WARNING TO ALL VISITORS: I AM
NOT A TAX ATTORNEY, DO NOT RELY ON ANY TAX ADVICE ON THIS
PAGE. GET ADVICE FROM A COMPETENT TAX ATTORNEY WHO
UNDERSTANDS BANKRUPTCY LAW.
DISCHARGING PERSONAL FEDERAL INCOME TAXES: article
by Dan Furlong, Arizona bankruptcy attorney.
Splitting A Tax Year In
Chapters 7 And 11.
The general rule is that
the chapter 7 trustee cannot pay taxes that become due for
the tax year in which the bankruptcy was filed. For example,
if you file chapter 7 bankruptcy on July 1 of a year (one
half through the tax year) and the following April it is
determined that you owe income taxes for that year, the
trustee will not pay any of those taxes, not even one half,
unless you split the tax year as explained in the next
paragraph. There is language in the bankruptcy code, 11 USC
§507(a)(8)(A)(iii), that seems to say the trustee can pay
such taxes. However, most courts, including In re Allen,
Bkrtcy. D. Mass. December 11, 2006, No. 04-1266-JNF have
ruled that the trustee cannot pay such taxes unlessthe
debtor elected to split the tax year.
The IRS code, 26 USC
§1398(d)(2)(A), allows a Chapter 7 or Chapter 11 debtor to
split a tax year into two short tax years. One short tax
year ends the day before the bankruptcy is filed. The other
short tax year starts the day the bankruptcy is filed. If
such an election is made by the debtor, then the tax
liability for the first short tax year may be paid by the
trustee as a priority claim.
The election by the debtor to
split the tax year must be made on or before the due date
for filing the return for the tax year in which the
bankruptcy was filed. The election is irrevocable.
However, the election does
not apply if the bankruptcy is dismissed. The election may
not be made if the debtor has no nonexempt assets. Daniel F.
Furlong
SUMMARY: Most federal income taxes in Chapter 7 are
dischargeable only if the debtor meets all of the following
conditions:
-
The
discharge is for income taxes: Payroll taxes and
penalties for fraud are not eligible for discharge.
-
The
debtor filed a legitimate tax return: The debtor filed a
tax return for the relevant tax years at least two years
before filing for bankruptcy.
-
The tax
liability is at least three years old: The tax debt is
from a tax return that was originally due at least three
years before filing for bankruptcy.
-
The
debtor is eligible under the 240-day rule: The
IRS assessed the tax debt at
least 240 days before the debtor filed for bankruptcy.
-
The
debtor did not commit willful tax evasion: Possible
evasive actions include changing your Social Security
number, your name, or the spelling of your name;
repeated failure to pay taxes; filing a blank or
incomplete tax return; and withdrawing cash from a bank
account and hiding it.
-
The
debtor did not commit tax fraud: The return contains no
information that was intended to defraud the
IRS.
In other
words, there are a number of subtle requirements that must
be met before you can discharge a tax debt in bankruptcy.
The best way to make sure you fulfill the requirements is to
speak to a local attorney.
1/12/12 - DO YOU ADD 90 DAYS, OR 180 DAYS TO CDP TOLLING
PERIOD? IRS says 90, but won't put it in writing!
As we know, in order to discharge a personal income tax
liability in bankruptcy, five rules must be satisfied.
One of these rules is, the bankruptcy must have been filed
at least more than 3 years from the most recent due date for
filing the return (typically, from April 15, or October 15).
The 3-year period is extended for certain "tolling" events
that may, or may not have occurred in the history of the
liability.
For example, if, during the running of the 3-year period,
the debtor filed either a previous bankruptcy, or a request
for a collection due process hearing ("CDP"), the clock
stops on the running of the 3-year period, for a
period of time as provided in the Bankruptcy Code. But
the language of the Bankruptcy Code appears to be at odds
with the rule as actually practiced by the IRS, and therein
lies a potential disaster for analysis of dischargeability
of taxes.
