Monthly Archives: February 2013

Yes, Virginia, You Can Discharge Taxes in Bankruptcy — Sometimes.

Taxes and bankruptcy is a complicated subject.  There are multi-volume book sets written on the issue.  Still, there are some general rules that a blog post can cover.

First of all, you have to determine what kind of taxes you owe.  Personal income taxes, business withholding taxes, sales taxes, property taxes; they are all treated differently.

The most common case is personal income taxes.   In order to determine whether or not your personal income taxes are dischargeable, your attorney will need to know four things.

  • When the returns were due, that includes lots of things, but the big one is whether or not you filed for an extension;
  • When the return was actually filed, and that means received by the IRS not just put in the mail;
  • When any taxes were officially assessed by the IRS, and this includes any assessments following audits or revisions to the return;
  • Finally, your attorney will need to know if you have filed a Bankruptcy or made an Offer in Compromise since the time the taxes were incurred.

In order to be absolutely sure about these dates your attorney will probably require a tax transcript that includes all of this information.

The general rule is that personal income taxes become dischargeable in Bankruptcy once the returns have been due for at least three years, the returns have been on file for at least two years and the taxes have been assessed for at least 240 days.  These rules make certain assumptions — the returns were not fraudulent, the taxpayer has not made any attempts at tax evasion, etc.

Then, of course, there are the exceptions; and there are way too many exceptions to go into them here.  Although one exception that is developing rapidly (and not in a good way) is the effect of a late filed return on the ability to discharge taxes.  This is an area where you just have to talk to an attorney, and again this is an area where a tax transcript is invaluable.

You should never assume that taxes will (or won’t) be dischargeable until you have actually talked to an attorney and probably gotten transcripts for the appropriate years.  Still, in most cases where these three rules are met, the taxpayer may file for bankruptcy and discharge his personal liability for the taxes.  That filing will not avoid any tax liens that have attached to property prior to the filing, but it will stop liens from attaching to after-acquired property and it will stop the IRS from attempting to collect from you personally.

It is not uncommon for people to come see me who have many years of past-due taxes owed.  In some cases those taxes add up to hundreds of thousands of dollars.  In many cases they have been making payments for years and have done so without realizing that unless otherwise indicated the IRS will apply payments to the oldest outstanding tax year.  In many cases a Bankruptcy filing will not discharge all of their taxes, but it can convert an unmanageable debt into a manageable one.

So, if you have more tax debt than you can pay, don’t discount the possibility of contacting a bankruptcy attorney.  Do mention when making the appointment the amount of taxes in play.  Not all attorneys are comfortable filing cases with large amounts of tax debt.  So, don’t be surprised if the first attorney you contact refers you to someone else.  Also, don’t expect to get completely out of trouble; but you may be very surprised at what a bankruptcy can do for you.

Oh, and if you remember one thing from all of this, file your tax returns ON TIME.  If you can’t pay, you can’t pay; but file your returns ON TIME.  Extensions are fine, just file before the end of the extension period.  Returns not filed timely can create a problem you can’t change.


Old Debt, Foreclosed Home, 1099 in the Mail — Oh NO!

Once upon a time the start of tax season was heralded by would-be clients who had been to see me sometimes months earlier calling very excited, because they finally have the money to file.  Then, there are the Trustees wanting a share of tax refunds that accrued to debtors prior to the filing of their bankruptcies — those calls are less fun.

Recently, though, tax season has started a bit earlier — in January and early February.  Former clients are calling scared, because they have just gotten a 1099 in the mail for some HUGE amount of money that they thought they had discharged in their Bankruptcy — and they are right.

Any time a creditor “forgives” debt, which is a very broad term and doesn’t necessarily have anything to do with whether or not they still intend to collect it or the Debtor still owes it, the creditor is required to send a 1099 for the amount of the forgiven debt to the Debtor and the IRS.  The IRS is then going to assume (unless told to the contrary) that this amount is to be included in the debtor’s gross income for that taxable year.

Breathe.  I promise, it isn’t nearly this bad.  Go back and read that “unless told to the contrary” part again.  If you have filed for Bankruptcy and discharged your personal liability for debt, it does not have to be included in your taxable income.  There is an IRS form 982 that will solve this problem for you.  Form 982 deals with 1099’s if the debt has been discharged in Bankruptcy or if the Debtor was insolvent at the time the debt was forgiven.  The insolvency exception is considerably more difficult and more treacherous.  The Bankruptcy (Title 11) provision is much more straight forward.

There are different rules if the forgiveness of debt involved your homestead, and the property was foreclosed or the subject of a short sale; but the 1099 may still qualify to be excepted from your taxable income.  In that event, I suggest you talk to a competent CPA.   Likewise, if you have any questions regarding the application or use of Form 982, a CPA is the person to call.

Where those 1099’s can be a real issue is if you did some type of debt management plan where you paid less than 100% of your debt.  If it was a Chapter 13 Bankruptcy, Form 982 may still apply.  Otherwise, you might have a real problem; and you cannot call a CPA for help too soon.  I hate getting calls from people who tried to do the right thing, tried to pay their debt; and then after years of scrimping and suffering find out after the fact that they now owe tax on the total amount (including interest) that they didn’t pay.  A Chapter 13 Bankruptcy would likely have been cheaper, more effective and actually gotten them out of debt instead of into tax debt.

So happy tax refunds, and do not pay tax on discharged debt unnecessarily!