BIG MYTH – Tax Debt Can’t Be Discharged in Bankruptcy

bigstock-Chalkboard--Facts-And-Myths-50156069After many years helping people deal with tax debt and the IRS, and with all the information on the Internet about solving tax debt problems, I am still surprised when someone tells me that tax debt can’t be wiped out in bankruptcy. 

But it happens all the time.

The truth is that tax debt can be discharged in bankruptcy and not just income tax.  Here is a quick review of income tax debt and bankruptcy as well as other types of tax debt and bankruptcy.

Income Tax

Income tax debt is the most common type of tax debt discharged in bankruptcy.  I have helped clients get rid of millions in income tax debt.  Income tax debt is wiped away in bankruptcy if it meets a few requirements.

  • The return was due more than three years before the bankruptcy filing
  • The return was filed by you not the IRS more than 2 years before the bankruptcy filing
  • The debt was by the IRS more than 240 days before the bankruptcy filing.
  • The return that the tax is based on cannot have been filed “Fraudulently” and:
  • The Taxpayer cannot have attempt to “evade or defeat” the tax

There are exceptions to these rules and exceptions to the exceptions.  If you have serious tax debt, it is mandatory that you have an experienced lawyer review the history of each tax year before filing a bankruptcy.

Now…as mentioned above, other tax debts can be discharged in bankruptcy too.

Payroll Tax – Non Trust Fund

If you are self employed or own a small business you are required along with every other employer withhold income, social security and Medicare tax (FICA) from your employee’s paycheck.

You have to match the FICA and send it all in.  If you don’t send it in, you will owe the entire amount personally without any action being taken by the IRS, if your are self employed or the business is a “Single-Member LLC”.

This means that you will owe the Employee’s Income Tax, FICA and your matching amount with penalty and interest.

The employee amount along with penalty and interest that attaches to it is never going to be discharged in bankruptcy, as it is a “trust fund” tax i.e. you were holding it in trust and were responsible for it.

But…your part, the employer part, can be discharged in bankruptcy if the criteria mentioned above under the income tax requirements are met and there haven’t been any “tolling” events.

I just finished a Bankruptcy case where my client owed more than $50,000.00 in old employment related debt that consisted of the employee portion and her portion.  The Bankruptcy stripped off the employer portion with it’s interest and discharged her obligation on it, making it possible for her to more easily set up a payment plan with the IRS.

Arizona Transaction Privilege Tax

Arizona Transaction Privilege Tax is thought of as a sales tax, but it isn’t.  It isn’t collected from your customer.  It is just a tax for the privilege of doing business here in Arizona.  Not every business has to pay for the privilege of course.

The amount of the tax is determined by a percentage of sales and because you as the business owner weren’t collecting and holding the money that belonged to someone else…this money isn’t considered “trust” money.  This is key.

Because if isn’t a trust fund tax…it is dischargeable if it meets the basic criteria laid out above.

This is usually an issue where a small business went south a few years ago, filed the Transaction Privilege Returns while struggling to stay afloat, but just couldn’t pay the amount with the returns.  Now, the business owner is on to something else and the State of Arizona Department of Revenue is on her heels.

I recently helped a client use bankruptcy to discharge personal debt and some of this old Arizona TPT debt of more than $25,000.00 that was lingering around and causing the State to take enforced collection action.  It happens.

IRS Penalties

The IRS likes penalties.  Penalties are the primary way it “teaches” us all not to do the same thing twice.  File your return late…penalty.  Pay the tax late…penalty.

These Failure to Pay and Failure to File Penalties are the most common.

Chapter 7 Bankruptcy will wipe away these two penalties if the “triggering” event or the event that resulted in the penalty assessment occurred more than 3 years ago.

Chapter 13 Bankruptcy will wipe them out …but they don’t have to meet any of the date criteria above.

These penalties can easily double a tax debt over a relatively short period of time.  Many of my clients have used Chapter 13 Bankruptcy to treat these penalties as dischargeable and pay the non-dischargeable tax debt over 3-5 years.

Property Tax

If your property tax bill is 1 year old, your obligation to pay it can be discharged in bankruptcy.  However, the Property Tax may be a lien on your property, so even if the obligation is discharged, you still may have to pay the debt to protect the property.

IRS Civil Fraud Penalty (IRC Sect. 6663)

A Civil Fraud Penalty is serious business.  It is a penalty assessed by the IRS on a tax return filed fraudulently with the intent to pay less than what was really owed.  The penalty amount is 75% of the principal tax debt amount.  If the tax debt is $100,000.00 than the penalty is $75,000.00.

If the fraudulent returns were filed more than 3 years before the bankruptcy filing…this penalty could be dischargeable as well.

The myth will endure of course…but now you know better.  If you have a serious tax debt problem, talk to someone with experience in these matters and find out whether a bankruptcy can help.