A strict reading of the Bankruptcy Code, and the Tax Code,
on the tolling effect of a CDP clearly results in the
conclusion that the tolling period is the period from
initial request for a CDP, to the date of final
determination of the hearing, plus an additional 180 days.
The problem is that bankruptcy practitioners, and the IRS,
assume one need only add 90 days. But if in fact one must
add 180 days, it's inevitable that some attorneys are going
to file cases after only 90 days have been added, thus
resulting in non-dischargeability, because the 3-year period
will not have been satisfied.
Tolling and Taxes: the 3-year period that
ordinarily commences on the most recent date the tax return
for the year in question is due, pursuant to 11 U.S.C. §
507(a)(8)(A)(i). The basic rule is, if the tax collection
entity (state or federal) is prohibited from tax collection
due to the existence of the automatic stay in a bankruptcy
case that arose during, or overlapped, the running of the
3-year time, the time is tolled (or "suspended") for the
time in which the previous case's automatic stay overlaps
the 3-year period, plus an additional 90 days.
That rule is relatively simple to apply. You begin
with the due date, extend it out 3 years, then add the time
a prior bankruptcy case stay overlapped, then add on an
additional 90 days.
THE COURT HELD THAT THE
DEBTORS' PRIOR CHAPTER 13 DID NOT TOLL IRS COLLECTION OF THE
TAXES - HENCE THE 3-YEAR RULE WAS SATISFIED AND THE TAXES
WERE DISCHARGED
KOVE V. INTERNAL REVENUE SERVICE SEPT. 22 2011 (Bkrtcy.W.D.Wisconsin)
The debtors in this case filed a prior chapter 13 prior to
the date several previous tax liabilities actually came due.
That case was later dismissed prior to plan completion.
The plan contained the boilerplate provision found at 11
U.S.C. § 1327(b) vesting all property into the hands of the
debtors. Subsequently, more than 3 years following the
filing due date of the previous tax liabilities, the debtors
filed a new chapter 13. The IRS argued that the prior
chapter 13 had tolled the running of the 3-year period, thus
rendering the liabilities non-dischargeable in the new case.
The case raised several questions.
1. If a tax is not due at the time the bankruptcy is filed
and the automatic stay arises, can it be said that the
filing of the bankruptcy tolled the 3-year period, given
that the stay did not prohibit collection (since there were
no taxes due for which collection could be "prohibited")?
2. Did the prior chapter 13 toll the 3-year period at all,
since the confirmation of the plan re-vested the assets (or
a substantial portion of them) into the hands of the debtors
(thus rendering them not protected against post-petition tax
collection).
In other words, where the IRS was prohibited from collecting
only a portion of the debtors' assets (the
postpetition income dedicated to the plan), did the case
toll the running of the 3-year period? The court said,
no.
The court made several rulings, including, that it is not
the bankruptcy per se that can be said to prohibit
collection, but rather the automatic stay; that it cannot be
said that the IRS was prohibited from collecting a tax that
had not yet come due; and that since the Plan did not
prohibit all tax collection, it cannot be said that the time
period was tolled for discharge purposes.
Excerpted from the opinion:
" ... after confirmation the debtor receives control of at
least some of the assets which had formerly been property of
the estate. What does this mean for the equitable tolling
(or suspension) of the lookback period in this case? After
the debtors' extension requests expired, the 2005 and 2006
income taxes were due October 15, 2006, and October 15,
2007, respectively.
"The debtors' chapter 13 plan was confirmed in February of
2006. The plan does not appear to have contained any
provision which would prohibit the collection of these tax
claims. The confirmation returned control over all
pre-confirmation property of the estate to the debtors, and
at least some post-confirmation property as well.
"This revesting meant that the automatic stay — which had
previously acted to prevent post-petition creditors from
pursuing property of the estate — was no longer "in effect"
as to those assets. The stay never prohibited the IRS from
pursuing a collection action against the debtors, and at the
time these tax claims came due, the "stay of proceedings"
was in effect (at most) as to only a portion of the debtors'
post-confirmation assets.
