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TAXES CAN BE
DISCHARGED IN
BANKRUPTCY…SOMETIMES
Bankruptcy Code Sections 523(a)
and
507(a)(8) specify taxes that are not
dischargeable in bankruptcy. The following describes the general rules
under
which a debtor may or may not be allowed relief from certain tax debts.
This article discusses income,
excise, trust
fund, property and sales taxes, as well as tax penalties and tax liens.
A. INCOME
TAXES
Generally, Federal and State “income” taxes are not
discharged (forgiven)
in a Chapter
7 or Chapter
13 bankruptcy. But they can be discharged if
certain tests or conditions [per
Bankruptcy Code 11 U.S.C. § 523(a)(1)] are met:
Income
Tax Discharge Tests - all of which must be met to
discharge the tax:
1.
Three
Year “Tax Due” Test: The tax must be owed at least 3 years
after the tax
return was due. Normally, the tax return was due on April 15.
Example: 2007
taxes are due on April 15, 2008. To
pass
this test, the bankruptcy must be filed after April 15, 2011.
2.
Two Year “Tax Return” Test: The tax return must have been
filed more than 2 years
before filing bankruptcy. This rule applies to all
filers but
especially to late filers.
Example: 2005
taxes, but the tax return was not filed until August 23, 2010. To pass this test, the
bankruptcy must be
filed after August 23, 2012.
3.
240 Day “Assessment” Test: The tax must have been assessed
more than 240 days
before filing bankruptcy.
Example: The year
2006 tax return did not accurately reflect all the tax that was due;
therefore
on July 14, 2009, the IRS finished assessing additional taxes after
discovering
the mistake. To
pass this test, the
bankruptcy must be filed after 240 days, i.e., approximately March 10,
2010.
Warning – Taxes
“Assessable” but Not
Yet Assessed are not dischargeable: The Bankruptcy
Code [11
USC §507 (a)(8)(A)(iii)] defines as
nondischargeable [per 11 USC
§523(a)(1)]
taxes not yet assessed but assessable
by applicable law or agreement.
Assessable by
Law:
Federal IRS
Assessability Time Limit: Generally
three years. See
Part “H” below near the end of this
article.
California Assessability
Time Limit: Generally
four years from the later of the date of tax return filing or due date.
See
Part “H” below.
Assessable by
Agreement: Additionally,
priority (nondischargeable) tax
definition also
includes taxes that continue to be assessable “by agreement”.
It is
reported that tax officials discussing tax matters frequently pressure
a
taxpayer to sign an agreement (with a clause or provision that extends
the time
limit that taxes can be assessed).
When are
taxes “assessed?” The Internal
Revenue Code makes assessments
through the Secretary of the
Treasury. Before making an
assessment, the secretary must to send a notice
of deficiency to the taxpayer. Unless the taxpayer
contests the
deficiency, the secretary may assess a deficiency after a certain
period of
time.
For
federal income taxes, the date of the assessment is the
date the summary record is signed by the assessment officer.
Other
factors:
The 3-year and
240-day wait periods may be, in certain
cases, tolled or extended by a prior bankruptcy, request for collection
due
process hearing, an offer-in-compromise, contesting of a proposed
assessment,
and other potential factors.
4.
“Fraud” or “Motive” Test: The bankruptcy filer must not
have made a fraudulent
return or willfully attempted to evade or defeat payment of the tax [See Bankruptcy
Code - 11 USC §523(a)(1)(C)].
Example: Generally,
evidence of simple non-payment, without anything more, does not provide sufficient proof that a
person tried to evade or defeat payment of the tax.
But nonpayment combined with efforts to hinder,
frustrate and/or prevent collection may render a debt nondischargeable.
B. TRUST
FUND TAXES
Trust
fund
tax liability is not dischargeable
(forgiven, wiped out,
erased) in bankruptcy. Even
if the debt
is old, trust fund taxes are not discharged.
Common
example
of trust fund tax: Employee wage
withholding (that is, wages that an employer
withholds from the employee's paycheck).
Potentially
responsible (liable) persons: Employer or a "responsible
person" for a
corporation, LLC or partnership that did not pay withheld funds to the
taxing
authority.
In some states, sales
taxes are also trust fund
taxes. In other states, such as California,
sales taxes are excise taxes which
can be dischargeable with time. See George
v. California
State
Board of
Equalization (In re George), 95 B.R. 718, 720 n.4 (B.A.P. 9th
Cir. 1989).
C.
EXCISE TAX
An excise tax is dischargeable
if the bankruptcy petition is filed no
earlier
than three years from the date a
return is due, or if no return is due, three years from the date the
transaction occurred.
