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DISCHARGING TAXES IN BANKRUPTCY
Posted on Wednesday, October 30 @ 05:32:09 MST by editor

USA  United States DISCHARGING TAXES IN BANKRUPTCY

 

 

DISCHARGING TAXES IN BANKRUPTCY

 

Daniel M. Press © 2013                                                                                  NVBBA 9/18/2013
dpress@chung-press.com

Chung & Press, P.C.
6718 Whittier Ave. #200
McLean, VA 22101
703-734-3800
703-734-0590 fax

DISCHARGING INCOME TAX IN CHAPTER 7

 

The requirements to discharge taxes, found in 11 U.S.C. § 523(a)(1) and § 507(a)(8), apply equally to State and Federal income taxes.

 

An income tax is dischargeable, and not a priority debt, if it meets all of the following requirements:

 

(a) THE THREE-YEAR RULE [§ 521(a)(1)(A)/§ 507(a)(8)(A)(i)]

 

The due date for the return (typically April 15 of the year after the taxable year), including extensions, is more than three years before the filing date.  An extension to file the return delays the start time.

 

WATCH FOR: Extensions, including automatic extensions; State due dates later than federal due dates; Due dates extended because they fall on weekends/holidays.

 

TOLLING: Prior bankruptcy, collections due process hearing (any collections hearing or appeal that tolls collections), plus 90 days (Lastra v. United States (In re Lastra), 2012 W.L. 6681739 (Bankr. D.N.M. 2012)).   NOT tolled by Offer in Compromise (In re Paradis, 477 B.R. 295 (Bankr. D. Me. 2012)), nor by installment agreement.

 

A tax that fails the 3-year test is a priority debt, and is not dischargeable.

 

(b) THE TWO-YEAR RULE [§ 523(a)(1)(B)]

 

A return or equivalent report or notice, if required, has been filed or given either on time (including extensions) or at least two years before the filing date of the bankruptcy.

 

WATCH FOR: What is a “return?”   What is an equivalent “report or “notice?”

 

Per the hanging paragraph following § 523(a)(19), a "return" means a return that satisfies the requirements applicable of non-bankruptcy law.  It includes SFRs prepared pursuant to IRC § 6020(a), but not SFRs pursuant to § 6020(b).  See  Moroney v. United States (In re Moroney), 352 F.3d 902 (4th Cir. 2003) (Once an SFR filed, a subsequent "return" is still not a "return").

 

WATCH FOR: State tax:  The required report after a federal audit adjustment is the equivalent of a return.  In re Ciotti, 638 F.3d 276 (4th Cir. 2011).

 

NOT TOLLED under the Code by prior bankruptcy, OIC, CDP, etc.   BUT: IRS takes the position that equitable tolling applies.  See below.

 

Failing the 2-year rule makes the tax non-dischargeable, but does not make it a priority debt.

 

(c) THE 240-DAY RULE [§ 521(a)(1)(A)/§ 507(a)(8)(A)(ii)]

 

The tax was assessed at least 240 days preceding the filing date of the bankruptcy, EXCLUDING the time an Offer in Compromise was pending or in effect (plus 30 days), or a stay of proceedings against collections was in effect due to a prior bankruptcy case or collections due process hearing (any collections hearing or appeal that tolls collections), plus 90 days.

 

WATCH FOR:  Offers in compromise:  If possible, avoid filing until 240 days after assessment.

 

WATCH FOR:  Date of IRS assessment is easily ascertainable from an account transcript.  State taxes may not be so easy.  

 

Obtaining Account Transcripts.

Get IRS Form 8821 signed by client.

Call the Hotline at the IRS Hotline phone number.

IRS Priority Hotline tel. # is (866) 860-4259.

 

WATCH FOR: taxes not assessed but still assessable post-petition (other than those non-dischargeable due to the 2-year or fraudulent/evasive rules) fail the 240-day rule.

 

NOTE:  A subsequent assessment starts a new 240-day period only as to the additional tax assessed. 

 

Failing the 240-day rule makes the tax a priority debt, and not dischargeable.

 

(d) NON-FRAUDULENT RETURN, NO WILLFUL EVASION [11 U.S.C. § 523(a)(1)(C).

 

The return in question was not fraudulent and there was no willful attempt to evade or defeat the tax.

 

Fraud or evasion makes the tax non-dischargeable, but does not make it a priority debt.

   

NOTE: TRUST FUND TAXES (EMPLOYEE SHARE 941's, MOST SALES TAXES) ARE NEVER DISCHARGEABLE!!

   

INCOME TAX IN CHAPTER 13

 

If the tax fails the 2-year rule, or is fraudulent or evasive, the tax is not discharged  (even if paid in full, interest still accrues).  Otherwise the tax is dischargeable in a Chapter 13.   BUT ... priority taxes must be paid in full (assuming the taxing authority files a proof of claim).

 

Do not self-file a proof of claim for a dischargeable tax (unless your client wants insurance against owing it if the case dismisses or converts)!

   

PENALTIES

 

Penalties other than in compensation for actual pecuniary loss (i.e., basically all penalties except trust-fund recovery penalty) are not priority debts.  They are dischargeable in chapter 13.  In chapter 7, penalties are dischargeable if the transaction or event for which the penalty is assessed is over 3 years old. 11 U.S.C. § 523(a)(7)(B).

   

TAX LIENS IN BANKRUPTCY

 

Liens survive bankruptcy but, if the tax is discharged, do not attach to after-acquired property.

 

IRS liens attach to exempt property, including entireties property and “non-estate” property such as 401(k) accounts and 529 plans. 

