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
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
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