Tax debt is one of the hardest kinds of debt to shake. First of all, the IRS knows where you are. Also, they have special enforcement powers to collect their debt. They can put a lien on your house or your property without suing you. They can take money in your bank account without a judgment. They can seize tax refunds. They can take you social security. And they can also garnish your wages, often for a lot of money. But contrary to popular belief, tax debt can be wiped out in bankruptcy , especially if it’s old. Here’s how it works.
1. The rules: For income tax debt to be wiped out in bankruptcy, the following three rules must apply:
Rule 1: The income tax return must have been due more than three years ago. The first question we ask to figure out income tax dischargeability is whether the tax return was due more than three years before the date of bankruptcy filing. 2008 income taxes were due on April 15, 2009. Today is February 8, 2012. These taxes are not dischargeable today, but they pass this test if we wait until April 16 to file. But there’s one wrinkle. If you filed for a six-month extension that year, your tax return wasn’t due until October 15, 2009. So if you’re looking to discharge income taxes, we can’t file your bankruptcy case until October 16, 2012.
Rule 2: The income tax return must have been filed more than two years ago. This one seems easy. If the return was filed more than two years before today, this test is satisfied. In some cases, the taxpayer never actually files a return, and so the tax agency files one for them (sometimes called a “substitute return.”). When that happens, the two-year clock never starts running, and until the taxpayer actually files his/her own return, this test can never be met.
Rule 3: The tax must have been assessed more than 240 days ago. This means that the tax agency’s determination that you owe a debt must have been made more than 240 days ago. The “determination” can be a few different things–wither you filed your return and acknowledged you owe a balance. That’s an assessment. Or the IRS changed your return to say that you owed a balance. That’s an assessment too. Finally, if you were audited, and the IRS added a balance based on the results of the audit, that’s an assessment too. This part of the test is the most confusing, and you might want to see a tax professional (tax accountant or attorney) to figure out the assessment date.
2. Other factors add time to the clock. If you’ve filed bankruptcy before, the amount of time your case was open, plus six months, are added to all the time limits above. Also, filing an Offer in Compromise with the tax agency can stop the clock.
3. Some kinds of taxes are never dischargeable. Income taxes can be discharged if they meet all the above tests. There are other kinds of debts, such as sales taxes or payroll taxes collected on behalf of an employee, that will never be dischargeable. See a tax attorney if you’re facing these types of debts.
4. If a tax debt can’t be discharged, you still may be able to stop collection by filing Chapter 13. Chapter 13 bankruptcy stops all collection efforts by a tax agency, and allows you to spread the tax debt over a three to five-year period. This can be a big relief when the tax agency is looking to put liens on your property or garnish your wages, sometimes up to 90 percent of your income.
If you’re struggling with tax debt, give us a call for a free consultation. Often, there’s lots we can do to help.