All posts in Taxes

Los Angeles County is Challenging the BAP’s Decision in Mainline Equipment

I have been advised that Los Angeles County has appealed the adverse decision in Mainline Equipment to the Ninth Circuit.  It has filed its opening brief and the responsive brief should be coming in the next few weeks absent any extensions.  Obviously, the county disagrees with Judge Brand’s decision but we’ll see what happens.  It seems to me that the tax is still a priority debt and must be paid in full with interest (which is 18% at the present time) so it really only matters if the debtor is trying to sell the property free of the county’s lien.

My brief of the BAP decision is below: Read more…

Simplify the Tax Code by Reducing the Brackets? Give me a Break.

When I was in law school in the 70s, I took a tax class.  I still have the Internal Revenue Code I purchased for the class.  It is a small paperback of a few hundred pages – even then basically unreadable.  Today the code is thousands of pages – it is at least a few thick volumes.  The tax brackets take up two- three pages at most.  Once the taxable income is determined, it takes eighth grade math to compute the tax.  With fewer brackets, even if it is reduced to one, it would still probably take eighth grade math to compute the tax.

Will fewer brackets reduce the few thousand pages?  Of course not.  What are the few thousand pages anyway?  A portion is directed to how to figure the taxable income.  A portion is credits – special incentives offered to corps and others to supposedly motivate them to do stuff that the government essentially pays for.  But most of it is taxation of certain industries, certain income, certain different types of entities and special exceptions.   Read more…

Doing My Taxes – Calling My Son for Advice

My oldest son Joshua, the proud father of my two grandsons, is a CPA with a large firm in Phoenix.  I called him with a quick question on my taxes.  I am doing them today because I don’t want to wait until the last minute, Thursday.  He told me he is reviewing a return in his office now – an individual Form 1040 – that is 5,000 pages, literally and no joking!  The taxpayer obviously makes a lot of money.  My son said also that they shipped a return recently and the FedEx charge was $1,800.  I love the politicians that say they will make the code simple by reducing the brackets to a single bracket or two.  Right.

Meet the New Face of the IRS in the Central District

Last Saturday I attended the CDCBAA CLE on “Handling Tax Debt Dischargeability and Bankruptcy Tax Disputes.”

The speakers were Judge Kwan, Arnold H. Wuhrman, Esq. of Serenity Legal Services, P.C., and assistant U.S. Attorneys Robert F. Conte, Esq. and Najah Shariff. Judge Saltzman and Judge Houle’s former law clerk, Jolene Tanner also made a special guest appearance. Najah and Jolene are the two new faces of the IRS. They will have the primary responsibility for all bankruptcy related litigation in the entire Central District of California.

Judge Kwan

(from far left to right: Jolene Tanner, Robert Conte, Najah Shariff, Judge Kwan, and Arnold H. Wuhrman)

Read more…

IRS Substitute For Return (SFR) Isn’t Always Nondischargeable

Debtors can discharge their taxes in bankruptcy so long as they meet certain tests: the three-year test, the two-year test, the 240-day test and no fraud. I lay it out in the first paragraphs here and in the last paragraphs here.

One of the tests is that the return has to have been actually filed: “A discharge . . . does not discharge an individual debtor for any debt  . .. for a tax or a customs duty . . . . with respect to which a return  . . .  was not filed or given.” 11 USC § 523(a)(1)(B)(i). A “return” must satisfy non-bankruptcy law, and can be a return prepared by the IRS under IRC § 6020(a), but not under 6020(b). 11 USC § 523(a).

This jargon and its cross-references mean that a taxpayer has to have submitted their own, good-faith tax return in order to have the resulting tax be dischargeable. Under IRC § 6020(b), the IRS can prepare a return without the taxpayer’s cooperation and make an assessment on it. This is known as a “substitute for return” (or SFR), and its assessment is never dischargeable. The taxpayer can never replace the SFR with a late-filed return after taxes owed from an SFR have been assessed.

How do you know that the IRS has filed a substitute for return? You look at the taxpayer’s account transcript. The first entry is almost always under TC (transaction code) 150. When the taxpayer files his own return, the entry states “tax return filed,” and it shows the taxes due on the return such as on this transcript. When the IRS files the taxpayer’s return, the entry states “Substitute tax return prepared by IRS,” and it shows a dollar entry of “0.00” such as on this transcript.

Read more…

What’s a Taxpayer Thinking When S/he Tries to Evade a Tax?


