Southern California Bankruptcy Law Blog

Dealing With Tax Debts: Part 1

Posted in Tax debts

Taxes w Ben Franklin imageYou’ve fallen behind on your tax obligations.  The IRS has sent you notices, which you didn’t open ― after all, who needs the aggravation.  You’ve just received a notice of levy from your bank.  It’s that time, it’s Miller time.  No, wait; that’s not the right commercial.  It’s tax debt resolution time!

What can you do to resolve your problems with the IRS?  Ben Franklin is reputed to have written, “In this world nothing can be said to be certain, except death and taxes.”  If you can’t pay that certain tax debt, you could turn to the other side of Franklin’s quote and commit suicide, but that’s not a great choice.  Or you could move to a country with no extradition treaty with the U.S.  Unfortunately, most of those countries are run by psychopathic tyrants, so again, not a great choice.

There are four main ways to resolve tax obligations:  (1) pay them in full right away; (2) discharge them in bankruptcy (if possible); (3) enter an offer in compromise; and (4) enter an installment agreement.  Which one should you use?  As you might have guessed, the answer is simple to state:  It depends.  “On what?” you ask impatiently.  To answer that second question we need some background.

First a couple of important facts:

 

The Return Filing Requirement

 

One thing is certain no matter which approach you use:  To resolve your tax problems you must first file a return for the year(s) in question.  If you haven’t filed a return, you are ineligible for any relief.

 

The Collection Statute

 

26 U.S.C. § 6502(a) has a ten-year statute of limitations on IRS collections, measured from the day the tax is assessed by the IRS.  A tax is assessed when the IRS enters the assessment into its internal system.  The ten-year limitation is specific to the IRS.  Other taxing authorities have different limitations periods.  For example, according to Cal. Rev. & Tax. Code §19255(a), the California Franchise Tax Board has a twenty-year statute of limitations on collections.  Jerry Brown wants your pound of flesh to pay for his train set).

With these truisms out of the way, let’s look at the four aforementioned approaches in seriatim.  Today’s blog covers the first two: pay in full and discharge your tax debts in bankruptcy.  The next blog will cover the third and fourth approaches: Offer in Compromise and Installment Agreements.

 

1.  Immediately Pay In Full

 

I know this will come as a terrible shock, but the IRS will accept immediate payment in full of your tax obligation.  However, if you could pay the debt in full, you probably wouldn’t be receiving the delinquency notices.  Therefore, I won’t spend any more time on this option.

 

2.  Discharge The Taxes In Bankruptcy

 

I have written at some length about discharging tax debt in bankruptcy.  See Discharging Income Taxes: The Importance Of Pre-bankruptcy Planning ; Discharging Income Taxes In Bankruptcy After A Substitute For Return Is Filed; and The Treatment Of Unemployment Taxes In Bankruptcy.  Therefore, rather than hashing through that material here, I will briefly summarize the three-year, two-year, 240-day dischargeability rule, and ask you to read those previous posts if you want more depth.  As you will see when you read them, the relevant statutory foundation is a combination of 11 U.S.C. § 523(a)(1) and 11 U.S.C. § 507(a)(8)).

By the way, all three portions of the rule must be satisfied.  I recently attended a presentation in which the speaker incorrectly averred that either the three-year requirement, or a combination of the two-year and 240-day requirements suffice to discharge tax debts in bankruptcy.  Do not make that mistake in your analysis, or you may go through a bankruptcy without getting the relief you want.

 

A.  The Three-Year Requirement

 

The tax return for the year in question must have been due ― with extensions if you took them ― at least three years before the day you file your bankruptcy papers.  There is no wiggle room here.  If you file the bankruptcy even one day too soon, you lose.  There is no mercy with the IRS.  The agency embodies the legal philosophy of Draco.  (See, e.g.,  (“The laws, however, were particularly harsh.  For example, any debtor whose status was lower than that of his creditor was forced into slavery.  The punishment was more lenient for those owing a debt to a member of a lower class.  The death penalty was the punishment for even minor offences, such as ‘stealing a cabbage.’”))  This three-year rule is tolled during prior bankruptcies and offers in compromise.  Therefore, prior to filing a bankruptcy you will need to age the tax debt for the amount of time the three-year rule was tolled, plus thirty days if the tolling was due to an offer in compromise, and ninety days if the tolling was due to a prior bankruptcy.

Notice that this first requirement does not assume that you actually filed a return.  Instead, it looks at when the return was due.

 

B.  The Two-Year Requirement

 

You must have actually filed a legitimate, nonfraudulent return at least two years before the day you file your bankruptcy papers.  Again, there is no leniency, so count the time carefully.  This requirement has some interesting complications, some of which I explored in Discharging Income Taxes In Bankruptcy After A Substitute For Return Is Filed.

 

C.  The 240-Day Requirement

 

The IRS cannot have assessed the liability you are seeking to discharge during the 240-day window prior to the day you file the bankruptcy papers.  And, shock of ages, there is no grace here either.

This requirement has potential tolling pitfalls.  If you were in either an offer in compromise, or a prior bankruptcy case, the 240-day clock was tolled during their pendency.  Therefore, once either of those actions is terminated, you must wait for the additional time necessary to complete the 240 days after the assessment, plus an additional thirty days (if an offer in compromise was the tolling event) or ninety days (if a prior bankruptcy case was the tolling event).  See 11 U.S.C. § 507(a)(8) for the statutory details.

 

D.  Trust Fund Taxes Are Never Dischargeable In Bankruptcy

 

Most people seeking to discharge tax debt in bankruptcy are dealing with income taxes.  However, there are other types of taxes.  One type that is never dischargeable in bankruptcy is a trust fund tax.  As I wrote in a previous post:

Certain types of taxes must be collected by a third party — typically an employer — and remitted to some government agency.  For example, an employer is required to collect payroll taxes and send them to the appropriate taxing authority — either the IRS or the Franchise Tax Board.  In the process, the employer holds the money in trust for the taxing authority before sending it to the dark side of the force.  This is why the tax is called a trust fund tax. . . . The bad news:  this type of debt is NEVER dischargeable in bankruptcy because:  (a) it is a priority debt that has no statute of limitation, and (b) the money does not belong to the debtor — it is, after all, being held for the benefit of the taxing authority.  See, e.g., In re Shank, 792 F. 2d 829, 830 (9th Cir. 1986) (“A trust fund tax is always given a priority and is never subject to discharge in bankruptcy.”).

Everything I have written about discharging tax debt in bankruptcy applies not only to the IRS, but also to other taxing authorities such as the California Franchise Tax Board; with the caveat that trust fund tax debt is never dischargeable in bankruptcy.

I’ll talk about the Offers in Compromise and Installment Agreements in the next post.

 

Image courtesy of Flickr (Licensed) by DonkeyHotey