Excise
taxes are generally
taxes on events like the purchase of gasoline, alcohol, cigarettes,
airline
tickets, tires, etc. They
are usually
included in the price of the item rather than being listed separately
as sales
taxes are.
Whether
a particular tax is an excise tax varies from state to state (e.g.,
sales
taxes, estate taxes, gift taxes, wagering taxes, truck taxes, and
workers’
compensation premiums).
D.
PROPERTY TAX
A
property tax assessed before
the filing of bankruptcy is dischargeable if the bankruptcy petition is
filed one year or more from the
date for
which the tax was last payable without penalty.
Note:
In some states (California included), property taxes “run with the
land”
meaning that, after, for example, a foreclosure sale, the new owner now
owes
the delinquent property tax.
E.
TAX PENALTIES
Unsecured tax penalties are
dischargeable in
bankruptcy if the underlying tax debt is dischargeable.
But if the underlying tax debt is NOT
dischargeable in bankruptcy, then the tax penalty is NOT dischargeable.
F.
TAX
LIENS
1.
What
is a tax lien? A tax lien
is
a lien (a type of legal claim) upon assets or property imposed by law
arising after
certain events occur to secure the
payment of delinquent taxes.
What
Property and Assets?
A federal tax
lien attaches to virtually
all property. Courts have interpreted Internal
Revenue Code (IRC) §6321 to include all real, personal and
intangible
property of the taxpayer, including after-acquired future property
(that is, acquired
by the taxpayer after the lien has
come into existence), .
But
see
discussion on bankruptcy's effect on
after-acquired property below.
Further,
individual States cannot enact laws that exempt (protect the taxpayer)
from the
reach of the federal tax lien. See United States v. Bess, 357 U.S.
51 (1958); United States v. Stern, 357 U.S.
39 (1958).
A state tax lien
issued by the California Franchise Tax Board attaches to all property
and
rights to property located in California
that belongs to you.
Levy
/ Seizure: The
Internal Revenue Code
(IRC) authorizes levies to collect delinquent tax. See IRC §6331. Any
property
or right to assets and property can (after proper due process notices
and opportunity
to contest), be levied / seized unless it is a type of property that is
exempt (that is,
protected from levy or seizure). See IRC §6334.
Federal
Tax Lien Statute of Limitations: The statute of limitations under
which a federal tax
lien may become "unenforceable by reason of lapse or passage of time"
(generally 10 years after the date
of assessment) is found at 26 U.S.C. § 6502. Various
exceptions may extend
the time periods (for examples waiver signed by the taxpayer,
bankruptcy
proceedings, etc.)
California
Tax Lien Statute of Limitations: California
state tax
liens have a lifespan of 10 years,
and then they expire and
become
unenforceable (but can potentially be renewed for another 10 years if
the
proper paperwork is filed within 90 days before the lien is set to
expire). [Revenue
and Tax Code (RTC) §6711, Government
Code §7172].
A bankruptcy filing
tolls or extends the 10 year limitation tax lien by 101 days [CA Code of Civil Procedure (CCP)
§356. See also RTC
§2963, 3007].
2. BANKRUPTCY:
Tax liens against the
taxpayer’s real estate or personal property are not discharged
(forgiven, wiped
out, eliminated) by a bankruptcy.
Existing
property:
If a tax has obtained lien status on property of the
debtor before the bankruptcy is filed, it will continue to attach to
that
property even though
the tax liability may have been discharged in
bankruptcy. Therefore,
the property will remain subject to
the tax lien.
Thus, if the tax
debt liability is dischargeable, then your “personal liability” to the
government entity (federal or state) is discharged.
But the government entity still has a claim
against your real or personal property [“in rem”,
“against the thing”]
that is subject to the lien.
After-acquired
property: In
contrast to a non-bankruptcy debtor, a tax debt that is discharged in
bankruptcy does
not
attach to the property acquired by the debtor after the date that
the bankruptcy
papers were filed with the court.
Some assets (like household
goods) lose value over time. Discharged debtors sometimes
ignore the lien
with the expectation that the asset will eventually become worthless
causing
the tax authorities to not likely enforce the lien against the personal
property. Further, IRS statutes exempt certain types of
personal
property so that
the IRS cannot levy on it (See IRC §6334).
Regarding tax liens, state
exemptions that protect certain property generally do not apply to the
IRS.
G.
BANKRUPTCY BENEFITS REGARDING CERTAIN TAX DEBTS
1. Chapter 7 Bankruptcy
filings may benefit tax debtors.
