“Can I eliminate or reduce my past due tax debt if I file for bankruptcy?”
I get this question frequently from clients and potential clients:
- self employed sales people such as real estate agents, commissioned sales men and women and truck drivers
- small business owners who have been struggling to make ends meet and who have not been diligent about filing tax returns and paying debts
- entrepreneurs who have started small businesses on the side but who have not dealt with their tx obligations
- salaried employees who have adjusted their withholdings so that little or no tax deductions are being made
Bankruptcy can eliminate tax debt but only if certain conditions are met. If your tax liability is the main reason or a significant reason that you are considering bankruptcy, you should not guess about whether your tax debt is dischargeable.
The information contained in your IRS file may be different from what you remember. I have seen many situations where a client was certain that he filed a tax return for a certain year, but the IRS had no record of that filing, or other cases when a client was certain that she file tax returns on time but the IRS showed a late filing.
When someone comes to me with significant tax debt I will always recommend that my client seek guidance from a tax professional who has knowledge about tax dischargeability issues.
One of the resources I turn to is local CPA Gary Massey. In addition to his work as an accountant for individuals and small businesses, Gary understands how to obtain and analyze tax transcripts to determine whether your tax debts may be dischargeable.
Gary also has experience with preparing offers in compromise and installment agreements, which can be viable alternatives bankruptcy. And, of course, sometimes Gary may advise you to do nothing – at least right now – because waiting a few months or even years can be to your advantage. The key takeaway here is that you should not guess, and as you will see from the information below the rules can be complicated.
Gary recently published a nice summary of the tax dischargeability rules on his blog and he graciously agreed to let me republish here:
Using Bankruptcy To Resolve Back Tax Issues
by Gary A. Massey, CPA
I mentioned in previous posts that the IRS requires taxpayers to be current with their tax return filings and estimated tax payments in order to negotiate an installment agreement or a settlement to reduce taxes (the offer in compromise). For taxpayers who find it difficult to get current with their tax obligations, bankruptcy is an option worth considering.
Bankruptcy allows for taxes to be discharged, if certain key conditions are met, without the requirements of IRS tax compliance.
Other advantages of bankruptcy to resolve back tax issues include stopping all IRS collection activities and forcing the IRS to accept payment agreements it otherwise may not be interested in accepting.
Here are some key rules for discharging taxes in bankruptcy:
Three-Year Rule: Taxes are discharcheable if the return was due at least three years prior to the bankruptcy. The extended due date of the return is used for this purpose. The filing date of the return is not considered.
Two-Year Rule: Taxes on a late-filed return are dischargeable if the return was filed with the IRS at least two years prior to the bankruptcy.
240-Day Rule: Additional taxes resulting from an audit or an amended return are dischargeable if the tax was assessed at least 240 days prior to the bankruptcy.
Substitute for Return Rule: If the government prepares a return for the taxpayer, that tax year is never dischargeable in bankruptcy, even if the taxpayer files their return at a later date.
“Trust Tax” Rule: Payroll taxes, withholding taxes and sales taxes are “trust taxes” and are not dischargeable in bankruptcy.
Fraud and Evasion Rules: Taxes will not be discharged in cases of civil or criminal fraud or the willful evasion of taxes.
Discharging taxes in bankruptcy is complicated. Our firm performs detailed reviews of IRS transcripts, in collaboration with bankruptcy attorneys, to determine if taxes are dischargeable in bankruptcy. We look at the type of tax, how old the tax year is, when the return was filed, and if the taxpayer might have done anything to extend the three-year rule. In all cases, we recommend that taxpayers consult with a bankruptcy attorney to discuss the details of their situation.
