If you are a debtor that owes taxes to the Internal Revenue Service (the “IRS”), you might want to consider bankruptcy. The Bankruptcy Code contains several provisions that address which taxes are dischargeable. Generally speaking, the categories of non-dischargeable taxes fall into the four (4) categories discussed below.
Income Taxes Where the Return Last Came Due within Three Years of the Bankruptcy Filing Date
Taxes based upon a debtor’s income or gross receipts for a tax year ending on or before the date of the filing of the petition for which a return, if required, is last due, including extensions, after three years before the date of the filing of the petition. 11 U.S.C. §§ 523(a)(1)(A) and 507(a)(8)(i). Tax debts stemming from tax returns filed more than three (3) before the petition date (after adding all extension dates) are therefore dischargeable. If the tax return is filed more than three years before the petition date but the last date to file the tax return under and extension is within the three (3) years of the petition date, the subject tax is not dischargeable.
Income Taxes Where the Debtor: (1) Failed to File Returns or (2) Filed Returns Late within Two Years Prior to Bankruptcy
Where a tax return is filed late, but within two years of the filing of a bankruptcy petition, the subject tax is not dischargeable. 11 U.S.C. § 523(a)(1)(B). Additionally, section 523(a)(1)(B) also excepts from discharge a tax where the return or equivalent report or notice was not filed or given.
Taxes Assessed Within 240 Days of the Bankruptcy Filing
Any tax assessed within 240 days of the bankruptcy petition date is not dischargeable. Further, this 240 day period is extended for the time during which an “offer in compromise” is pending (plus thirty (30) days) and the time during which a stay in proceedings was in effect during a prior bankruptcy case (plus ninety (90) days). 11 U.S.C. §§ 523(a)(1)(A) and 507(a)(8)(ii). Note that this 240 day assessment rule is most likely to come into play where the IRS asserts additional taxes are due and owing after an examination or audit.
Taxes that not assessed pre-petition but which are still assessable “under applicable law or by agreement” are likewise not dischargeable. 11 U.S.C. §§ 523(a)(1)(A) and 507(a)(8)(iii). This would address those taxes remaining assessable because of a pending Tax Court matter or a waiver of the statute of limitations on assessment. Common sense would therefore dictate that where bankruptcy is an option, such waivers should be entered into cautiously.
Lastly, and perhaps obviously, a tax for which a debtor “made a fraudulent return or willfully attempted . . . to evade or defeat” is not dischargeable under Chapters 7, 11, 12, or 13. 11 U.S.C. § 523(a)(1)(C).
Federal Tax Liens
Tax liens survive the filing of a bankruptcy regardless of the dischargeability of the tax. Discharge is an in personam remedy. That is, it is a remedy directed at the person. Discharge is not an in rem remedy. In other words, a bankruptcy discharge does not alter a creditor’s rights in property. A lien is a property right not affected by discharge. Thus the IRS’ rights of enforcement against property remain in full force and effect after a debtor receives a discharge.
Accordingly, it is of great import to understand what property is subject to levy by the IRS and what property is exempt from levy. The rules of exemption applicable to the IRS are not codified in any State law. The IRS exemption provisions are set forth in 26 U.S.C. § 6334. These exemptions do not protect your homestead, most pensions plans and much of a debtor’s personal property (household goods in excess of $6,250.00), including vehicles and jewelry.
Once a tax is assessed, demand made and not paid, a federal tax lien automatically attaches to all of the debtor’s property regardless of location. 26 U.S.C. § 6321. Because there is no public filing required, this lien is often referred to as a secret lien. This lien is perfected as to third parties once recorded. 26 U.S.C. § 6323. However, while many statutory liens (an IRS tax lien is a statutory lien) are avoidable in bankruptcy, an IRS tax lien is not. This is so even where there is no notice of federal tax lien filed or recorded. 11 U.S.C. § 545(2), see also 11 U.S.C. § 522(c)(2)(B) (A tax lien, “notice of which has been properly filed” may not be avoided).