federal Income Taxes can be discharged in BK? There are basically 4 rules:

    1. The 3 year rule. An income tax can be discharged if the Tax Return Due Date is 3 years prior to your BK petition filing date. This rule assumes the tax return was filed.
    Example: ALL 1040's are due April 15. Thus, the most recent tax you could discharge this year (2008) would be income taxes from tax year 2004 because the due date for that return was April 15, 2005 and that date is more than 3 years ago.
    Caveat: The extension date COUNTS. Thus, if you filed an extension for tax year 2004 so that your return was due in October 2005, that same tax debt WOULD NOT be dischargeable until November of 2008. Also, the time runs from the Due date, so if you filed your return early--say Feb '05--you still must wait 3 years from April 15.

    2. The 2 year rule. For taxes that meet the 3 year rule, but you filed a LATE return, you must wait 2 years to discharge the tax from the date you filed that late return.
    Example: You owe for 2002 (hence, Due date was Apr 15, 2003 satisfying the 3 year rule), but you did not actually file the 2002 1040 until April of 2006. That IRS debt can be discharged NOW because you filed the return more than 2 years ago and the due date of the return satisfies the 3 year rule.

    3. The 8 month audit rule: If you are audited and ADDITIONAL tax is assessed, you must wait 8 months before you can file a BK petition to discharge that additional tax.

    4. The fraud rule: The IRS can challenge the discharge of tax debt if you committed any sort of fraud. Keep in mind, BK fraud is less strenous than regular fraud in that the creditor normally need not prove "actual" intent.

    Oh wait, Federal Tax Liens

    IRS DEBT IS TECHNICALLY SECURED DEBT.

    This is where most BK attorney's drop the ball. By operation of law, the IRS has a lien on all property of the debtor whenever a tax liability is created, the govt. makes a demand for payment, and you don't pay. The lien exists regardless if the IRS files a Notice of Federal Tax Lien. All the Notice does is put the IRS in 1st place over certain creditors, but the lien exists and is created by statute.

    Whether this is an issue for you depends on whether you have any assets. If you own a house, this tax lien becomes problematic. As with any lien, the lien survives the BK. Thus, if you owe $40K to the IRS and have $50K in home equity, the IRS can foreclose that lien after your BK discharge even if the underlying tax debt is dischargeable. However, at the same time, the value of the lien is established at the time of filing petition. Let me explain...

    So, what can you do? In today's real estate market you can do a quasi lien strip. Lets say you owe the IRS $40k, but only have $5K in home equity at the time you file the petition (i.e. the equity is Fair market value - superior liens to IRS, i.e. your mortgages). You need to file a Motion to Determine Value of Lien with the BK court. This act starts an adversarial proceeding. The reason to do so is to establish the value of the IRS's lien. Take this one step further, if there is no value to the home, then the lien attaches to no value and you can extinguish the lien.

    If you don't file that adversarial proceeding, you enter into a legal grey area. The IRS has a lien for the full amount of the tax liability, that lien survives the BK even though the underlying tax is discharged as to you personally. Thus, in that respect, the IRS debt is no different than a non-reaffirmed mortgage; you have discharged your "personal" responsibility to pay the debt, but your assets (i.e. home) remain liable. If you don't file the Adversarial in BK, you are not without hope, but you will create one complicated, difficult, and EXPENSIVE mess to clean up that few attorney's or tax professionals are equipped to handle.

    FEEL FREE TO POST COMMENTS AND QUESTIONS
    Last edited by HHM; 01-31-2009, 07:40 PM.

  • #2
    IRS Lien but without assets

    Hi i filed Pro Se for chapter 7 bankruptcy, 2 weeks ago. I have a quick question. I currently no assets, no car or house, no major purchases everything that I own, is covered within my state exemptions. But I owe the IRS 6000 for taxes from 2004. My lien is on my credit report and I included them within my Bankruptcy as a priority debt, that is not secured. Was that the correct thing to do, and I also had a question in regards to student loans, I realize that both your tax debt and student loans are very hard to get discharged but what is correct way to include them in your bankruptcy if you file a 7 and have no assets.

    Comment


    • #3
      The student loan issue is moot, the loan cannot be discharged without you showing a hardship. So that debt will survive the BK and you will have to pay it back.

      With the Tax debt, you will still want to file a Motion to Determine the Value of the Lien, however given the technical nature of such a motion and the adversarial process, you will be hard pressed to find a form online you can use. When it comes to tax liens, you really need a court to say the lien is worthless.

