Last post we began a discussion on the July 23rd article in the Wall Street Journal online edition. In the first post of this series we mentioned the consideration of other solution alternatives outside the OIC and an Installment Agreement. The solutions considered in the WSJ article completely ignore the possibility of bankruptcy in eliminating a tax liability. There are some tax liabilities that are never dischargeable in a bankruptcy proceeding, chiefly; the Trust Fund portion of Payroll Taxes, taxes assessed by a Substitute for Return (when a taxpayer fails to file a return and the IRS files one for him or her) and Civil Penalties (not to be confused with penalties and interest associated with failure to file, failure to pay, and paying late which are dischargeable). However, contrary to the prevailing perception, bankruptcy can be a reasonable alternative in eliminating an outstanding tax liability.
In order for an income tax liability (including interest and penalties) to be dischargeable in a bankruptcy proceeding it needs to meet a series of three (3) “timing” tests. First, the income tax must be a liability resulting from a return that was due three years (including extensions) prior to the date of the bankruptcy petition. Second, the tax return from which the income tax liability results must have been filed two years prior to the date of the bankruptcy petition. Finally, the income tax liability itself must have been assessed 240 days prior to the date of the bankruptcy petition. This 240 day period is increased if an Offer in Compromise was pending with respect to these assessed taxes by the period of time the OIC was pending plus 30 days. In calculating when an income tax liability is eligible for discharge a given tax year is considered independently, and each assessment of tax (if there are multiple assessments) within a given tax year are considered independently.
For some taxpayers a bankrupcty tax discharge analysis can be quite simple. If a taxpayer has additional assessments in a given tax year that resulted from an audit for example, or unsuccessfully attempted to settle with the IRS previously by filing an OIC, the analysis is more complicated. Sometimes a taxpayer may find themselves in the position where part of a a given year’s tax liability is eligible for discharge, but an additional assessment in that year is not eligible until more time passes. These factors complicating the analysis make competent professional assistance essential when considering bankruptcy as an option. Many bankruptcy attorneys do not possess the necessary tax expertise and will forgo including tax liabilities in a bankruptcy petition to avoid professional liability. Simply filing a bankruptcy petition one day too soon can cost a taxpayer that would otherwise qualify the opportunity to discharge their outstanding tax liability through bankruptcy proceedings.
A taxpayer that has tax liabilities from a past period of financial difficulty that is now looking for a “fresh start” should strongly consider enlisting the assistance of a competent tax professional to provide a bankruptcy timing discharge analysis to his or her bankruptcy attorney. An Offer in Compromise might be able to settle your tax debt for “pennies on the dollar,” but a bankruptcy could be the “nuclear bomb” that wipes your tax debt out completely with the IRS left holding the tab.