It is an all-too-common issue in bankruptcy. The bankruptcy attorney will be preparing the case for filing, and will discover that the debtor or debtors have not filed federal or state tax returns for some year or years. If there is one piece of advice I would want to give regarding bankruptcy and taxes, it is this: always file your tax returns in a timely way. Can’t pay the tax? File the return anyway. Don’t want to deal with it? File the return anyway. Stressed out or depressed? File the return anyway. Don’t want to put the effort in to get the returns done? File the return anyway.
No matter what, do not let your tax returns go delinquent. Why? The short answer is that by not filing your returns, you can potentially deny yourself benefits that you might otherwise be eligible for in bankruptcy. Elsewhere, I have written about the requirements for discharging income taxes in bankruptcy. One of the requirements for discharging your tax debts is that you must have filed your returns. Having gaps of missed returns, or incomplete returns, can make you ineligible for the benefit of discharge that you might otherwise receive.
One of the requirements for discharging income taxes in a bankruptcy is that you must have filed your income tax return at least 2 years before filing your bankruptcy petition. But this prompts an interesting question? What does it mean to “file” a return? What if the IRS or state department of revenue files a return for you? Does that count as “filing” a return? The Fourth Circuit case of In Re Maroney, 352 F.3d 902 (4th Cir. 2003) discussed just this issue. Filing a return means that you must file a return before the IRS files one for you.
Section 6020(b) of the Internal Revenue Code authorizes the IRS to file a return for you if you don’t do it yourself in a timely manner. It’s called a “substitute for return” or SFR. This all might sound convenient and nice of them to do this, but be warned. The SFR is in fact a stealth enforcement mechanism for the IRS. This is how this works. If you don’t file a return, the IRS will file one for you. And since they know next to nothing about your actual income, deductions, exemptions, and other relevant tax data, they will prepare the SFR based on their best guess as to what you might have earned. Of course, their numbers will be wildly inaccurate and you will often end up owing far more than you should. And there other consequences as well.
Because you have not voluntarily filed a return, the IRS’s 10 year statute of limitations on collections does not begin to run. And they have essentially forever to collect a SFR against you. Once you actually file your return, the agency will treat the delinquent return as a request for audit reconsideration. The SFR will be replaced by your return, hopefully.
What is a “return”? According to the Fourth Circuit, a document purporting to be a tax return must: (1) purport to be a return; (2) be executed under penalty of perjury; (3) contain sufficient data to allow calculation of tax; and (4) represent an honest and reasonable attempt to satisfy the requirements of the tax laws.
But here is another problem with SFRs. Once the IRS files one for you, it can present problems for completely discharging your old tax debt in a Chapter 7 case. And some courts (e.g., the Fourth Circuit) have taken the position that, absent some legitimate excuse, filing a return after the IRS has filed an SFR for you doesn’t qualify as a “honest and reasonable attempt to satisfy the requirements of the tax laws.”
In practice, though, there is always more than one way to reach the desired goal. Even if you do not qualify for totally discharging all your old income tax debt in a Chapter 7, you can still deal with your tax debt issues with a Chapter 13 or Chapter 11 case. In those types of bankruptcies, you would only be responsible for paying back the priority portion of the taxes (often a small fraction of the total tax debt). So, there are ways to deal with the issue.
But the bottom line is that you should always file your returns when they become due. It’s the law, it’s good practice, and it can enable you to head off serious unexpected problems down the road.
Read More: Tax Debts In A Chapter 7 Bankruptcy Case