 

 

 

I have a Serious IRS Tax Debt and I have been out of the Country for a few years, how will being out of the Country affect my Tax Debt?

bigstock-Face-Of-Antique-Grandfather-Cl-1687387The IRS’ ability to collect a Tax Debt ends 10 years after the IRS assesses the Tax.  This also applies to IRS Liens. This 10 year period starts running on the date the IRS assesses the Tax or writes in down in it’s books as a debt owed by you.  The 10 year period doesn’t start to run when the IRS lien is recorded.

Example

Fred owes unpaid Income Tax for the 2005 tax year.  This tax was “assessed” on October 20, 2007.  The IRS records it’s Lien in August of 2010.  The 10 year date from assessment will occur on October 20, 2017.  The Lien will self release on that date as well.

Most Important Exceptions

Judgement

If the IRS sues you on the underlying debt and obtains a Judgement, it will than be able to renew that Judgement indefinitely and the Statute of Limitations period won’t help you.

Bankruptcy

Filing a Bankruptcy will extend the Statute for a period equal to the time in Bankruptcy plus six months.  If you file a chapter 7 bankruptcy and from filing date to closure date the case is open for 12 months, the Statute of Limitations on collection will be extended for 12 months.

Offer in Compromise

The filing of an IRS Offer in Compromise stops the clock from running as well during the time in the Offer plus 30 days.  Sidenote…most Offers are still rejected, so if you are going to use an IRS Offer in Compromise in hopes of eliminating tax debt, make sure you have a good chance of winning.

Appeals

As a general rule, appealing IRS collection activity will stop the Statute of Limitations Clock from running as long as it stops IRS Collection Activity.

Out of Country

If you have been out of the Country for a continuous period of more than six months, that absence will extend the statute period as well.   Generally, the time period of extension is limited to 5 years.

Example:

If you have been out of the Country for continuous period of one year visiting family, than the Collection Statute can be extended for 1 year as that period is longer than 6 months. If you visited family for less than 6 months, the extension won’t apply.

Important to Know the Date

If you have a serious Tax Debt and it has been around for a while, it will be important to know the 10 year collection statute date before embarking on an IRS Offer in Compromise, Bankruptcy or some other serious legal option.  Your solution may be as simple as arranging or re-arranging an installment agreement or non-collectible status with the IRS and waiting out the clock.

I have a Serious Tax Debt, I don’t know who to talk to about finding a way to resolve it. Who should I call?

idea_lightbulb_cartoon2-thumb-375x491-53213If you had a serious illness like some form of Cancer, who would you want to consult with first?

  • Your Cousin Fred
  • A Nurse
  • A Family Doctor
  • A Doctor who specializes in Treating Your type of Cancer

You would want to speak with the Specialist right?  Why?  A Specialist has been trained for years to understand your illness and specifically treat it.

Go it alone

If you have a serious Tax Debt problem wouldn’t the same thought process apply?

I mean, you could go it alone right, talk to Fred a bit and do some research…

But if the problem were serious enough, would you take the chance that you had the time and ability to learn how to solve it and implement what you had learned?

Of course you are going to do some of your own reading on the subject, but reading some websites and downloading a few articles isn’t going to help you find and obtain the best solution to a serious tax problem.  It wouldn’t help you solve your own serious illness either.

The IRS is trained and collects taxes every day – they are good at it.  You will be doing it once…hopefully.  You aren’t good at it and Fred probably isn’t either.

The IRS is trained to make you feel  comfortable and to disclose things or provided thing that will hurt your case.

A Tax Attorney is specifically trained to research and zealously pursue his or her client’s best interests agains the IRS.  A good Tax Attorney will make the IRS work hard, and

will often find ways to reduce or eliminate substantial amounts of tax debt using methods you may not know existed.

What about your Accountant?

Accountants do a lot of accounting like Preparing Financial Statements and balancing Books.  Most Accountants spend very little time dealing with Tax Resolution issues, if any time at all.  Accountants are great for planning ahead, preparing necessary items, calculating tax returns and helping you take advantage of legal tax breaks.

An accountant isn’t always equipped and doesn’t necessarily want to be equipped, to deal with the serious problems that arise from failing to file returns or failing to pay the tax debt.

Thats the job of a Tax Lawyer, someone who focuses on the law surrounding tax debt collection and tax controversy.

Tax problems are a legal issue.  They are based on United States Laws that state that give the IRS the ability to seize money and property and charge you with a crime.

An Attorney?

If you are really ill, you may visit your family Doctor first, I agree.  A good family Doctor will recognize quickly that you need to see a specialist.  A good Attorney will do the same and tell you to see another lawyer who focuses on dealing with Tax Debt.  Attorneys who don’t focus their practice on Tax Problem Resolution are at a disadvantage primarily because they haven’t spent enough time dealing with the issues surrounding Tax Collection to know all of the ins and outs.

I don’t practice Family Law for the same reason.

You wouldn’t continue to see your Family Doctor if he or she didn’t deal with your type of Cancer on a regular basis either would you?

Serious Tax Debt

Serious IRS Debt requires the use of an Attorney who deals with the IRS directly and in Bankruptcy Court all the time.  If you don’t use an Attorney with that type of practice you may very well miss out on a loophole in the law that will cure your problem.