Bankruptcy: Yes, Personal Income Taxes Can Be Discharged!
There are two guarantees in life: Taxes and Death. Believe it or not, certain income taxes can be discharged in bankruptcy. Since income taxes can be defeated that leaves only death to figure out. Maybe I'll write an article on that someday. In the meantime, let's focus getting rid of tax debt.
It is easier to discharge income tax than it is student loans. I remember the first time I heard that income taxes were dischargeable in bankruptcy. It was 8:00 am on a Thursday morning and only about 20 of us showed up for the lecture. Apparently no one wanted to wake up early for a lecture. That particular lecture is one that changed the way I practice bankruptcy law and may be the one lecture that has made the biggest difference in my practice. In order to discharge taxes in bankruptcy there are a couple of criteria that must be met.
All of the criteria that go into determining if taxes can be discharged are too numerous to discuss in this article. The first three criteria that I consider when determining if a client's taxes are dischargeable are:
Other criteria include, but are not limited to, issues surrounding the nature of the tax and if returns were filed fraudulently.
What Does It Mean To Have Taxes Due More Than 3 Years Ago?
Returns for a particular year are filed after that year (i.e. 2010 returns are filed in 2011). Traditionally the return isn't required to be filed until April 15. Additionally, any income tax that is owed is also required to be paid on April 15. Therefore 2010 taxes become due on April 15, 2011. Consequently 2010 income tax won't be able to be discharged until April 15, 2014 (2010 income taxes due April 15, 2011 plus 3 years). On April 15, 2011 debtors will be able to discharge 2007 income tax.
There are a couple of places where debtors can get messed up with the 3 year rule. First, sometimes the date, April 15, changes. This can be caused by April 15 landing on a Saturday or Sunday. In addition, 2010 taxes and returns are due on April 18, 2011 because the IRS decided so (actually it was because Congress took so long with particular legislation). Finally, filing for an extension will change the date to a later date than April 15. Make sure you tell you attorney if you filed an extension!
What Does It Mean to Have the Returns Filed More Than 2 Years Ago?
First point I want to make about this rule: If you want to discharge taxes for a particular year but haven't filed a return for that year, you will not be able to discharge the taxes.
The measuring date is from the day you file your bankruptcy petition. This means that if you recently filed outstanding returns they are most likely not going to be dischargeable. Take the date the bankruptcy was filed and subtract two years. If the return in question was filed before that date, you are fine. If it has been a while but not quite 2 years visit with your bankruptcy attorney to see if there is a way to delay filing the bankruptcy.
Combining the previous two rules: On May 1, 2011 a client comes to me and wants to discharge taxes from 2007 but didn't file his 2007 returns until June 1, 2009.
I would tell the client to wait until June 2, 2011 and file for bankruptcy. That way the returns would be on file for 2 years and the taxes would have been owed for more than 3 years.
What Does It Mean To Have Taxes Assessed?
When a taxing authority assesses taxes what that really means is that the authority is "crystallizing" the liability to pay tax and the amount to be paid. In other words, when a tax is assessed the requirement to pay and the amount are determined. This is not determined when the return is filed. It is an internal procedure that a taxing authority applies. Normally it is done shortly after a return is filed, but not always.
Take for example the individual who files a return and is self-employed. If someone he did business for files a 1099 with the IRS after the due date the IRS is still going to expect taxes to be paid on the earned income. A tax may be assessed based on the late filing of the 1099 against the self-employed individual. The timing of the assessment will be determined based on when the Internal Revenue Service gets around to "auditing" the account. I have seen the Iowa Department of Revenue take a few years to adjust the assessment.
The timing of the assessment can be affected by tax returns being filed late; returns being audited; and offers and compromises being entered into with the taxing authority. The best way to determine when a tax was assessed is to contact the authority.
What Is The Nature Of Some Taxes That Are Not Dischargeable?
As previously discussed, income taxes can be dischargeable if certain criteria are met. Of course not all taxes are income tax. The most common type of taxes that are not income tax are called fiduciary taxes or trust tax. Fiduciary taxes include:
Fiduciary taxes are those that someone collects from a third party and pays on behalf of the third party.
As an example, when you go to the store you pay sales tax. The clerk merely serves to collect the tax you pay. Later, the clerk pays that on your behalf to the authority. More plainly stated, fiduciary taxes are collected from a third party (sales tax and income withhold tax, etc.) and held in trust. Since they are not the property of the debtor, the tax cannot be discharged.
The issues surrounding the discharge of tax in a bankruptcy can be very complicated. Even more complicated is how to deal with taxes in bankruptcy that cannot be discharged. It is important to seek competent legal advice from a bankruptcy attorney with experience in this area.