"Which circles back to the crucial question. Was the IRS
actually prohibited from collecting these tax claims at any
point after the October 2006 due date of the 2005 taxes or
the October 2007 due date of the 2006 taxes?
"This Court agrees with [prior case] Jones that the answer
to this question is no. The tolling provision of § 507(a)(8)
only applies to situations in which the taxing authority
was actually affected by the automatic stay in the prior
case.
"The phrase "stay of proceedings" in the statute relates to
"an otherwise applicable time period" as to collection of
tax claims. The congressional purpose in enacting the
statute was to codify the decision in Young, which was
premised upon the idea that tolling was justified because
the IRS had been "disabled from protecting its claim" during
the pendency of the prior case. ... As the IRS did not in
fact suffer under any such disability, and could instead
have acted to collect the post-confirmation taxes at any
time after they came due from those assets which had
revested in the debtor upon confirmation under § 1327, there
is no basis for tolling, whether pursuant to the statute or
in equity."
CLICK HERE FOR FULL TEXT OF CASE
Loving v. United States (In re Loving) (Bankr.S.D.Ala.,
2011) (8/29/11) DEBTOR FILES CASE BEFORE 3-YEAR RULE
SATISFIED
On April 8, 2011 a consumer bankruptcy attorney filed a
bankruptcy case to discharge income taxes for tax year 2007.
Unfortunately, the 3-year rule would not be satisfied until
7 days later (April 15 2011). The IRS objected to discharge,
citing the 3-year rule that the due date for filing the
return must be over 3 years prior to filing the bankruptcy.
11 U.S.C. § 507(a)(8)(A)(i).
The Court observed: "In [her] response, Plaintiff
asserted that she filed her tax return on February 19, 2008,
a date that is more than three years prior to her bankruptcy
filing. Also, she alleged that her 2007 taxes were assessed
more than three years prior to her bankruptcy filing."
In granting the IRS motion for summary judgment in the case,
the court noted that the rule regarding when a tax is
assessed had no bearing on the key issue here; to be
dischargeable the tax must have been assessed more than 240
days prior to bankruptcy, which occurred in this case. 11
U.S.C. § 507(a)(8)(A)(ii). The court also observed that the
date the bankruptcy was filed was within 3 years from the
most recent due date for filing the return.
Morgan King - Ed. Note: This case is a textbook example
of the attorney getting the rules for discharge all mixed
up.
240 day rule: tax must be assessed more than 240 days.
2 year rule: the taxpayer must file his/her return more than
2 years before the bankruptcy. 11 U.S.C. § 523(a)(1)(B).
3 year rule: The due date for filing the return that must be
over 3 years prior to the filing of the bankruptcy. The due
date is either April 15th of the year following
the tax year, or at the time of all extensions.
Litigating Position Regarding
the Dischargeability in Bankruptcy of Tax Liabilities
Reported on Late-Filed Returns and Returns Filed After
Assessment:
http://www.irs.gov/pub/irs-ccdm/cc_2010_016.pdf
Sales
taxes or transaction privilege taxes:
4-08:ADOR
vs Action Marine, Az Ct Apps 1 CA-TX 06-0006 - in a
recent Arizona Supreme Court decision that holds that the
"responsible persons" for a business entity may be
PERSONALLY liable for the transaction privilege taxes (you
probably call these sales taxes) collected by an entity if
the entity doesn't pay them over to the ADOR, even if the
entity files for bankruptcy relief. Historically, most
people would have thought that the "responsible person" for
the taxes was just the entity itself and not the individuals
involved in the entity and that the individuals could not be
held liable. Indeed, that was the very holding in
bankruptcy decision called "Inselman" that is cited by the
Arizona Supreme Court.
