As an Austin bankruptcy attorney I see many situations where my clients have accumulated tax obligations. There are some circumstances where relief can be obtained in a Chapter 7 filing, but the rules, like all bankruptcy matters, are very specific and fact based.
Generally your personal state and local income taxes in arrears can be discharged. If you have unpaid obligations from a prior tax return due to insufficient withholdings or a shortfall in estimated payments, those can be erased. However, if, for example, you have a household childcare employee to whom you have paid W-2 income and have withheld taxes “in trust” for government entities, you remain liable for those until fully paid. Similarly, if you run a small business and have collected sales taxes from your customers, those too remain your liability.
More common are cases where there are personal income taxes due to the IRS, and the rules there are much more complicated. You generally have to meet all these conditions to obtain a discharge:
1. You must have filed honest returns and not willfully tried to evade your taxes. If you can’t pass this first basic requirement, you need read no further.
2. More than 3 years must have elapsed since the tax return was due, including any extensions. So, as of my writing this today November 26, 2012, if you owe money on your 2008 personal income tax return for which the filing was extended to October 15, 2009, you may be in the clear. I say “may” because the 3 year rule can be extended by prior bankruptcies, innocent spouse relief proceedings, and other IRS collection hearings. As with all things related to your case, you are best served by giving me all the facts and letting me ascertain your possible standing versus any of these complex and somewhat arcane rules.
3. Your tax return in question must have been filed more than 2 years earlier than the bankruptcy petition. Thus, even if you’ve passed gates #1 and #2 above and have been careless about filing, you run afoul of this rule. As your bankruptcy lawyer I will refer you to a CPA if needed for such filings, but this is outside the scope of a Chapter 7 process.
4. And yes there’s more. At least 240 days must have elapsed since the date of any assessment you are hoping to discharge. Assessments generally arise from amended returns or audit adjustments. If, however, you’ve attempted to deal directly with the IRS via an “Offer in Compromise” (OIC) during this 240-day window, the term of that process adds to the 240 days; and it can take many months. If you’ve just worked out a simple installment agreement, you’re in the clear, as long as you are adhering to the terms of the installment plan.
And now for the bad news: Often the IRS will file a lien against you in the amount of any unpaid taxes and penalties. This lien applies to any and all assets you own at the time it is filed, and worse yet it attaches to anything you acquire while it is in place. It won’t go away until the debt is fully satisfied or the time limit for collection has expired. This rather “sticky” lien will be discovered in a title search if you try to conduct a real property transaction. If you are losing money on that transaction, the IRS may issue a waiver in that case, but if you have a gain you will be expected to apply that to your tax debt. The presence of such a lien also negatively affects your credit rating.
One important thing to note is that if a couple is considering bankruptcy and the source of a tax lien applies to only one spouse, married filing separately status on your tax returns may shield one of you from that lien. If you’ve filed jointly, however, you can’t reverse that status by amending into separate returns.
As with all things related to bankruptcy, many decisions are based on precise timing, and particularly decisions with respect to these IRS related matters. You may be able to time your bankruptcy filing in a way that gives you the maximum tax discharge benefit, but it’s the bigger picture of all your debt that is the more important. My job is to understand that full picture and help you find the best possible overall outcome in a Chapter 7 proceeding.