Taxes and tax debt is a common problem facing millions of Americans. Bankruptcy may be a solution. To understand taxes and bankruptcy, read on.
CAN TAXES BE DISCHARGED IN BANKRUPTCY?
Chapter 7 or Chapter 13 bankruptcy is a great solution for people who are up to their eyeballs in debt because it can wipe out most, if not all general unsecured debt. General unsecured debt is debt that is secured only by your signature. Credit cards, pay day loans, medical and dental bills are typical unsecured debts. Secured debt is debt that is secured by collateral. You can give the collateral back and not owe anything, or, you can keep the collateral and pay for it. If you owe money on a car, home or refrigerator you bought at Best Buy – your creditor has a security interest in your collateral.
There are certain limitations to what Chapter 7 & Chapter 13 bankruptcy can discharge: student loans, back child support, spousal support, criminal fines (this includes parking tickets) and income taxes, generally speaking, are not dischargeable. So why even discuss discharging taxes Bankruptcy? Well, in law there are always exceptions – and back taxes happen to have their own tricky, narrow and often confusing exceptions. People with tax debt do have some hope.
FIRST THING FIRST – WHY YOU SHOULD FILE TAXES EVEN IF YOU CAN’T PAY
Many people choose not to file their tax return because they already know that they will be unable to afford the balance due. It’s like not opening a bill because you are afraid to look at the balance, or because you can’t pay. This is a huge mistake, and I’ll explain why. First, the IRS charges penalties for both failure to file and for failure to pay. It’s simple and inexpensive to file. There is no reason why you should get hit with two penalties when you can minimize the damage with a little bit of effort.
Second, filing the return starts the clock ticking on the 10 year statute of limitations on collection of taxes due (26 USC § 6502) as well as the three year period in which the IRS can assess more taxes for the year in question (26 USC § 6501).
Last but not least, if you are looking to discharge any back tax debt for a particular year, the taxes must have been filed. There is no exception and this applies to both Chapter 7 and Chapter 13. It’s that simple. You don’t file, you don’t discharge. Period.
DISCHARGING TAXES IN CHAPTER 7 & CHAPTER 13 BANKRUPTCY IS POSSIBLE
The FIVE rules of discharging taxes: If the income tax meets all five rules, then the tax debt is dischargeable in EITHER Chapter 7 or Chapter 13.
- Federal Income Taxes Only: The taxes must be strictly for taxes on income (1040 Income Tax). Taxes such as payroll taxes, trust fund taxes, sales tax or fraud taxes cannot be eliminated in bankruptcy.
- The 3 Year Rule: The tax return on which the tax debt arises must have been due at least three years before you file for bankruptcy. The due date includes any extensions. Generally speaking the due date is April 15 of the year the return is due. If an extension is filed, then it means August 15 or October 15 of that year, or beyond to the actual filing date. If the 15th falls on a Saturday or Sunday, the return wasn’t due until the following Monday.
For example, if a tax was due from a 2005 tax return, the due date of that tax liability would be April 15, 2006. In this example, not including any extensions, you would have to wait until April 15, 2009 to file the bankruptcy in order to be eligible to discharge the IRS tax debt. Many times, you must be careful to wait the appropriate time period in order to ensure that the tax debt will be wiped out.
- The 2 Year Rule: For taxes that meet the 3 Year Rule, but you filed a LATE return, you must wait 2 years to discharge the tax from the date you filed that late return. The time is measured from the date the taxpayer actually filed the return. This means even if the debt is over three years old, if you filed the return late and two years has not yet passed, then you cannot wipe out the IRS debt.
- The 240 Day Audit Rule: If you are audited and ADDITIONAL tax is assessed, you must wait 240 days (8 months) before you can file a bankruptcy petition to discharge that additional tax. The IRS assessment may arise from a self-reported balance due, an IRS final determination in an audit, or an IRS proposed assessment which has become final. The IRS can extend this time period due to suspended collection activity because of an offer in compromise or a previous bankruptcy filing.
- The Fraud/Willful Evasion Rule: You cannot wipe out tax debt if you filed a false or fraudulent tax return or willfully attempted to evade paying taxes. For example, if you underreported income falsely, you cannot wipe out the debt after getting caught. Keep in mind, Bankruptcy fraud is less strenuous than regular fraud in that the creditor normally need not prove actual intent
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