All About Clearing Tax Debt with Bankruptcy
The bankruptcy code does not specify which tax claims can be eliminated; instead, you determine which tax claims are not dischargeable.
Below is a summary of the general rules surrounding the discharge of income tax claims (although other types of tax claims may also be eliminated in bankruptcy).
Rules for Discharging Income Tax Claims
To eliminate income tax claims, you must satisfy certain timing rules (created to allow the government an opportunity to collect the tax) and not violate other rules that address the taxpayer’s conduct.
Timing Rules
Three-Year Rule
The income taxes must have been incurred more than 3 years BEFORE the bankruptcy. Taxes are deemed incurred on the later of the due date or the extended due date.
*Importantly* – Various acts (“Tolling Events”) can extend the three-year rule including prior bankruptcies, Collection Due Process (CDP) hearings and related appeals, Offers-In-Compromise, amended returns, etc.
Two-Year Rule
If the income tax return was filed late, it must have been filed more than two years BEFORE the bankruptcy case. In addition, the tax return must have been prepared by the taxpayer and not the taxing agency.
*Note:* In most states with income taxes, an IRS audit or amended tax return assessment triggers a state requirement to file or “report” the IRS adjustments to the state. Failure to do so timely can cause a violation of the two-year rule for that state tax claim.
240-Day Rule
Each income tax assessment (there can be multiple assessments for each tax year – i.e., original return, amended return, audit adjustment, etc.) must have been made more than 240 days before the bankruptcy (plus any period during which an Offer-In-Compromise was pending, plus 30 days). Like the three-year rule, this period may be extended by several tolling events. Additionally, a tax that has not yet been assessed, but remains “assessable,” violates the 240-day rule. This is known as the “sleeping assessment” and typically occurs when the taxpayer files a late tax return more than two years ago but not yet three years before the bankruptcy case is filed. In this instance, the late-filed tax return is still subject to audit and additional assessment because the statute of limitations for assessment remains open under IRC section 6501. Thus, although the due date of the late return was more than three years ago and the tax assessment based upon the tax return filed was assessed more than 240 days ago, any additional assessment made during the remainder of the 3-year statute of limitation under this scenario would not be eliminated in bankruptcy.
Conduct Rules
No Tax Evasion
The taxpayer must not have engaged in conduct that constitutes a willful attempt to evade or defeat the tax.
Non-Fraudulent Tax Return
The tax return must not have been a fraudulent one.
Clearing Interest on Income Tax
If the income tax claim is dischargeable, any interest accrued with respect to that income tax claim is also dischargeable (assuming there are no tax liens which attached to the property before the bankruptcy).
However, even if the income tax claim is not dischargeable because it violates one of the timing rules discussed above, it can still be repaid in bankruptcy without interest.
Clearing Tax Penalties
Tax penalties, including tax fraud penalties, are dischargeable if (a) they are related to a dischargeable tax claim, or (b) the event giving rise to the penalty occurred more than three years before the filing of the bankruptcy case.
Additional Rules
As summarized above, certain rules and conditions must be met to ensure that your income tax claims can be cleared; there is an entirely different set of rules related to the elimination of sales, excise, property, and employment taxes. At Tax Workout Group, we prepare a comprehensive Tax Dischargeability Analysis (TDA) report which is crucial to a proper determination regarding the timing and type of bankruptcy filing for any type of tax claim.
Clearing Tax Debt With Bankruptcy FAQs
1. What is a “tax-motivated” bankruptcy?
Answer: A “tax-motivated” bankruptcy filing is one where the principal claims in the case include substantial tax claims, and where the debtor seeks to ensure the best possible treatment of these tax claims to eliminate or otherwise reduce them to the greatest extent possible.
2. What is a “Tax Dischargeability Analysis?”
Answer: In each bankruptcy case, it is crucial to obtain various tax transcripts from each taxing agency and then perform a comprehensive Tax Dischargeability Analysis (TDA) Report. This report is designed to “flush out” all the information necessary for a complete review of each tax claim. There are numerous tolling events, some mentioned above, which could impact the proper timing of the bankruptcy case. Our TDA Report will detail all facts in support of our conclusions and provide our detailed recommendations.
3. What is a “sleep tax assessment”?
Answer: A “sleeping assessment” is a tax that has not yet been assessed but remains “assessable” and therefore violates the 240-day rule. This typically occurs when the taxpayer files a late tax return more than two years but not more than three years before the bankruptcy case is filed. In this instance, the late-filed tax return is still subject to audit and an additional assessment because the statute of limitations for assessment remains open under IRC section 6501. Thus, although the due date of the late return was more than three years ago and the tax assessment based upon the tax return filed was assessed more than 240 days ago, any additional assessment made during the remainder of the 3-year statute of limitation under this scenario would not be cleared in bankruptcy.
Next Steps With Tax Workout Group
Obtain a real fresh start, one free from not only consumer debt but tax debt as well.
We do what matters most – focus on eliminating tax debt in bankruptcy – plain and simple. We live and breathe tax-bankruptcy law and strategically plan each case to resolve the tax debt effectively. While most other bankruptcy law firms focus on bankruptcy and deal with the tax claims as an afterthought, we don’t. Either give us a call at (866) 2TaxDefense (866.282.9333 ) or complete the form below and we will contact you immediately to schedule a tax case evaluation. We respond immediately.
