Unfiled tax returns upset all the normal rules about discharging taxes in bankruptcy. This story tells you why.
Two clients, each with $200,000 in tax debt, came to my office this week.
One can escape it all now; the other is facing several years before bankruptcy will do anything for him.
What’s the difference?
Filed tax returns
The first man had filed his tax returns, even though he hadn’t paid the taxes called for.
The second man had not filed returns for the last 10 years.
In each situation, the IRS computed their tax debt to be the same.
One I can help today, the other has to fend of the feds for at least two years before bankruptcy can help.
Why? because you cannot discharge liability for tax year for which you have not filed a return.
Erasing taxes in bankruptcy
You CAN discharge most taxes.
The idea that taxes are forever is a myth. It simply requires a filed return, appropriately aged.
And even if bankruptcy is not in the cards, the statute of limitations on collection of taxes doesn’t start to run until the return is filed.
Two year tax discharge rule
The two-year rule of tax dischargeability says that to be discharged in bankruptcy, any tax for which a return was not filed when due must be on file for two years before the bankruptcy case is filed.
Extensions of time to file your taxes move the starting point for counting. The rule tells us to start from the date at which the return could last have been filed without incurring a penalty.
- Get an extension til October 15 , and October 15 is the starting point for counting. That’s so, even if you file the return in September.
- Fail to get an extension and file in September, then you start counting when actually filed, since you’ve already missed the “last day to file without penalty” provided in the rule.
Watch for filing dates that fall on weekends and holidays. Don’t bet the farm, so to speak, on April 15th being the date for tax filing in a year long past.
The unfiled tax return
The first task for my client with a decade of unfiled returns is to get returns filed and get the clock ticking on dischargeability. He hopes to retire soon and even his Social Security benefits can be levied by the IRS for unpaid taxes.
If lack of paperwork keeps you from filing for years long past, the IRS will provide a report of income paid to you for which it has a record. You may not be able to do a perfect job without records, but it’s enough to file a return.
Remember, too, that a filed return can be amended for three years from filing.
If you find better information, you can go back and refine the calculations. But the two year clock for bankruptcy relief doesn’t start running until the return is filed.
More about tax issues in bankruptcy
FAQ about taxes and bankruptcy
Getting rid of tax liens in bankruptcy
Chapter 13 as an alternative to an offer in compromise
Image courtesy of Pixabay.
Michael Rice says
So funny. I have different facts, but the same circumstances that I was just researching today. You post came across on my Feedly right after I came to the same conclusion. Hard to imagine that people have enough foresight to plan their bankruptcy two years in advance, but it be great in these circumstances.
Cathy Moran says
I agree that most people who don’t file timely aren’t planning ahead. But if you don’t file the return you don’t have many options.
Mark Markus says
This is true. It’s also important to get those returns filed because if the taxing agency files a substitute return, then the taxes are never dischargeable for that year. And there’s the line of cases out there (McCoy, et al) which is taking the position that if the return is filed late, the taxes are never dischargeable (even if the taxing agency never files a substitute return).