In re: Brenda Marie Jones, No. 10-60000
In a bankruptcy dispute involving the discharge of taxes
owed by debtor in a new chapter 7 case to the California
Franchise Board, judgment of the bankruptcy court is
affirmed where debtor's prior Chapter 13 bankruptcy case had
no effect on the look back period such that the period was
not suspended and the tax debt discharged. Read
more...
Practical Notes: in order to be certain that a tax is
discharged - file an adversary in the bankruptcy to
discharge the debt. This gives us an order that the IRS has
to follow. IRS no longer uses the efficient and logical
administrative procedure regarding dischargability of income
taxes in chapter 7 bankruptcy cases that they used for so
many years where we could write to them and they would tell
us if they agreed that the tax was dischargeable. In the
adversary, IRS will usually stipulate to the order if the
times are correct. This gives the debtor ironclad proof of
the dischargeability.
Regarding the extension, look at the transcript. An entry
for “Code 460, Extension of time to file” certainly shows an
extension. Also, look for the Code 150: “Tax Return
Filed”. This will show a date. A date before August 15
usually indicates an April 15 filing; IRS just logs it in
late. If the case is still open, you could still file the
adversary. Or, go the the IRS local office now and try and
get them to agree that the tax is discharged.
WARNING: THE FOLLOWING IS OLD LAW AND MAY OR MAY NOT
APPLY TO ANY CASES FILED AFTER OCTOBER 17, 2005.
Taxes and BK -
nonfiling pre-BK and no assessment by IRS, more than 3 years
old + non priority. Neilsen has decided that such taxes are
priority (State agrees) but IRS still does not believe that
these are priority. (11/97)
As of 1997 the information below
was the law
on how to discharge taxes after a bankruptcy has been filed.
It may have dramatically changed since this writing. This should be included in every client letter of a person who
owes back taxes to the Federal Government. (This info was
obtained at
http://www.mckenzielaw.com/BANKRUPT.html )
As a result of Bankruptcy Code
Sections 523 and 507 the following taxes are dischargeable:
1. Tax penalties for
non-filing, late payment, late deposit, fraud penalties and
late estimated payments if the taxes to which they relate are
dischargeable.
2. Income taxes which are:
a. Over three years old;
b. Have been filed at
least two years prior to the petition; and/or
c. Have been assessed as
an audit deficiency for at least 240 days.
3. Estate and gift taxes which
are over three years old.
** A taxpayer must not have filed
a fraudulent return or otherwise tried to willfully evade
payment of the tax.
Once a discharge has been entered
by the Bankruptcy Court, submit a written request to Special
Procedures Branch that the IRS abate the tax. The Service will
abate the liability by preparing a Form 3870. The author has
found that the IRS is very inefficient in preparing
post-bankruptcy abatements. Many clients have had levies made
on their wages or bank accounts after a bankruptcy. You must
aggressively pursue abatement. If all else fails, the client
may request that the Bankruptcy Court hold the IRS in contempt
of court. Until the IRS begins protecting the rights of
bankrupts, the IRS may take illegal levy action
notwithstanding the bankruptcy. If you have taken reasonable
steps to notify the IRS of the bankruptcy and discharge, you
will have a potential cause of action for reckless violation
of the Code [IRC § 7433].
However, the Bankruptcy Court has
the authority upon review of a debtor's Chapter 7 bankruptcy
to deny discharge and dismiss the matter if it believes the
debtor can partially or fully repay some debts. In other
words, the Court might try to force a conversion to a Chapter
13 bankruptcy upon a person who originally petitioned for a
Chapter 7 bankruptcy. Such a decision is based upon an income
and expense statement which all debtors have been required to
file since the 1984 amendments to the Bankruptcy Code.
IN RE BUNYAN (01/20/04 - No.