If the government can prove that you “willfully attempted in any manner” to “evade or defeat” a tax, then you cannot discharge that tax debt in bankruptcy.  11 U.S.C. 523(a)(1)(c).   I’ve always seen this as a very low bar for the IRS to prove, because the elements are simple: 1) the taxpayer had a duty to pay a tax; 2) the taxpayer knew that he had this duty; and 3) the taxpayer voluntarily and intentionally violated that duty.  Payment of any expense beyond subsistence, such as a child’s college tuition, at a time when taxes remain unpaid could meet the standard.  That’s what the cases around the country teach.

The 9th Circuit, however, has changed the standard here in California and elsewhere in its domain.  In Hawkins v. FTB, Case No. 11-16276, decided on September 15, 2014, the court has held that the taxpayer needs to have a specific intent of evading tax for this discharge exception to apply.  Outside the 9th Circuit, a “willful attempt “ to intentionally violate the duty to pay tax means a deliberate act that results in nonpayment of tax.  Here in the 9th Circuit, the “willful attempt” means a deliberate act with the intent of evading tax.


The facts in Hawkins are rather shocking to this former IRS attorney.  The debtor-taxpayer made a fortune in Silicon Valley enterprises, and tried to shelter some of his capital gains through sophisticated yet dubious transactions.  A large tax bill ensued, and then his enterprises lost a great deal of money. Yet he continued to live large: in the face of of a $25 million tax bill, he continued to maintain two residences worth a total of more than $6 million, and bought a fourth family car (in a two-driver family) for $70,000.  The family spent between $17,000 and $78,000 more per month than its income for several years.

I think that the result in Hawkins is wrong.  This kind of spending by a taxpayer who knows he owes $25 million in taxes is dishonest.  As a taxpayer, I do not want my fellow Americans to get away with this by saying “gee, I wasn’t trying to avoid paying the taxes, but I just couldn’t stop myself from spending.”  But I do salute the attorneys who reached this result.  It is a good result for my clients, and I intend to use it until the Supreme Court reverses the 9th Circuit.


Taxes and Bankruptcy – Declaratory Judgments

When discharging taxes, I have always thought that it is the best practice to seek a judgment from the bankruptcy judge that the taxes are discharged. That’s because unlike many other nondischargeable debts (fraud, malicious tort, etc.), the debt may remain in force with no further word from the court. The IRS or the FTB could come back five years after the discharge and just start collecting on taxes where it wasn’t made explicitly clear that the tax was discharged. A declaratory judgment gets rid of this ambiguity.
I’m changing that stance now.
Up until now, I have operated on a simple procedure: I file an adversary proceeding for a declaratory judgment stating that the taxes are discharged, the IRS either stipulates that they are, thereby ending the issue, or it doesn’t stipulate and the parties go through a trial to determine dischargeability. Section 523 gives six exceptions to dischargeability: the assessment is from a tax return due less than three years before the bankruptcy petition; the assessment is from a tax return actually filed less than two years before the bankruptcy petition; the assessment occurred less than 240 days before the bankruptcy petition (think of an audit assessment); the tax return was never filed; the assessment is from a fraudulent return; or the taxpayer willfully attempted to “evade or defeat” the tax (some of these clocks can be tolled under circumstances such as offers in compromise or prior bankruptcies, but that’s a discussion for another day).
The first five exceptions are very easily determinable: either the number of days or the filing exist, or they don’t.
It is not always so easy to determine whether the taxpayer “evaded” tax. The tax authority merely needs to prove that the taxpayer knew about the tax liability and did something (or failed to do something) to avoid paying the tax. This could be as small as paying $3,000 for a kid’s tuition, or a trip to Las Vegas with a fine dinner and some casino time while learning to play with real money slots, during a period when tax was owed.

Here are some cases on evasion:
Dalton v. IRS, 77 F.3d 1297 (10th Cir. 1996)
In re Fegeley, 118 F.3d 979 (3rd Cir. 1997)
U.S. v. Jacobs, 490 F.3d 913 (11th Cir. 2007)

