Discharging tax debt in bankruptcy gets lots of families out of a horrible hole.
Tax debt can be large and swelled beyond the tax by interest and penalties.
Collection on old tax debt often compromises the ability to stay current on more recent years.
Bankruptcy can save their bacon because taxes found on returns due three years ago or more are generally dischargeable in bankruptcy.
But there is a key that opens the door to discharging taxes in bankruptcy.
And that key is a return that has been filed.
When old taxes live on
The man in my office expected to wipe out his liability for several years of taxes that were now four and five years old in a Chapter 13 case. Chapter 13 would allow him five years to pay the more recent, non dischargeable taxes through his reorganization plan.
Only the rule for discharging taxes in bankruptcy has three prongs:
- the three year rule,
- the two year rule, and
- the 240 day rule.
Turns out that the returns for those four and five year old taxes were never filed. He prepared the returns, but didn’t file them because he couldn’t pay the tax due.
So those old taxes failed the two year rule:
taxes for years where the return wasn’t filed on time are only dischargeable when the return has been on file for two years.
The story gets worse: because the taxes are not priority claims under the bankruptcy code, they don’t get the same special treatment for payment that the more recent tax debts get as priority claims.
The non dischargeable but non priority taxes will get the same fractional payment in Chapter 13 that the medical bills will get, but the tax will survive the bankruptcy and be collectible later because these taxes are non dischargeable.
So, even if you can’t pay the tax now, not filing the return is not a meaningful long term strategy.
File the return and get the two year clock ticking for bankruptcy relief.
Four reasons to file even if you can’t pay
Outside of bankruptcy, the 10 year statute of limitations on collection of federal taxes doesn’t start running until the taxes are assessed by filing a return.
Filing returns without any records
Got no records for the unfiled tax year? That’s often why a tax return goes unfiled. Without records, it’s hard to calculate what you owe, or what’s owed to you.
The IRS can help.
You can request a Wage & Income transcript from the IRS for free. It will tell you what items of income have been reported to the IRS from your employer, bank, or mortgage lender.
Under certain circumstances, that may be as good as you can do. If you get better information after you’ve filed the return, you can amend the return for three years from filing.
The key is to get a return on file and get those assorted time periods running.