02-56786) (U.S. 9th Circuit Court of Appeals) Pursuant to 11
U.S.C. section 505(a)(2)(A), the bankruptcy court lacked
jurisdiction to consider the validity of income tax
assessments filed by the IRS in Chapter 13 proceedings. A 1993
circuit court order granting the Commissioner's motion to
dismiss necessarily adjudicated the issue of when the tax
court decisions became final.
DUNMORE
v. U.S., (9th Cir. 2004) ONLY BK ESTATE HAD STANDING TO
PURSUE TAX REFUND THAT DEBTOR FAILED TO SCHEDULE
Dunmore, as a debtor seeking bankruptcy relief, had a duty to
carefully schedule his assets, including his refund claims, on
his bankruptcy petition. Cusano v. Klein, 264 F.3d 936, 945-46
(9th Cir. 2001). Dunmore, however, breached this duty when he
chose not to schedule his claims against the IRS on his
Chapter 7 petition. By operation of statute, assets that
Dunmore failed to schedule remained the bankruptcy estate's
property, even after the court discharged his debt. 11 U.S.C.
§ 554(c), (d). Thus, the unscheduled tax refund claims
remained the estate's property post-bankruptcy. Accordingly,
we conclude that the bankruptcy estate was the real party
plaintiff in interest at the time Dunmore filed his action.
IN RE OLSHAN (01/28/04 - No. 02-56792) (U.S.
9th Circuit Court of Appeals) Bankruptcy court erred in
rejecting the IRS' claims for unreported nonbusiness income
and overstated business deductions after finding that the IRS'
method of computing debtor's unreported business income was
flawed. Undisputed evidence in the record will enable the
bankruptcy court to determine debtor's liability for taxes,
penalties, and interest.
DUNMORE v. US (01/29/04 - No.
02-15789) (U.S. 9th Circuit Court of Appeals) Plaintiff's tax
refund claims are "non-core" proceedings under the Bankruptcy
Code, despite the offset claim asserted by the IRS; the
bankruptcy court therefore could not enter a final judgment
without plaintiff's consent. District court abused its
discretion when it affirmed the bankruptcy court's final order
dismissing the claims.
US INTERNAL REVENUE SERV. v.
SNYDER, No. 02-15618 (9th Cir. September 15, 2003) An IRS
claim for delinquent taxes secured outside of bankruptcy by a
lien on a debtor's interest in an ERISA-qualified pension plan
is not secured under 11 U.S.C. section 506(a), because a
debtor's interest in an ERISA-qualified plan is excluded from
the bankruptcy estate pursuant to 11 U.S.C. section 541(c)(2).
http://caselaw.lp.findlaw.com/data2/circs/9th/0215618p.pdf
US INTERNAL REVENUE SERV. v.
SNYDER (9th Cir. 09/15/03 - No. 02-15618) An
IRS claim for delinquent taxes secured outside of bankruptcy
by a lien on a debtor's interest in an ERISA-qualified pension
plan is not secured under 11 U.S.C. section 506(a), because a
debtor's interest in an ERISA-qualified plan is excluded from
the bankruptcy estate pursuant to 11 U.S.C. section 541(c)(2).
http://caselaw.lp.findlaw.com/data2/circs/9th/0215618p.pdf
ERRONEOUS TAX REFUND IS DISCHARGEABLE
In re Frontone ___ B.R. ___ (C.D.Ill. 2003)
Held, an overpayment to the taxpayer of a tax refund
is a debt owed to the IRS, but is not treated the same as the
underlying tax, and therefore is dischargeable in Chapter 7.
In May 2001 the IRS sent debtors a notice saying they had
overpaid their tax and refunded them $5,140. Subsequently, the
IRS assessed additional taxes owed, and demanded the refund be
paid back. In September 2002 the debtors filed Chapter 7 and
filed an objection to the IRS claim. The court held that §
507(c) gives an erroneous tax refund the same “priority” as
the underlying tax, but not the same nondischargeable status.