While the burden is on IRS to prove evasion, the evidentiary standard is low, and yet the IRS very rarely asserts this exception. In 10 years as an attorney practicing bankruptcy law within the IRS, I never saw this exception asserted.
Recently, the Department of Justice changed its policies on stipulating to dischargeability of tax. The local US Attorney’s Office no longer stipulates to dischargeability across the board. It requires the taxpayer-debtor to stipulate that the United States may later rely on the evasion exception if it uncovers evidence. That somewhat defeats the point of the stipulation: the IRS could administratively determine, five years after the discharge, that the debtor had actually evaded the payment of tax, and open collection proceedings. Our clients could first learn about this when the IRS files a notice of federal tax lien against them. The client’s recourse is to then re-open the bankruptcy case and prosecute another adversary proceeding against the IRS.
In other jurisdictions, the United States has started to move to dismiss these declaratory adversary proceedings on grounds of ripeness or nonjusticiability. The IRS argues that there is no controversy: it will admit that the tax is dischargeable under five out of the six tests, that it has administratively abated the tax, and that it is not threatening to collect the tax. No controversy, no need for a judicial decision. Midwestern courts agree. See, for instance, In re Mlincek, 350 B.R. 764 (Bankr. N.D. Ohio 2006), or In re Erickson, Case No. 12-59165, Adv. Pro. No. 12-05546 (Bankr. E.D. Michigan 2013). (The IRS hasn’t yet succeeded in dismissing these cases in California).
So what do I advise now? Today, I cooperate with what the IRS wants us to do here: get your discharge, then call the bankruptcy specialist to ask what tax years are discharged. If you agree with the IRS’s answer, leave it alone. If you disagree, ask why the IRS analyzes it differently than you, and take a deep breath before filing suit to get a declaration of dischargeability.
Why the deep breath? Because the lawsuit may well become more expensive than the taxes being discharged. Your adversary in bankruptcy court will be a Special Assistant U.S. Attorney, directed by the Tax Division of the Department of Justice in Washington, DC, answering to Eric Holder. My experience of the Tax Division is that it is staffed by very intense and driven attorneys living in a cocoon who see their patriotic duty as expanding the law in favor of the government; it will often require its attorneys to argue cases that the IRS itself (answering to Jack Lew) is willing to concede.
This strikes me as unsatisfactory, but I must defer to practicality. We represent taxpayer debtors. At the moment when they get their discharge, they have, by definition, few assets. They cannot bankroll a lawsuit against the Department of Justice when it is willing to throw highly-trained bodies from across the country in the service of vindication of a highly esoteric point of law.

Statutes of Limitation, the IRS, and the FTB

A potential client called me last week for help in dealing with the IRS.

It seems he owed a lot of taxes for tax years from 1992 to 1996.  Had he filed the returns on time?  Yes.  Had he filed bankruptcy in the meantime?  No.  Had he filed an offer in compromise?  No.  Has he heard anything from the IRS in the last three years?  No, but he thought that was because he had moved and not written to the IRS collection department to tell them about the move.  Has he filed a tax return from his new address?  Yes.

I told him not to worry, that he probably didn’t owe the taxes anymore because it took more than 10 years for the IRS to collect those taxes.  And it occurred to me that I should explain how statutes of limitation can work to the taxpayer’s advantage.

Audit and Assessment – Three Years IRS, Four Years FTB

The IRS has a three-year limitation period on assessment from the time of the return’s filing.  That means that if three years pass from the time you, the taxpayer, filed your return, the IRS can no longer audit you for that tax year.

Sounds simple, right?  But when did you actually “file the return?”  Let’s take a return for the 2011 tax year.  If you filed it before April 15, 2012, the law says that the return was filed on April 15.  If you had an extension until October 15 and filed the return on September 1, the limitation period starts on October 15.

If you filed the return late, the law says that it was filed on the day the IRS received it.

In California, the Franchise Tax Board generally enjoys more liberal state laws than the federal IRS.  The FTB has four years to assess more taxes on a filed return.

There is a big difference between how the IRS and the FTB go about “assessing” a tax, and how their audit procedures work.  For the IRS, assessment occurs at the end of the audit process.  Thus, the IRS generally tries to reach potential audit targets within a one-to-two-year window after the return is filed.  If the three-year clock has been ticking for two years and ten months, and you haven’t heard from the IRS, you are unlikely to get audited for that year – although there are relatively uncommon exceptions.  The IRS has to start its audit soon enough that it can complete the process and issue a Statutory Notice of Deficiency more than four months before the end of the limitation period, for reasons that are too complicated to mention here.

The relatively uncommon exceptions?  The IRS gets six years to audit you if it can show a large understatement of income, and if it can show that your return is fraudulent, it can open the audit and assess at any time; there is no statute of limitations on a fraudulent return.

The FTB, on the other hand, assesses the increased tax as soon as it smells a problem.  Like a deputized posse member who shoots first and asks questions later, the FTB starts its process with a Notice of Proposed Assessment; this counts as the “assessment” for purposes of the statute of limitations.  This notice can be mailed on the last day of the four-year clock, and it’s still effective.

