Income Taxes and Bankruptcy

Discharging Income Tax Debt in Bankruptcy

This is how I like to bankrupt income taxes. The bankruptcy code is just one tool to eliminate tax debt. The bankruptcy court does not typically strip a tax lien.  When the bankruptcy court strips a lien, it is usually a consensual lien like a mortgage, where you sign and allow a lien to be placed on the property, or a judicial lien, where a creditor sues and obtains a lien.   A tax lien arises by statute, and filing for bankruptcy rarely strips a statutory lien like property taxes or workman’s liens.

However, income tax liens do expire after ten years.  Income taxes are normally dischargeable three years after the return is due if you file the taxes on time and have no other problems that prevent you from filing to discharge tax debt.  You can, therefore, use some planning to age a tax lien or the tax years and discharge tax debts.

Methods to age a tax debt until you can get the bankruptcy discharge.

You can litigate a tax assessment, make a payment agreement as low as zero per month, or dispute the assessment to age the tax year until it becomes dischargeable.  Some activities, such as bankruptcy or an offer in compromise, do not age the tax debt while they are pending.  Plus, the returns must be filed in a timely manner to obtain bankruptcy discharge.  The bankruptcy code defines the bankruptcy discharge as the final and permanent court order that bars collection.  While the bankruptcy case is going on, the court order is temporary and is called a stay, which is more potent than the discharge order.

A Bankruptcy filing starts the stay.  The bankruptcy code and IRS code define these timelines.  There are no unique motions to prepare to discharge the tax debts.  Either you file on time, or you don’t.  So you have to know the rules. Miss it by a day and you remain liable for the debt. The bankruptcy trustee manages the bankruptcy estate and ensures the petition is accurate.

Make sure your bankruptcy case discharges the income tax when you file bankruptcy.

If you want to eliminate tax debt, you must analyze your tax transcript and meet the conditions for discharge. Eliminating tax debt involves factors such as the date your return was due and when you filed your return.   The age of the tax debt and filing history govern eliminating tax debt.  Just getting the tax transcript can be challenging. Our office uses a particular IRS form that gives us power of attorney authority to get your tax transcript. Federal income tax can be affected by any prior bankruptcy petition you filed.  There are at least six general rules to consider, plus you have to be able to read the tax transcript and understand the codes.   Any attempts at tax evasion can lengthen some waiting periods or, in some cases, make it never dischargeable.   A tax may never be dischargeable if you have trust taxes, tax evasion, or other issues.  A previous bankruptcy filing stops the clock from running on the Internal Revenue Service tax debt.

Most bankruptcy attorneys analyze the three primary rules:

1. that the tax must have been due for three or more years,
2. that you filed the return at least two years before filing bankruptcy, and
3. there have been no assessments within 240 days before filing.

The minor rules for eliminating tax debt

1. Tax fraud or an attempt to evade can make discharging the tax impossible.
2. Filing bankruptcy during the prior three years extends the time you have to wait to file.
3. Filing an offer in compromise also extends the three year rule while the offer is pending.

Bankruptcy can impact your tax refund, and its legal implications must be considered. Procedures for filing tax returns and handling tax attributes for specific tax years relevant to the bankruptcy case are also important.

Explaining the three major rules of discharging Income taxes and Bankruptcy

However, there are at least 13 more items you must make sure of and another five, which will affect how much you can get back.

Essentially, the taxpayer has to wait three years after the tax becomes due. Since your taxes become due a year after the reporting year or four years after earning the income.  If April 15th fell on a weekend or holiday, you need to wait a few extra days to ensure this is three business years after the return became due.

You also have to timely file your taxes and must have filed the tax return over two years before you filed the bankruptcy. If you asked for an extension until October 15th, this is three years after this date. Fraud in your tax account or attempts to evade prevent you from discharging income taxes. Failure to file returns will trigger fraud or attempts to evade penalties.  If the IRS has filed a substitute for your return because you failed to timely file, you may never be able to file and discharge your taxes.

