Tax pros should be aware of the following 9 facts about tax debt and bankruptcy.
Chapter 13 Bankruptcy can be a quick and more certain alternative to an IRS Offer in Compromise
A chapter 13 bankruptcy can be confirmed by the Bankruptcy Judge within 3-4 months after the case is filed and that confirmation will bind the IRS just like any other creditor. The plan must pay any secured irs debt with interest, priority irs debt without new interest, penalties are treated as dischargeable debts, and underlying unsecured, non-priority tax debt may be dischargeable as well.
Debts that are discharged in a bankruptcy don't “trigger” any cancellation of debt income
Debts that are cancelled as a result of a bankruptcy discharge do not get included in the debtor's income. Bankruptcy is the first exception on form 982 to the inclusion of forgiven debt in gross income.
The IRS and State Taxing agencies are subject to Bankruptcy Code's Automatic Stay provision
Taxing authorities are stopped from taking any further collection action when a bankruptcy is filed. Garnishments and Levies must end the moment the case is filed.
Tax debt can be wiped away by a bankruptcy filing
Tax debt can be treated as dischargeable if it is non-trust fund tax like income tax, the return was due including extensions 3 or more years before the bankruptcy filing, any late tax-payer filed return has been on file for at least 2 years (not true if the returns were filed late and you live in a 5th or 10th circuit state and possibly more circuits in the future), there is no fraud or attempts to evade or defeat, and the taxes were assessed more than 240 days before the bankruptcy case is filed.
Tax penalties are dischargeable in bankruptcy
All tax penalties that are associated with a dischargeable tax are dischargeable, penalties are dischargeable in a chapter 13 even if the underlying debt isn't dischargeable, and penalties related to non-dischargeable tax are dischargeable in a chapter 7 even if the tax debt isn't, if the events giving rise to the tax are more than 3 years old.
A Bankruptcy “Estate” is created by a chapter 7 bankruptcy but not by a chapter 13 bankruptcy
A bankruptcy estate is created when the chapter 7 is filed and that estate is required to file a tax return and pay taxes on any capital gains it recognizes as profit. The estate property remains property of the estate until the estate is closed or the property is abandoned.
Any tax attributes that belonged to the Debtor pass to the Bankruptcy Estate
The debtor's basis, exclusions and loss carry forwards are usable by the Chapter 7 Trustee and only revert back to the Debtor when the bankruptcy estate closes.
Tax liens survive a bankruptcy case
A tax lien remains attached to any assets the debtor owned on the date of filing even if the underlying debt is discharged. The lien doesn't attach to any assets the debtor buys or acquires after the case is filed. In a chapter 13 case the lien is paid but only up to the value of the assets subject to the lien.
A debtor can elect a short tax year for the year a bankruptcy is filed
A short year election can make tax attributes available to the debt on the return for the pre-bankruptcy part of the year. It can also help to verify the amount of tax due in the year of filing so that the debt becomes a priority claim and is paid first from any assets to be distributed by the bankruptcy trustee.