All posts tagged dischargeable taxes

Tricky Tax Issues / You have an extra day to file federal tax returns

If a client of mine wants to file for bankruptcy, for the purpose of discharging income tax debt, I will wait as long as I can to be sure the three year rule is satisfied. I will make sure there are no prior bankruptcies, and I will make sure no extension was requested.

Most of the time, our clients cannot wait, and will want the bankruptcy filed asap. So when are those taxes dischargeable for this year?

I thought to myself, simple:

April 15 is a Sunday.
April 16 is Emancipation Day.

So, taxes are due on April 17!

WRONG Read more…

Taxes and Discharge – A New Horror Story

I was chatting with an attorney at the recent Inn of the Court Meeting and heard a new horror story on discharging taxes.  Seems this debtor met the three year rule, the two year rule etc. etc.  Post closing, the IRS sends a letter saying “You still owe.”  The attorney tracks down the right guy at the IRS who promises to investigate.  Some time later he calls back and advises the attorney that the debtor was a resident of some county in Texas some time ago when the IRS unilaterally gave everyone an eight (or ten or whatever) month extension on filing their tax returns because of a disaster that had hit the area.  Therefore the due date of the tax return was not what they thought it was and was not more than three years before the filing.  Pay up!

Why can the IRS use a refund to pay off dischargeable taxes?

The client owes $15,000 in taxes for the 2004 tax year, and you’ve done the analysis and determined that this is a dischargeable debt.  He also owes $10,000 for the 2009 tax year, and this isn’t dischargeable.  For some reason, no notices of federal tax lien are on file, so there is no question of a secured debt (or so you think).  After filing his 2011 tax return, he gets a $12,000 refund.  You’re filing his chapter 7 petition tomorrow.  What happens to the refund?

Answer: it pays off $12,000 of the dischargeable tax from 2004, and none of the 2009 liability.
Why, you ask?  And then, depending on your temperament, you may even add the phrase “that ain’t fair” after your question.  After all, the IRS didn’t have a Notice of Federal Tax Lien, so why does it get to pay itself on a tax debt that is going to be discharged?

The reason is that the 2004 tax debt, while dischargeable, is also secured, specially if the person gets to know the Different Types Of Loans. IRC Section 6321 puts a silent lien on all property of a tax debtor to secure the payment of tax. When the taxpayer gives the IRS money in the form of excess withholding of tax, the IRS has a lien on that money to pay the delinquent tax.  Because this is not a voluntary payment, the IRS, not the taxpayer, gets to determine where the tax refund will be applied.

So, as of December 31, 2011, the taxpayer-debtor had a credit of $12,000 on his 2011 tax account (even if this computation did not take place until a few months later). He also owed $15,000 on the 2004 tax year, which we assume is the oldest collectible tax delinquency. When he files his bankruptcy petition on February 15, 2012, the IRS is in possession of his tax refund, and it may use it as an offset against the 2004 debt – prepetition asset against prepetition liability. So what if the 2004 liability was going to be wiped out in the bankruptcy? At the end of the 2011 tax year, when the IRS had full possession of the tax refund, the liability existed.

The good news for your debtor: the IRS won’t apply his 2012 refund against the 2004 liability, because the 2004 liability will have been discharged.