      You still need to list ALL debts on your BK petition, I assume you mean by the phrase "include them in your bankruptcy", you mean, have those debts been "discharged" in your BK. Student loans, you need to show hardship (i.e. total disability and inability to work), for the Tax Debt, your personal liability will be discharged, but you need to quash the lien.
      Last edited by HHM; 01-31-2009, 07:44 PM.

      Comment


      • #4
        How would I know if an IRS debt was ACTUALLY discharged in my particular case?

        I owed the IRS around $4k at the time of my filing (small potatoes compared to some, I know). Prior to my bankruptcy and discharge (discharged July 9th of this year) I was paying the IRS about $50 a month on a "payment plan" to satisfy this debt (including the IRS absorbing my tax returns and stimulus check as well), after I filed Ch7 I received a letter from the IRS telling me to stop making the payments to the payment plan until the discharge in case the debts were settled. I assume that its now my responsibility to call them back and re-instate the payment plan for any debts not discharged?

        My first question is, how to I know if any of the debts were actually released?
        (some do fall within your parameters above, but I'm not 100% sure on the dates)

        My second question is - the IRS also sent me a letter a month ago (during the BK proceedings) saying that in 2006 one of my creditors "released" me of a $16,000 debt (one of debts listed on my BK), so therefore my income for 2006 was increased by $16k and I now owe an additional $4,000 in taxes to the IRS for that particular year. Even though I included that debt in my bankruptcy, am I still pretty much stuck with that extra IRS debt now?

        Thanks.

        Comment


        • #5
          Hi....... I have the same question as zakaddy. When I filed in 6/2008, I was on a payment plan with the IRS. I had owed almost $8000. They absorbed the stimulus payment to reduce that debt. I was paying $400 per month. They sent me a similar letter telling me to make no more payments. I assume that I will need to start making payments after my discharge (still waiting). Should I expect any guidance in this from the Fed BK Court, or from the IRS? Is this all my responsibility to start a new payment plan? Should I just wait until next year and see if they send me a bill?

          Thanks,
          UAC

          Comment


          • #6
            We also have the same situation as zakaddy and UAC. We owe a huge income tax debt for years, 2007, 2006, and 2005. The stimulus check was applied to the 2007 taxes. Prior to filing, we also had been on a payment plan with the IRS. AFter filing we received the letter, just as the above posters, telling us to make no more payments til everything was done and finished. Except, they are also sending dunning letters wanting full payment for the rest of 2007 that we owe. About $7K. Yeah, right. For each dunning letter we send copies of the BK paperwork, and the previous letters telling us to stop payment until after BK.

            So I guess we will just wait and see what happens.
            "To go bravely forward is to invite a miracle."

            "Worry is the darkroom where negatives are formed."

            Comment


            • #7
              State Taxes?

              I haven't seen anything about state taxes. Would they be discharged? Does the trustee want to see state returns as well as fed returns?

              J

              Comment


              • #8
                2006 Taxes

                Hello - I finally had to realize that I have to file for Capter 7. I've been working at it for 2 weeks. Today, I was shocked to learn that I missed a W2 on my 2006 taxes. Also, the deadline to turn my Chapter 7 paper work to my lawyer is today. File date is Sept 18. Should I call the IRS and make amends immediately and I assume I should inform my lawyer? Please help! I'm panicking!

                Su

                Comment


                • #9
                  NOW I'm upset

                  OK, Now I’m confused and a bit nervous. I have just been discharged and owe 5K to the asset case for preferential payment, 5K overage of assets, and $26,487.00 IRS.

                  Taxes for year 12-31-2004 $5,115.55
                  Taxes for year 12-31-2005 $3,133.00
                  Taxes for year 12-31-2006 $10,284.00
                  Taxes for year 12-31-2007 $7,953.00

                  I was on a payment plan paying along and was mailed a letter to stop paying until after my BK. Now We get three letters each for intention to levy. What about the third year roll off? If they levy on my SS I won’t have enough money to pay off my Trustee. Also they have compiled more interests. Anyone out there with some knowledge of how to handle this? ‘Hub
                  If I knew it all, would I be here?? Hang in there = Retained attorney 8-06, Filed 12-28-07, Discharge 8-13-08, Finally CLOSED 11-3-09, 3-31-10 AP Dismissed, Informed by incompetent lawyer of CLOSED status, October 14, 2010.

                  Comment


                  • #10
                    The only conceivable year you could have discharge was 2004. But that assumes you filed the return April 15, 2005.

                    Can you afford the payment that you were on? If so, call the IRS ASAP and request reinstatement of your installment agreement.

