A Chapter 7 bankruptcy can be filed either by individuals or corporations. One of the issues that debtors in a Chapter 7 case often face is the problem of owing large amounts income taxes. These income taxes can be either federal, state, or local. To complicate matters further, we often have situations where people have not filed their tax returns for several years. Sometimes the tax authorities will have put liens on properties or have begun to garnish wages of debtors. Trying to figure out the treatment of tax debts in bankruptcy is basically impossible with the help of an experienced attorney. Here’s the IRS’s information page on Chapter 7 bankruptcy, which is so arcane as to be nearly hopeless to decipher:
Luckily, there are better ways of approaching the problem. First, it is important to understand that the IRS (as well as state and local tax authorities) are subject to the automatic stay of bankruptcy, just like any other creditor. When a case is filed, they can’t continue their collection efforts against a debtor. They must stop garnishments and other debt collection activity.
Income tax debts (not sales taxes, withholding taxes, customs duties, property taxes, or other types of taxes) can be discharged in a Chapter 7 bankruptcy if these conditions are met:
- (1) The most recent due date for filing of your tax return for the tax in question must be more than 3 years old;
- (2) You must also have filed a tax return for each tax year which you have back income taxes, at least more than 2 years prior to filing your bankruptcy case;
- (3) The IRS or state taxing authority must also have “assessed” the tax at least 240 days prior to the date you file your bankruptcy case. Assessment generally refers to when you are told you owe the income tax.
- (4) You cannot have filed fraudulent returns, or have willfully evaded the tax. (This is very rare. Most people do not get accused of fraud or evasion by the tax authorities).
Although these requirements are easy to list, in practice they are extremely complicated to analyze. This is something you should do with the guidance of an experienced bankruptcy attorney. For example, regarding requirements (1) and (2) above, the “date” requirements can be complicated to determine, because often people get extensions on their due date for filing a return. And, in some cases, people have unfiled or amended returns. For requirement (3), it is often not an easy matter to know when the taxes were actually assessed.
Section 523(a)(1)(B)(i) of the Bankruptcy Code provides that tax debts with respect to which a tax return or equivalent report or notice was not filed or given are nondischargeable regardless of when the taxes or the return was due. This is what it is so important for a debtor to simply file his or her tax return, even if the tax cannot be paid. Failing to file a return is s commonly encountered problem, but one that should be within the means of debtors. Disputes can arise on occasion as to what constitutes the filing of a tax return for the purposes of Section 523(a)(1)(B)(i). For a document to qualify as a “return”, generally:
- It must purport to be a return
- It must be executed under penalty of perjury
- It must contain sufficient information to permit calculation of a tax
- It must be an honest and reasonable attempt to comply with the tax laws.
See In Re Wagoman, 475 B.R. 239 (B.A.P. 10th Cir., 2012). In general, documents are deemed to be “filed” when they are delivered to and received by the IRS. In addition, the return should be filed by the taxpayer and not by the taxing authority. There are times when the IRS or some other taxing authority will file its own substitute “return” (which generally is completely inaccurate) if the taxpayer has not filed it himself or herself. It appears that the burden is on the debtor to make sure that returns are promptly and accurately filed.
Finally, things can get even more complicated if there are tax liens that have been filed either pre-petition or post-petition. Then we get in to the nuances between in personam liability and in rem liability.
The bottom line here is that income taxes can be, and are, discharged in a Chapter 7 bankruptcy all the time. But analyzing the factors discussed in this article is not as simple as it seems. You need an experienced bankruptcy attorney to help you resolve these issues. Even if the taxes don’t meet the requirements for dischargeability, there are often other avenues that can be used to reduce or lower the tax burden.