It is easier to discharge income tax than it is student loans. I remember the first time I heard that income taxes were dischargeable in bankruptcy. It was 8:00 am on a Thursday morning and only about 20 of us showed up for the lecture. Apparently no one wanted to wake up early for a lecture. That particular lecture is one that changed the way I practice bankruptcy law and may be the one lecture that has made the biggest difference in my practice. In order to discharge taxes in bankruptcy there are a couple of criteria that must be met.
All of the criteria that go into determining if taxes can be discharged are too numerous to discuss in this article. The first three criteria that I consider when determining if a client's taxes are dischargeable are:
- Were the taxes due more than 3 years ago?
- Were the taxes filed more than 2 years ago?
- Has the tax been assessed more than 8 months (240 days) ago?
Other criteria include, but are not limited to, issues surrounding the nature of the tax and if returns were filed fraudulently.
What Does It Mean To Have Taxes Due More Than 3 Years Ago?
Returns for a particular year are filed after that year (i.e. 2010 returns are filed in 2011). Traditionally the return isn't required to be filed until April 15. Additionally, any income tax that is owed is also required to be paid on April 15. Therefore 2010 taxes become due on April 15, 2011. Consequently 2010 income tax won't be able to be discharged until April 15, 2014 (2010 income taxes due April 15, 2011 plus 3 years). On April 15, 2011 debtors will be able to discharge 2007 income tax.
There are a couple of places where debtors can get messed up with the 3 year rule. First, sometimes the date, April 15, changes. This can be caused by April 15 landing on a Saturday or Sunday. In addition, 2010 taxes and returns are due on April 18, 2011 because the IRS decided so (actually it was because Congress took so long with particular legislation). Finally, filing for an extension will change the date to a later date than April 15. Make sure you tell you attorney if you filed an extension!
What Does It Mean to Have the Returns Filed More Than 2 Years Ago?
First point I want to make about this rule: If you want to discharge taxes for a particular year but haven't filed a return for that year, you will not be able to discharge the taxes.
The measuring date is from the day you file your bankruptcy petition. This means that if you recently filed outstanding returns they are most likely not going to be dischargeable. Take the date the bankruptcy was filed and subtract two years. If the return in question was filed before that date, you are fine. If it has been a while but not quite 2 years visit with your bankruptcy attorney to see if there is a way to delay filing the bankruptcy.
Combining the previous two rules: On May 1, 2011 a client comes to me and wants to discharge taxes from 2007 but didn't file his 2007 returns until June 1, 2009.
I would tell the client to wait until June 2, 2011 and file for bankruptcy. That way the returns would be on file for 2 years and the taxes would have been owed for more than 3 years.
What Does It Mean To Have Taxes Assessed?
When a taxing authority assesses taxes what that really means is that the authority is "crystallizing" the liability to pay tax and the amount to be paid. In other words, when a tax is assessed the requirement to pay and the amount are determined. This is not determined when the return is filed. It is an internal procedure that a taxing authority applies. Normally it is done shortly after a return is filed, but not always.
Take for example the individual who files a return and is self-employed. If someone he did business for files a 1099 with the IRS after the due date the IRS is still going to expect taxes to be paid on the earned income. A tax may be assessed based on the late filing of the 1099 against the self-employed individual. The timing of the assessment will be determined based on when the Internal Revenue Service gets around to "auditing" the account. I have seen the Iowa Department of Revenue take a few years to adjust the assessment.
The timing of the assessment can be affected by tax returns being filed late; returns being audited; and offers and compromises being entered into with the taxing authority. The best way to determine when a tax was assessed is to contact the authority.
What Is The Nature Of Some Taxes That Are Not Dischargeable?
As previously discussed, income taxes can be dischargeable if certain criteria are met. Of course not all taxes are income tax. The most common type of taxes that are not income tax are called fiduciary taxes or trust tax. Fiduciary taxes include:
- Unemployment Taxes
- Withholding Taxes
- Sales Tax
Fiduciary taxes are those that someone collects from a third party and pays on behalf of the third party.
As an example, when you go to the store you pay sales tax. The clerk merely serves to collect the tax you pay. Later, the clerk pays that on your behalf to the authority. More plainly stated, fiduciary taxes are collected from a third party (sales tax and income withhold tax, etc.) and held in trust. Since they are not the property of the debtor, the tax cannot be discharged.
The issues surrounding the discharge of tax in a bankruptcy can be very complicated. Even more complicated is how to deal with taxes in bankruptcy that cannot be discharged. It is important to seek competent legal advice from a bankruptcy attorney with experience in this area.
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