                    Do the letters say, "Final Notice of Intent to Levy". If so, you have 30 days (from the date on the letter) to appeal those letters. Just because the IRS sent those letters does not mean on day 31 they will levy. Call ACS (Automated Collection Service)and request reinstatement of your installment agreement. If the agent won't do that, then Search the IRS website for the Collection Due Process request form, follow the instructions, and request an appeal of the Notices.
                    Last edited by HHM; 01-31-2009, 07:45 PM.

                    Comment


                    • #11
                      Originally posted by HHM View Post
                      The only conceivable year you could have discharge was 2004. But that assumes you filed the return April 15, 2005.

                      Can you afford the payment that you were on? If so, call the IRS ASAP and request reinstatement of your installment agreement.

                      Do the letters say, "Final Notice of Intent to Levy". If so, you have 30 days (from the date on the letter) to appeal those letters. Just because the IRS sent those letters does mean on day 31 they will levy. Call ACS (Automated Collection Service)and request reinstatement of your installment agreement. If the agent won't do that, then Search the IRS website for the Collection Due Process request form, follow the instructions, and request an appeal of the Notices.
                      If I knew it all, would I be here?? Hang in there = Retained attorney 8-06, Filed 12-28-07, Discharge 8-13-08, Finally CLOSED 11-3-09, 3-31-10 AP Dismissed, Informed by incompetent lawyer of CLOSED status, October 14, 2010.

                      Comment


                      • #12
                        2004 was not discharged because you filed before the 3 years expired. If you filed your tax return in November of 2005 (for tax year 2004), then you needed to FILE bk AFTER November 2008 to get a discharge of those taxes.

                        Given your circumstances, ask the IRS to put you on "non-collectible status" (also known as Status 53). What that means is the IRS concedes that they cannot collect from you. It is not permanent, but given your age, they probably will not press the issue and allow you to stay in Status 53 for the length of the statute of limitations.

                        Nothing you can do about the penalties and interest vis-a-vis the BK.

                        Comment


                        • #13
                          Originally posted by HHM View Post
                          2004 was not discharged because you filed before the 3 years expired. If you filed your tax return in November of 2005 (for tax year 2004), then you needed to FILE bk AFTER November 2008 to get a discharge of those taxes.

                          Given your circumstances, ask the IRS to put you on "non-collectible status" (also known as Status 53). What that means is the IRS concedes that they cannot collect from you. It is not permanent, but given your age, they probably will not press the issue and allow you to stay in Status 53 for the length of the statute of limitations.

                          Nothing you can do about the penalties and interest vis-a-vis the BK.
                          Hold on folks.................I was always told that no taxes whatsoever could be discharged. Today I got my discharge thinking everything was cool and now I find out from you guys that a tax debt my wife had from a previous marriage could have been discharged in this bankruptcy.........its a tax debt that dates back to 1998 which the IRS has not taken any action with against my wife to this date. So my question is this, my case has not closed yet so could I technically go ahead and submit an amended schedule to include this debt.............if not could I reopen my case to include this tax debt? One other question regarding what a moderator said in another posting.............he stated that in a chapter 7 no asset case that all debt with the exception of those debts deemed not eligible for discharge whether listed or not on the filing is officially discharged............is that honestly true? The reason why I ask is because my wife's ex-husband had a court judgement placed against her regarding the divorce. I didn't include it in the bankruptcy because it was about to expire on the credit report.

                          Comment


                          • #14
                            regarding the 3 year and 2 year rule

                            i am confused. if you filed late tax returns, say you did not file your taxes for 2000 until April 2007. Does that mean that you have to wait 3 years from the year 2000 or 2007? In other words, the 2000 taxes are long over the 3 years being owed but not over the file date. So does the 3 year rule mean you have to wait until 3 years after you filed the late taxes.

                            And when you make a large amount say over 300k, is it unheard of for a judge to agree to Ch 7? our atty is really pushing 11 and i was a bit surprised it was due to our income and not our debt? the means test implies otherwise?

                            Comment


                            • #15
                              Originally posted by wornout101 View Post
                              i am confused. if you filed late tax returns, say you did not file your taxes for 2000 until April 2007. Does that mean that you have to wait 3 years from the year 2000 or 2007? In other words, the 2000 taxes are long over the 3 years being owed but not over the file date. So does the 3 year rule mean you have to wait until 3 years after you filed the late taxes.

                              And when you make a large amount say over 300k, is it unheard of for a judge to agree to Ch 7? our atty is really pushing 11 and i was a bit surprised it was due to our income and not our debt? the means test implies otherwise?
                              One of the requirements is that the return was filed. So it would be 2 years from the date you filed the return.
                              Last edited by HHM; 01-31-2009, 07:46 PM.

                              Comment

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