Bankruptcy is a very effective means of dealing with Income Tax debts. Although the Dischargeability of actual Income Taxes is the same in Chapter 7 and Chapter 13, there are still some distinct advantages offered by Chapter 13 when confronted with Non-Dischargeable Income Taxes. It is, therefore, very important to analyze the exact nature of your Income Tax Liability before deciding which Chapter of the Bankruptcy Code you should select in seeking Bankruptcy protection.
GENERAL RULE REGARDING DISCHARGEABILITY OF INCOME TAXES:
Generally, Income Taxes are Non-Dischargeable if they were incurred on an Income Tax Return that was last due, including any extensions to file, within three years before the filing of the Bankruptcy Petition. There are, however, several exceptions to this general rule:
Late Filed Returns:
If an Income Tax Return was filed late, different jurisdictions follow different rules. In some jurisdictions, the underlying Income Tax owed on a Late-Filed Income Tax Return cannot be discharged. This has become known as the "One-Day Late Rule," meaning if the Income Tax Return was filed late, even by one day, the underlying Income Tax is non-dischargeable.
In other jurisdictions, if the Income Taxes owed on an Income Tax Return would otherwise be dischargeable, they will still dischargeable, even if the Income Tax Return was filed late, provided the Income Tax Return was filed not less two years before the date on which the Bankruptcy Case was filed.
Assessments Within 240 Days of Filing a Bankruptcy Case:
To be Dischargeable, any Assessment of Income Taxes by the IRS must have occurred not less than 240 days before the Bankruptcy Case was filed. Even if the Income Taxes would otherwise be Dischargeable, if the Income Taxes were the subject of an assessment which occurred within the 240 day period before the Bankruptcy Petition was filed, the Income Taxes will still be deemed Non-Dischargeable.
Assessable but not Assessed:
Income Taxes, which are assessable at the time the Bankruptcy Case is filed but not yet assessed by the IRS, are also Non-Dischargeable.
Fraud or Willful Evasion of Taxes:
Even if Income Taxes are otherwise Dischargeable, they will still be deemed Non-Dischargeable if the Bankruptcy Debtor filed a Fraudulent Income Tax Return or attempted to Evade or Defeat the Income Taxes owed.
The time periods set forth above can be tolled (i.e. extended) in cases where prior Bankruptcy Cases, Offers in Compromise and Requests for Due Process Hearings and Appeals have been pending or where Form 656 Tolling Agreements have been executed.
DISCHARGEABILITY OF INTEREST:
If the underlying Income Taxes are Dischargeable, then so is the Pre-Petition Interest and Post-Petition Interest that accrues thereon. If, however, the underlying Income Taxes are Non-Dischargeable, then the Pre-Petition Interest and Post-Petition Interest is also Non-Dischargeable.
Although the Bankruptcy Code provides that a Chapter 13 Plan may provide for the payment of Post-Petition Interest on Non-Dischargeable Debts, most Bankruptcy Attorneys did not include such provisions in their Chapter 13 Plans because the IRS did not actively attempt to collect Post-Petition Interest after a Discharge Order was entered by the Bankruptcy Court.
Recently, the IRS has changed its policy and initiated collection activities for Post-Petition Interest that accrues on Non-Dischargeable Income Taxes during the pendency of a Chapter 13 Case even if the underlying Income Taxes were paid through the Chapter 13 Plan. This has created many problems for Bankruptcy Debtors who thought their Income Tax Liability had been resolved through their Chapter 13 Bankruptcy Cases.
DISCHARGEABILITY OF PENALTIES:
As with interest, in Chapter 7 Bankruptcy Cases, the Dischargeability of Pre-Petition Income Tax Penalties and Post-Petition Income Tax Penalties depends on the Dischargeability of the underlying Income Taxes. If the underlying Income Taxes are Dischargeable, the Penalties are also Dischargeable. If the underlying Income Taxes are Non-Dischargeable, the Penalties are also Non-Dischargeable.
In Chapter 13, Pre-Petition Penalties are Dischargeable provided they are Non-Pecuniary (meaning they are not imposed to compensate the IRS for actual Pecuniary Loss). This is true even if the underlying Income Taxes are Non-Dischargeable. In addition, Chapter 13 allows for the Discharge of Pre-Petition Interest that has accrued on Non-Pecuniary Penalties.
This is an enormous advantage over Chapter 7. In many cases, the Penalties owed by a Debtor can be greater than the Income Taxes they owe. Furthermore, Income Tax Penalties for failure to timely pay Income Taxes do not accrue while a Chapter 13 Case is pending pursuant to Internal Revenue Code Section 6658.
PAYMENT OF INCOME TAXES IN CHAPTER 13 CASES:
Priority Income Tax Claims:
In a Chapter 13 Bankruptcy case, a Debtor must pay all Income Taxes and Pre-Petition Interest that is entitled to be classified as a Priority Claim. The Bankruptcy Code defines a Priority Income Tax Claim as a claim for:
1. Income Taxes for Tax Years ending on or before the date the Bankruptcy Petition was filed for which an Income Tax Return was due, including extensions, within three years before the filing of the Bankruptcy Petition;
2. Income Taxes assessed within 240 days before the date on which the Bankruptcy Petition was filed. This 240 day period is extended by any time, plus 30 days, during which an Offer in Compromise made within that 240 day period was pending; and
3. Income Taxes that were not assessed before the Petition was filed, but were assessable as of the date on which the Petition was filed unless the Income Taxes were still assessable solely because no Income Tax Return was filed, the Income Tax Return was filed Late within 2 years of the filing of the Bankruptcy Petition or a Fraudulent Income Tax Return was was filed.
Failure of the IRS to File a Proof of Claim in a Chapter 13 Bankruptcy Case:
A Chapter 13 Discharge discharges all Income Taxes except those for which an Income Tax Return was not filed, was filed late less than two years before the Bankruptcy Petition was filed or a Fraudulent Income Tax Return was filed.
This is very important if the IRS fails to timely file a Proof of Claim for the Priority Taxes that are required to be paid through a Chapter 13 Plan. In the absence of a Tax Lien, if the IRS fails to timely file its Proof of Claim, the Priority Income Taxes will not be Paid through the Plan but will still be Discharged upon Completion of the Chapter 13 Plan and the entry of a Chapter 13 Discharge Order by the Bankruptcy Court.
CALL NOW FOR A FREE CONSULTATION:
If you owe Income Taxes, please call my office at (513) 528-0200 or send an email to Info@CincinnatiBankruptcy.com to schedule a Free, No-Obligation Consultation.
Despite what you may have heard, Bankruptcy could offer you the opportunity to hang your Tax Problems on your rearview mirror.
I look forward to helping you make a Fresh Start.