Read About How Much Bankruptcy Costs in Louisville

The Quick Checklist of IRS Codes

1. The IRS codes 910, 911, and 915 for Tax fraud or evasion.

These are Masterfile codes cross-referenced in most IRS internal files and documents, letting the IRS staff know you have a history of fraud. You will not qualify for discharging your income taxes in bankruptcy if these codes appear, but list the IRS debt anyway if you are filing bankruptcy.  The IRS is notified to file their claims whenever someone files a bankruptcy case. The account will be sent to an office in Pennsylvania that handles IRS claims in bankruptcy.  Tax departments are human, and they make mistakes and may treat it as discharged anyway or may give you more favorable repayment terms after discharge.

2. Extension periods, which increase your waiting period to discharge income taxes after bankruptcy filing.

Codes that will extend the waiting periods include the codes for filing bankruptcy during these three years and filing an offer in compromise codes 480, 481, and 482.  Filing bankruptcy tolls (extends) the period the time of the bankruptcy plus 90 days.  Submitting an offer in compromise tolls (extends) your 240-day assessment waiting period, the time the offer is under submission plus 30 days.

3. TXMOD and TXMODA transcripts.

The most detailed transcript is the TXMOD or TXMODA.  If you get the detailed transcript, it will include extra codes that affect how long you must wait and how completely you can discharge these taxes. Most events extend waiting periods the time of the event plus 30 or 90 days.

IRS Code 150 Tax Return Filed incorrectly.

• If the return was not signed, it was not filed.  Your signed returns are filed under penalty of perjury. Fraudulent returns can be prosecuted.  Essentially, a filed return is your agreement that the reported amount is at least the tax that is owed.  If the return is not properly filed, the waiting period for bankruptcy or the csed date, which is a 10-year statute of limitations for collections, never runs.
• The Csed date runs from the date of assessment, which is when the tax return is filed.   Blank amounts on the returns will also trigger a Code 150 problem.  The cure is to file the return properly signed with the amounts entered.  Until you properly refile the return, the csed dates will not run. If the IRS files a return for you (substitute for return), they will leave out the deductions, and the csed date never runs, and you probably lose the ability to file bankruptcy and discharge your tax debt.

IRS Code 320 Evidence of tax fraud or evasion.

• Forget any guarantee of discharging your taxes in bankruptcy if you have this code.  Eventually, the debt may no longer be collectible by the IRS, but you cannot discharge the debt by bankruptcy. There is a case where one IRS agent was simply told to come back later by a mother with a newborn.  The agent claimed that the act was a willful evasion, and the mother was disallowed from discharging the tax in bankruptcy.  Normally the department will not object to discharge based on fraud but instead on evasion, which is an easier standard for them to allege.  There is both a 3-year and 10-year rule that stops IRS collections.

IRS Code 431. Abatement of tax by IRS.

• This is an important item to look for.  The Department can reduce or eliminate your tax if it feels the taxpayer has a basis, such as high health costs or disability, which makes collection doubtful or liability for the tax doubtful.

IRS Code 420. Audit started.

• Audits generally toll ( start and stop) the waiting period. About one person in 100 people are audited.  As income increases, your chance of an audit increases.  Certain deductions will also increase the chances of an audit, such as home office expenses.  The audit ended is noted in the record by “Code 421 audit ends”.

IRS Code 249. Penalty assessed.

• Just because a penalty was assessed does not extend the waiting period to file a bankruptcy. Something must normally happen to delay their ability to collect like a bankruptcy to toll a statute of limitations or add time to a tolling period.

IRS Code 290 or 300.

• Additional tax assessed. The assessment of an additional tax is one of those things that will add to the time you must wait to file bankruptcy and discharge tax debt. There must be no additional tax assessed within 240 days before you file bankruptcy, or you will at least owe the additional tax.

IRS Code 460. Extension to file the return.

• Asking for additional time adds to the time you must wait to file bankruptcy and discharge the tax debt.  You must allow the tax department three years to collect before you can file the bankruptcy and discharge the debt.  File the tax return later in the year, and you will have to wait three years after October 15th instead of April 15th. Be sure to add a couple of extra days because April 15th may fall on a holiday or weekend.  I normally add ten days past the date the return was due, such as April 15th or October 15th.

IRS Code 308. Additional tax per audit.