 

IRS liens can be stripped down/off under 11 U.S.C. § 506.

 

Interest on tax liens must be paid at the statutory rate.   11 U.S.C. § 511.

 

Tax liens are subject to subordination to other priority claims.  11 U.S.C. § 724(b).

   

For more information, see IRS Publication 908, Bankruptcy Tax Guide

http://www.irs.gov/pub/irs-pdf/p908.pdf

   

ISSUES:

 

1.         Is the two-year rule subject to equitable tolling?   In Young v. United States, 523 U.S. 43 (2002), the Supreme Court held that the pre-BAPCPA three-year rule was subject to equitable tolling based on the pendency of a prior bankruptcy petition.

 

Congress “codified” this holding in BAPCPA, but only did so in 507 with respect to the priority taxes (the 3-year and 240-day rules).  The statute says nothing about tolling the 2-year rule.  Thus, under inclusio unius, exclusio alterius, Congress intended to only toll those provisions and not the 2-year rule.  However, the IRS has begun to take the position that a prior bankruptcy (and perhaps other events such as CDP hearings/appeals) equitably tolls the two-year rule.

 

There is no case law on this point at this time. 

   

2.         Is a late filed return a “return” for purposes of triggering the start of the 2-year rule?  This would seem pretty obvious, because the two-year rule exists only with respect to late filed returns.  But the 5th Circuit in In re McCoy, 666 F.3d 924 (5th Cir. 2012)  held that a late-filed return is not a “return” and thus the tax is never dischargeable.

 

            § 523(a)(1) (B) excepts taxes “with respect to which a return, or equivalent report or notice, if required— (i) was not filed or given, or (ii) was filed or given after the date on which such return, report, or notice was last due, under applicable law or under any extension, and after two years before the date of the filing of the petition.”

 

The § 523(a) hanging paragraph, added by BAPCPA, provides:

 

For purposes of this subsection, the term "return" means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements). Such term includes a return prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986, or similar State or local law, or a written stipulation to a judgment or a final order entered by a nonbankruptcy tribunal, but does not include a return made pursuant to section 6020(b) of the Internal Revenue Code of 1986, or a similar State or local law.

 

Interpreting the bold portion, the 5th Circuit included the deadline in “applicable filing requirements” and found that once late, a return is not a “return.”

 

The IRS disagrees with McCoy, I.R.S. Chief Couns. Notice No. CC-2010-016, but that does not mean that it won’t take advantage of it where it applies.

 

Note that if a return is not filed, one can comply with § 6020(a) (or similar state law) and cooperate with the IRS to file a late taxpayer-signed SFR return:

 

(a) Preparation of return by Secretary.—If any person shall fail to make a return required by this title or by regulations prescribed thereunder, but shall consent to disclose all information necessary for the preparation thereof, then, and in that case, the Secretary may prepare such return, which, being signed by such person, may be received by the Secretary as the return of such person.

 

That will clearly be a “return” to allow discharge after 2 years.

 

The cases outside the 5th Circuit are split:

 

Agreeing with McCoy (note that many of these are SFR cases, so the McCoy issue is effectively dictum):

In re Cannon, 451 B.R. 204 (Bankr. N.D. Ga. 2011);

In re Shinn, http://scholar.google.com/scholar_case?case=14187889298013115152 (Bankr. N.D. Ill. 2012);

Links v. United States (In re Links), 2009 WL 2966162 (Bankr. N.D. Ohio Aug. 21, 2009);

In re Perry, http://scholar.google.com/scholar_case?case=7522075598669202991 (Bankr. N.D. Ala. 2012);

In re Pendergast, http://scholar.google.com/scholar_case?case=2046306500215678217 (Bankr. D. Mass. 2013)

 

Disagree with McCoy:

 

In re Rhodes, A.P. No. 11-4074 (Bankr. N.D. Ga. May 6, 2013)

In re Martin, 482 B.R. 635 (Bankr. D. Colo. 2012)

In re Brown, 489 B.R. 1 (Bankr. D. Mass. 2013)

In re Perkins, A.P. 12-3030 (Bankr. D. Mass. 2013)

In re Pitts, A.P. No. 12-1191-SC (Bankr. C.D. Cal. Aug. 14, 2013)

 

There are no opinions from the 4th Circuit on this issue.

 

 

            3. How much tolling for multiple tolling events? 

 

United States v. Montgomery (In re Montgomery), 475 B.R. 742 (D. Kan. 2012): One 90-day period for multiple prior bankruptcy filings.

 

             

4.  How about post-petition taxes coming due during a prior Chapter 13?

 

            Because the automatic stay did not prevent them from being collected, tolling does not apply.  In re Kolve, 459 BR 376 (Bankr. W.D. Wis. 2011).  But see In re Tarby, http://scholar.google.com/scholar_case?case=12477894279944954130 (Bankr. D.N.J. 2012) (despite re-vesting, stay did preclude collection, so tolling applied).

   

Getting transcripts

             IRS Form 4506-T to request transcripts.

 

If a joint return, and either spouse did anything separately that could affect tax dischargeability dates, the you need to request a “non-master file” transcript.  This takes time, and should be done with a live human being on the phone.

             Practitioner hotline: 866-860-4259

   

            Transcript codes:

http://www.irs.gov/pub/irs-utl/transaction_codes_pocket_guide.pdf

http://www.irs.gov/pub/irs-utl/document6209.pdf

   

            Virginia Department of Taxation

Office of Customer Services

P.O. Box 1115

Richmond, VA  23218-1115

FAX  (804) 254-6113

   

Don’t want to run the numbers yourself?

 

            www.taxdischargedeterminator.com



 
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