“The legislative intent behind the change made in 1984 to the
language of Section 507(c) is easy to ascertain. Congress
obviously concluded - correctly - that it is inequitable to
treat taxpayers who fail or decline to pay their income taxes
the same as taxpayers who pay their income taxes but who incur
obligations to a governmental unit as a result of that
governmental unit's erroneously refunding taxes paid.”
http://caselaw.lp.findlaw.com/data2/circs/9th/0156992p.pdf
GOLDBERG
v. ELLETT (07/16/01 - No. 00-15128) (9th Cir.
Ct App) Bankruptcy court may enjoin a state tax official
from collecting state taxes purportedly discharged in a
bankruptcy proceeding in which state declined to
participate.
http://caselaw.lp.findlaw.com/data2/circs/9th/0015128p.pdf
DEROCHE v.
ARIZONA INDUS. COMM'N (11/29/01 - No. 99-16058) (9th
Cir. Ct App) In determining whether an employer's failure to
provide worker's compensation is an "excise tax" to the
Arizona Special Fund for worker's compensation and occurred
within three years prior to bankruptcy, the date of the
"transaction" is the date employee was injured.
http://caselaw.lp.findlaw.com/data2/circs/9th/9916058p.pdf
N. SLOPE
BOROUGH v. BARSTOW (10/21/02 - No. 01-35892/35901)(9th
Cir) Under Bankruptcy Code section 724(b), priority unsecured
creditors have a right to obtain only that portion of the
proceeds equaling the amount of the tax liens. Any remaining
proceeds go first to junior lien claimants, then to the
holders of the tax liens insofar as their claims were not
already satisfied and, finally, to the estate.
http://caselaw.lp.findlaw.com/data2/circs/9th/0135892p.pdf
BARSTOW v. US
INTERNAL REVENUE SERV. (10/21/02 - No. 01-35819) (9th
Cir) The term "tax lien" in Bankruptcy Code section 724(b)
means a statutory tax lien, and the term does not embrace a
judicial lien securing an underlying tax obligation.
http://caselaw.lp.findlaw.com/data2/circs/9th/0135819p.pdf
US v.
GALLETTI, No. 01-55953/4 (9th Cir. August 08, 2002) The IRS
cannot collect a partnership's tax deficiency directly from
the partners, without first making individualized assessments
or obtaining judgments against the partners, holding them
liable for the partnership's tax debts; bankruptcy claims were
time-barred.
http://caselaw.lp.findlaw.com/data2/circs/9th/0155953p.pdf
STEIN v. CADLE CO. (05/10/01 -
No. 99-56751) Under the Federal Priority Statute, 31 USC
3713 gives the federal government priority over other
judgment creditors notwithstanding the Federal Tax Lien Act.
http://caselaw.lp.findlaw.com/data2/circs/9th/9956751p.pdf
DEROCHE v. ARIZONA INDUS. COMM'N,
No. 99-16058 (9th Cir. April 05, 2002) When determining the
dischargeability in bankruptcy of an excise tax owed on a
"transaction," in which an employer reimbursed the state's
Special Fund for failure to carry insurance, the date of the
"transaction" is the date on which the worker was injured;
thus, since transaction occurred over three years prior to
filing bankruptcy, the excise tax debt was dischargeable.
MILLER v. US, No. 02-17073 (9th
Cir. April 13, 2004) The interplay of Bankruptcy Code sections
1141(d)(2), 523(a)(1)(A), and 507(a)(8) renders an IRS claim
for unpaid withholding taxes nondischargeable by a confirmed
Chapter 11 bankruptcy plan, whether or not that claim was
secured.
http://caselaw.lp.findlaw.com/data2/circs/9th/0217073p.pdf
OPINION
SUMMARIES ARCHIVE FindLaw archives case law summaries of
opinion issued since September 2000 by the U.S. Supreme Court,
all thirteen Federal Circuit Courts, the California Supreme
Court, the California Appellate Courts, and the New York Court
of Appeals.
http://caselaw.lp.findlaw.com/casesummary/index.html
