Bankruptcy & Taxes

OFFERS IN COMPROMISE

An offer in compromise is an alternative method of settling a tax debt by offering to pay IRS less than the full amount due. It is a non-bankruptcy remedy. The submission of an offer in compromise will toll the running of (stop the clock on) the 240 assessment time period. If the taxpayer makes an offer in compromise within 240 days of filing for bankruptcy, the 240 day time period will be suspended for the time during which the offer in compromise is pending, plus an additional 30 days.

TAX LIENS

Tax debts can become "secured" debts if the taxing authority takes the steps necessary to obtain a lien against the taxpayer’s property before he files for bankruptcy. If the taxing authority obtains a pre-bankruptcy tax lien, the attachment of the lien can drastically impair a taxpayer’s ability to avoid payment of the tax through a bankruptcy filing. 

Federal Tax Liens - Attachment of Lien. To obtain a federal tax lien valid in bankruptcy, IRS must file a "Notice of Federal Tax Lien" in the real property records of the county clerk before the taxpayer files for bankruptcy. 

Real Property (Land & Improvements). To assert a valid tax lien against real property (land and improvements to land), IRS must file the tax lien notice in the county where the land is located. 
Personal Property. 
To assert a valid tax lien against personal property (everything other than land and improvements to land), IRS must file the tax lien notice in the county where the taxpayer resides on the date the tax lien notice is filed. It is irrelevant whether the property is located in a county different from the taxpayer’s residence or whether the taxpayer moves to a different county after IRS files the tax lien notice. If the tax lien is properly secured, the taxpayer can not defeat the lien by moving his residence or property to a different county.

Pre-Bankruptcy Liens Survive Bankruptcy. A tax lien will continue to exist after the entry of a bankruptcy discharge with respect to all property the taxpayer owns on the date he files for bankruptcy. Although the tax lien survives bankruptcy, the taxpayer’s personal liability to pay the tax will be released if all other requirements for a bankruptcy discharge are satisfied. This means that after the entry of a discharge order, the taxing authority can never collect the tax as a personal obligation of the taxpayer, but can pursue collection by seizing and selling any property the taxpayer owned on the date he filed for bankruptcy.

Tax Liens Do Not Attach to Post Petition Property. Tax liens do not attach to property acquired by a taxpayer after he files for bankruptcy, unless he acquires the property with funds or property he owned before filing for bankruptcy. In other words, if the tax debt is dischargeable, and the taxpayer acquires any property after he files bankruptcy, with funds earned after the bankruptcy filing, the taxing authority will not be able to seize and sell the post petition property to pay the tax. For this reason, a tax lien will not affect a taxpayer with few assets on the day he files for bankruptcy.

STATUTE OF LIMITATION

Federal Taxes. 
IRS’s ability to collect any federal tax expires 10 years after it assesses the tax, unless it commences a lawsuit to collect the tax, obtains a favorable court judgment and periodically renews the judgment. The 10 year statute of limitations also applies to tax liens. A federal tax lien will expire 10 years after the tax is assessed, unless IRS begins a lawsuit to collect the tax, obtains a favorable court judgment, and periodically renews the judgment. The 10 year time period begins to run on the date IRS assesses the tax, not on the date it files a tax lien. A bankruptcy filing is unnecessary if the taxpayer’s primary goal is to avoid payment of a federal tax assessed more than 10 years ago.

Example: Taxpayer owes unpaid employment taxes (both the employer and employee portions) for the 1996 tax year. The unpaid tax was assessed on 1/15/1997. IRS files a tax lien five years later on 1/15/2001. Taxpayer can never discharge the employee portion of the tax in bankruptcy. However, the tax will become uncollectible, and the tax lien will expire, unless IRS files suit to collect the tax on or before 1/15/2007, 10 years after the tax was assessed. 

Chapter 13 Cases. The rules relating to discharge-ability of tax debts are more liberal in Chapter 13 cases than Chapter 7 cases. Tax claims (as well as all other debts) are classified as secured, priority or general unsecured debts. The classification of a debt as secured, priority or general unsecured will usually determine whether the taxpayer must pay all or none of the tax, and whether interest and/or penalty must be paid. 

Priority Taxes. A Chapter 13 repayment plan must propose full payment of all "priority" debts. The bankruptcy court will not approve a plan that does not meet these guidelines. A "priority" tax is any income, employment, sales or property tax which can not be discharged in a Chapter 7 case, except for two very important differences as follows: 

Two Tear Rule Not Applicable. The two year filing rule does not apply in Chapter 13 cases. For income tax debts, the tax will be classified as "general unsecured" rather than "priority," and can be discharged without payment, even if the taxpayer never files a tax return, so long as the 3 year age and 240 day assessment rules are satisfied. 

For employment taxes, the employer portion will not be classified as "priority," and can be discharged without payment, if the tax satisfies the 3 year age rule. A taxpayer’s failure to file a 941 tax return will not prevent discharge of the tax. 

Example

Chapter 7: The taxpayer never filed any federal income tax returns for the 1996 through 2006 tax years. Taxpayer can never discharge any of these taxes in a Chapter 7 case. It does not matter when the case is filed. A tax can never be discharged in a Chapter 7 case if Taxpayer never files a tax return. 

Chapter 13: If Taxpayer files a Chapter 13 case on or after April 16, 2007, the 1996 through 2003 taxes will be classified as "general unsecured" and can be discharged without payment if Taxpayer successfully completes a Chapter 13 plan ( assuming it is a plan in which the unsecured creditors do not get paid). The 2004 through 2006 taxes will be classified as "priority" taxes and the Chapter 13 plan must provide for full payment of these taxes. 

Tax Evasion Limitations Not Applicable in Chapter 13. The rules preventing discharge of taxes resulting from willful evasion or a fraudulent return do not apply in Chapter 13 cases. In Chapter 13, the taxpayer can discharge the tax without payment, even if he is guilty of tax evasion or filed a fraudulent return. However, the government can still criminally prosecute the taxpayer for tax evasion, even after the taxes have been in Chapter 13, so long as the 6 year statute of limitation for tax fraud prosecutions has not expired.

Interest and Penalty on Priority Tax Claims. A priority tax claim includes all accrued interest though the bankruptcy filing date, but excludes all accrued penalties. The Chapter 13 plan will not pay post filing interest on any priority claim, including priority tax claims.