• This is similar to the additional tax assessed, which tolls (extends) the 240-day waiting period.

IRS Code 480. Offer in Compromise pending.

• Code 481 OIC rejected or returned, Code 482 withdrawn. The IRS is required to consider an offer in compromise when the tax liability or collectability is in doubt. Often, they want more from you in your offer of compromise than they get in bankruptcy. Submitting an offer in compromise will extend the waiting period from the date of submission until the offer in compromise is rejected or returned, plus 30 days for the 240-day rule.

IRS Code 488. Installment agreement.

• Installment agreements allow you to age the account the three years so you can discharge the income tax debt in bankruptcy. There are partial payment agreements that will not pay off the debt because the interest is greater than the payments. If your financial situation is bad enough, you may even qualify for being currently not Collectible Code 530.

IRS Code 520. Tax litigation, bankruptcy, or collection due process appeal

• Essentially, anything, including filing a case with the US Tax Court in Washington, DC, will extend the waiting periods. Some cases have suspended collection and waiting periods for years. However, if your case is frivolous, you can be assessed the cost of litigation, which can include flying a federal judge to your location.

IRS Code 530. Currently not collectible status.

• If your financial situation is bad enough, such as you are on social security, you may qualify for being currently not collectible. Every year, the IRS will monitor your income, and if it remains low, you will stay inside this program. Just like installment agreements, the debt will age until it becomes dischargeable. Code 537 means you started making an income again, and the IRS can now collect again. Code 537 means the uncollectible status is reversed.

IRS Code 534. The collection statute expired.

• The most delightful code is the csed date. This is the statute of limitations for income taxes. 10 years after your assessment, the collection is supposed to stop see Internal Revenue Code section 6502. However, the IRS is not perfect, and you may have to remind them the debt has run the csed date and collections should cease. You can ask for a collection due process hearing if they forget, but this is not normally necessary. There are also taxpayer advocates in the tax department who can assist you with problems like this. Any tax lien is released.

IRS Code 539. Trust fund recovery cases.

• Trust taxes are primarily employer withholding taxes or sales taxes. These monies never belonged to the business owner or the corporate officer. If these taxes are not turned over to the tax department, the Kentucky tax department can refer it for criminal prosecution of corporate officers or owners. Never fail to pay these taxes because they are never dischargeable in bankruptcy, and the IRS or state tax department in Kentucky will not hesitate in filing liens against the owner of the business. I have seen cases where the Kentucky State Tax Department has handed the case over for felony prosecution and obtained convictions.

IRS Code 550, 560.

• Assessment or collection SOL also expires code 608. Similar to the csed date.

IRS Code 592 Tax Lien.

• Yes, the tax department can file a lien against your home for your income taxes or unpaid business taxes. I have had clients who lost their homes or who had to file a Chapter 13 bankruptcy to pay off tax debts. Normally, income tax liens self-release after ten years when the csed date expires with Code 534. You can strip judicial liens and perhaps a second mortgage that has no equity in the property in bankruptcy.
• But you cannot strip income tax liens which are attached by statute, even if there is no equity. Consensual mortgages, unsecured debt, or car loans can be modified by bankruptcy. But statutory liens such as property taxes are not. You can only pay off statutory liens such as property taxes or income tax liens in Chapter 13 or surrender the property. First mortgages can not be modified because of a section of the statute that disallows a consumer from modifying his first residential mortgage. But commercial and vacation homes can be modified.

Helpful Links for This Article:

Tax Account Transcript

IRS Tax Transcript

Tax Codes

Tax Discharge Determinator

Resources for Bankruptcy

Income Tax Bankruptcy Forms

Bankruptcy Manual

Other Related Information

IRS Transcript Codes for Bankrupting Taxes

Tax and Bankruptcy Lawyer for Business Trust and Income Tax

Chapter 13 and IRS Tax Returns and Refunds in Bankruptcy

State Income Tax Bankruptcy

File Bankruptcy on Income Taxes

How to Bankrupt Taxes

If you are thinking about filing bankruptcy, don’t delay because timing is crucial. I am here to help you. So, contact my office right away to start the conversation. Nick C. Thompson, Bankruptcy Lawyer: 502-625-0905.