Bankruptcy is a very powerful tool in discharging consumer debts. When it comes to tax liabilities, however, it may not be the best case scenario. Why? Because not all tax debts can be discharged in bankruptcy, even if a taxpayer qualifies for Chapter 7.
Here is a list of all factors to consider when trying to discharge tax liabilities:
- Three Year Rule. The bankruptcy must be filed more than three years after the tax return was due to be filed, including extensions. That means that the liability on the most recent 3 tax years cannot be discharged.
- Two Year Rule. The bankruptcy must be filed more than two years after the tax return was actually filed. This rule automatically closes the bankruptcy door for non-filers. More so, if the IRS files Substitute for Return (SFR) on behalf of the taxpayer, it precludes a discharge for those tax periods, even if the taxpayer files the original returns after SFRs (see Hindenlang, 164 F.3d 1029). In McCoy, 666 F.3d at 930, the Fifth Court of Appeals decided that the “applicable filing requirements” verbiage in the hanging paragraph of IRC §523(a) enacted in BAPCPA of 2005 precludes a bankruptcy discharge of tax liabilities on late-filed returns, even 1-day late. The McCoy case dealt with state taxes though, and other courts have followed a different approach in interpreting what constitutes a return, concentrating more on the substance of a return rather than the time of filing.
- 240-Day Rule. The bankruptcy must be filed more than 240 days after the tax was assessed. This rule is usually important when a taxpayer is audited and additional tax liability is assessed, especially when a larger chunk of tax is assessed after audit, than was reported on the original tax return.
- Fraud. If a penalty for filing a fraudulent return was levied, such tax period is not eligible for bankruptcy. Criminal fraud also negates the bankruptcy route.
- Tax Liens. Liens will survive bankruptcy until the collection statute expires (10 years from assessment date, but usually extended by various tolling events, i.e. bankruptcy, offer in compromise, CDP hearing, pending installment agreement, etc.). If your client cannot wait for their lien release until the CSED (Collection Statute Expiration Date), bankruptcy is not the best alternative.
- Prior bankruptcies. If a taxpayer
filed Chapter 7 bankruptcy in the
last eight years, they are not eligible
for a new bankruptcy filing. For
Chapter 13 bankruptcy the time limit
is two years. There are additional
rules when jumping from Chapter
7 to Chapter 13 and vice versa.
So what happens when some of the
factors described above come into
play, where bankruptcy is not a viable
option? The answer is simple – Tax
Resolution! There are three main
avenues for resolving a tax debt case:
- Offer in Compromise,
- Installment Agreement,
- Currently Not Collectible Status.
Let’s discuss briefly each alternative.
Offer in Compromise. Contrary to common belief, the acceptance rate on an Offer in Compromise (OIC) is not that low, statistically it is in the mid-30s. Of course, not all taxpayers qualify for this option, not unlike Chapter 7, but those who do can settle their tax debt for pennies on the dollar. The best advantage over bankruptcy is that you can file an OIC for any tax period as long as the tax is assessed, even if it’s assessed based on SFRs. There is no time limitation. Tax liens are released within 30 days after Offer in Compromise terms are met, i.e. when the taxpayer pays the offered amount in full. Collection activities stop when you file an OIC, so no more bank levies or wage garnishments. The offer amount is calculated based on the reasonable collection potential of the taxpayer plus any available equity in the assets owned. Offers can be paid in 2 different ways: 1. A Lump Sum Cash offer is paid within 5 months after acceptance, and 20% down payment is required upon submission; and 2. A Periodic Payment offer is paid within 24 months. Installment payments must start with the submission of the offer, but do not have to be equal. In other words, you can pay minimal amounts for 23 months and make the remaining balloon payment on the 24th month. Offer review takes between 4-18 months, depending on the amount owed and the existence of a ‘self-employed’ business. But the most attractive advantage of OIC over bankruptcy is the professional fee you charge, which ranges between $3,500 and $20,000.
Installment Agreement. When a taxpayer has disposable income to pay tax debt in full until the CSED (Collection Statute Expiration Date), you can establish a payment plan either online, through the Practitioner Priority Service over the phone, or by mail. When the liability is less than $50,000 and the tax debt can be fully paid in 72 months or less, a Streamlined Installment Agreement is also an option, no financials are required and it’s fairly easy to establish. When the liability exceeds $50,000 you can go for a Full-Pay Installment Agreement over the remaining statute (until CSED). Collection information statements are required in this case. If the remaining monthly income is not sufficient to pay off the tax liability until the collection statute expires, you may then establish a Partial Pay Installment Agreement.
Currently Not Collectible Status. When the taxpayer has no equity in assets and no disposable income, the government can put a hold on the taxpayer’s account and stop all collection activities. This option is similar to a Chapter 7 bankruptcy, but without the credit reporting disadvantages. The statute with CNC (Currently Not Collectible) cases does not stop running, which means that at some point the tax debt can simply expire. However, the IRS will conduct ongoing reviews of the account, and if the taxpayer’s financial situation improves, the CNC status is lifted and the collection machine starts rolling again, adding back penalties and interest accrued over time. Tax resolution is a great alternative when the bankruptcy route is closed. The case outcome definitely depends on the proficiency of the IRS representative. However, powered with invaluable tax resolution tools, bankruptcy attorneys can make the best of both worlds. PitBullTax Transcripts, available in October 2016, automatically analyzes your clients IRS transcripts, calculates the earliest bankruptcy dischargeability dates and CSEDs, as well as provides auto-generated reports based on transcripts data. You can analyze unlimited tax years for a flat fee. PitBullTax Software, the leading IRS Tax Resolution software, makes you a “go to” tax resolution expert, while streamlining your cases. Go to www.pitbulltax.com for a free trial.