Chapter
7 bankruptcies completely 100% wipe out, discharge, and forgive taxes
debt
personal liability but only to the extent that the tax debt is
dischargeable.
Thus,
if 100% of your tax debt is dischargeable, then a Chapter 7 wipes out
and
discharges 100% of the tax debt.
But,
if, for whatever reason, only 40% of your tax debt is dischargeable,
then a Chapter 7 wipes
out and
discharges only 40% of the tax, and for the other 60% you continue to
remain
personally liable for.
2. Chapter 13 Bankruptcy filings
may benefit tax debtors.
First, Chapter 13 bankruptcy
provides relief from collection efforts by taxing authorities.
Second, it may stop further
penalties
and interest to a tax debt.
Third, the taxpayer may
repay the tax debt over time (up to 60 months) through a Chapter 13
plan.
Fourth, unlike Chapter 7
debtors, Chapter 13 debtors may discharge a loan that they obtained in
order to
pay nondischargeable taxes.
Fifth, dischargeable
(non-priority) type of taxes and all tax penalties may often be
discharged by
paying less than full payment owed. Why? Because such
non-priority tax debts are relegated
to the same “low man on the totem pole” status as other unsecured debts
like
credit cards; thus such nonpriority
tax debts are paid with the leftover money (sometimes, pennies on the
dollar) after
higher
priority obligations and debts are paid.
But nondischargeable
priority taxes must ultimately
be paid in
full.
H.
STATUTE OF LIMITATIONS REGARDING TAX DEBTS
But
be aware there is a time limit (statute of limitations) on the
collection of
IRS taxes, including trust fund taxes. The time limit is generally 10
years
from the date of assessment.
In
California,
the statute of limitations for unpaid tax debt is generally 20 years.
How long
do tax entities has to assess?
IRS
Assessability Time Limit: The IRS has
three years to assess an additional tax
due [IRC section 6501(a)]. For example, for a taxpayer who filed a 2004
tax
return on April 15, 2005, the IRS has until April 15, 2008, to assess
an
additional tax. (Two major exceptions: First, IRS has six years to
assess where
the taxpayer omitted more than 25% of gross income [see IRC section
6501(e)(1)(A)]. Second, no statute of limitation in cases where no
return has
been filed, or where the taxpayer has filed a fraudulent return [see
IRC
sections 6501(c)(1), 6501(c)(2), and 6501(c)(3)].
California Assessability
Time Limit: The law
generally
requires the California Franchise Tax Board (FTB) to mail a
proposed deficiency assessment to the taxpayer
within
four years after the due date or the actual filing date of the
taxpayer's
return, whichever occurs last. There
are, however, exceptions.
Mailing:
An assessment
is generally
timely if it is mailed to the taxpayer's last-known address before the
applicable time limit. (Taylor v. Commissioner,
(1990) T.C. Memo.
1990-559; King v. Commissioner (9th Cir. 1988) 857
F.2d 676; Appeal
of W. L. Bryant, 83-SBE-180, August 17, 1983.)
Notice: The purpose of
the
statute of limitations is to specify the time within which FTB must
initiate
its assessment procedure. There are no limitations requiring that the
assessment
process be completed or finalized within any specific time period. (Appeal
of Jenkel-Davidson Optical Company, 81-SBE-101, May 19, 1981;
Appeal of
Peter I. and Inga M. Kune, 84-SBE-106, June 27, 1984.)
Disclaimer:
The information
provided in this article is informational, only. The subject matter and
applicable law is evolving and/or constant state of change. No legal
advice is
given and no attorney/client or other relationship is established or
intended.
The information provided is from general sources, and
I cannot
and do not represent, guarantee or warrant that the information
contained in this
website
is accurate, current, or is appropriate for the usage of any reader. It
is strongly
recommended that readers of this information consult with their own
legal
and/or professional counsel rather than relying on any information in
this
article.
This article
contains only a summary of the treatment of taxes in bankruptcy. The
effect of certain
activities which affect tax debts and other details of covered material
herein have
been omitted for simplicity.
To
determine whether or not
and how the above bankruptcy tax laws apply to your particular
situation, you
are urged to seek counsel from an experienced and knowledgeable
bankruptcy
attorney or, alternatively, a tax attorney with specialized knowledge
in
bankruptcy discharge laws.
Tax
laws are complicated and
changing. This article is not tax advice. To
determine whether or
not and how the above tax laws apply to your particular situation, you
are
urged to seek counsel from an experienced and knowledgeable tax
attorney,
accountant and/or other tax professional.
Copyright
2011
Article's
Author: Bankruptcy lawyer Matthew
B. Tozer.
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