If the taxpayer gets audited by the IRS and agrees to a higher assessment, the taxpayer has a duty to inform the FTB within six months.  The FTB then has two years to make its assessment.  If the taxpayer doesn’t make the six-month deadline, there is no limitation period – the FTB has an infinite amount of time to make the assessment.

These assessment clocks can be tolled (and often are) by agreement between the taxpayer and the taxing authority.  Sometimes this is a good idea, especially if the taxpayer just needs a bit more time to gather records to show to the auditor.  Sometimes it’s a bad idea, if the tax authority’s case is not very strong.

Obviously, the laws strongly favor the taxing authorities: our legislatures want to make sure that people do not get out of taxes owed by skillful procedural.  And while the FTB’s laws sound even more tilted against the taxpayer, there is a counterbalance: the FTB is generally less effective at opening and closing audits, and investigating a taxpayer’s affairs, than the IRS.  “Generally,” of course, doesn’t mean that it can’t be extraordinarily effective if it wants to be.

Read more…

The Notice of Federal Tax Lien on Personal Property and Bankruptcy

Debtor’s often have Notices of Federal Tax Liens outstanding at the time they file bankruptcy.  How are these handled?

First, a properly-noticed lien survives bankruptcy.  It continues to attach to any property owned at the time of the bankruptcy.  It does not attach to any property acquired after the petition date.

  1. Lien on real property.  If the bankrupt debtor owns a house and the IRS has filed a Notice of Federal Tax Lien against the debtor’s real property (in the county records), the IRS will generally keep that notice in place after bankruptcy.  The house may be underwater and the IRS lien thus worthless, but if the house appreciates in value, the IRS is entitled to the new value.

If, however, the debtor acquires a new piece of land after filing bankruptcy and discharging his taxes, the IRS lien won’t attach to the new piece of land.

  1. Personal property.  If there is a Notice of Federal Tax Lien filed against personal property, it attaches to everything the debtor owns on the day of the bankruptcy petition.  Once the debtor discharges the underlying tax, the IRS still has the right to seize all your personal assets (even those exempted) to satisfy its lien, but it just won’t.  Imagine: you, as a debtor, file for bankruptcy, go through the entire process, get your debts including your tax debts discharged, and then they send the Asset Recovery Team to your house to seize your car and sofas – for which it could get how much at auction?  Also, the lien doesn’t attach to newly-acquired property, so it would need to investigate whether the bracelet it proposes to seize and sell came from Aunt Tammy as a birthday gift after the bankruptcy petition was filed.  The IRS long ago figured out that the PR and legal problems here are huge, so they’ll go ahead and release the lien.

Relevance of Amending Tax Returns to Dischargeability of Taxes; John Fauchet to the Rescue Again


My PC filed his timely 2007 tax returns.  Seven months ago, the returns were amended reducing the tax owed.  Does the amendment restart the three year statute of limitations for dischargeability?

Stella Havkin

Stella, The three year statute runs from the date the return was first due.  Filing a late return, no matter how late, cannot change the date the return was first due.   Maybe John can comment, but when I’m working a tax case with  tax attorneys, they will file late, late, late amended returns if they believe the first return was wrong and overstated the liability.  The IRS can say, sorry, too late, but in appeals, it is my understanding, the IRS can actually consider them.  John?

Dennis McGoldrick

Stella and Dennis, I’m unaware of any statute that prevents a taxpayer from amending an already-filed tax return at any time.  See, for instance, this section of the IRM, which posits an amended return filed six years late:

The complications usually arise from the date of payment.  You can’t amend a tax return that’s already five years old and get back your original withholdings.  But you can file that return and affect the amount you owed on that return; if your five-year-old return says you owed $20,000, you never paid it, and you amend to show that you actually owe $10, your assessment will change and you’ll owe $10 – assuming the IRS doesn’t use that as the opportunity to audit you and find out that you really owed the $20,000 all along.

In Stella’s case below: the amended return shows an amount owed.  That’s what he owes; the date of assessment is the date that the IRS receives his amended return.  Count 240 days from that date, and it’s dischargeable under that rule.  But that’s not the only dischargeability rule.

The amended return doesn’t change the three-year statute all over again; the return was originally due on either 4/15/2008 or 10/15/2008, dates long since past.

But this amended return does implicate the two-year rule at 523(a)(1)(B)(ii).  You’ll have to wait another 17 months to discharge the tax showing on it, even though it decreases the assessment.

John D. Faucher