Another weapon in the taxpayer’s arsenal that stops the IRS in its tracks is bankruptcy. The filing of a bankruptcy petition will generally stop the IRS from collecting your tax debts. This article will discuss what taxes are covered and how a bankruptcy petition can freeze IRS collection activities and even eliminate your tax debts.
The most common types of bankruptcies are found in Chapters 7, 11 and 13 of the Bankruptcy Code. Chapter 7 (also known as liquidation) involves the collection – including conversion to cash if necessary – of all assets of the debtor and distributing them to the creditors in accordance with an established order of priority. Chapter 11 (also known as reorganization) is about the establishment of a plan of reorganization under which all or some of the debtor’s indebtedness are paid. Chapter 13 also involves a payment plan, but is limited to certain debts incurred at a certain time and for up to a certain amount.
Since Chapter 7 is the one usually used by taxpayers, I will be focusing on this type of bankruptcy petition as applied to an individual. The purpose of Chapter 7 is to discharge certain debts of the taxpayer and grant him or her a fresh start. Take note of the words “certain debts,” which means not all debts will be covered by the discharge.
Once a bankruptcy petition is filed, it will trigger the so-called “automatic stay.” In the context of taxes, an automatic stay stops all IRS collection efforts. This means the IRS cannot continue with its collection enforcement against a taxpayer like issuing wage garnishment or freezing your money in the bank. If the IRS is put on notice that a taxpayer has filed for bankruptcy and collection efforts continue, IRS agents who violate the automatic stay could be liable for monetary damages up to $1 million!
In addition to the fact that collection stops, tax liabilities could also be eliminated through bankruptcy provided certain requirements are met.
This simply means that your tax debts can be eliminated if a petition for bankruptcy is approved. However, not all tax liabilities can be discharged through bankruptcy. For instance, in the following, tax liabilities cannot be discharged:
(1) Taxes owed before bankruptcy not listed in the bankruptcy petition;
(2) The IRS was not provided notice of the petition;
(3) The taxes are due from tax returns that were not filed or were filed late within two years from the filing of the bankruptcy petition;
(4) In case of taxes due from fraudulent tax returns or there was a willful attempt to evade payment of taxes; or
(5) In case of priority taxes.
Priority taxes are those that are included in an order of priority covering the debts payable or subject to distribution from the debtor’s assets. Examples of priority taxes are trust fund taxes or those required by law to be withheld by an employer from employees’ wages. Also, income taxes arising from tax returns which are due within three years before the date of filing of the bankruptcy petition are considered priority taxes (three-year rule).
There are several intricacies involved in the bankruptcy process as they relate to tax laws that impact on your tax liabilities. An attorney knowledgeable and experienced in both bankruptcy and tax laws can help you file for bankruptcy and determine what taxes may be discharged or eliminated.
Discharging tax liabilities through bankruptcy is a complicated process where the assistance of a tax professional is almost always needed. Call us now so we can help you solve your tax problems and perhaps eliminate them completely through bankruptcy.
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Edgardo M. Lopez is an attorney licensed to practice in the Internal Revenue Service and the United States Tax Court. He has been an attorney for 25 years and he is a member of the American Society of Tax Problem Solvers. His IRS practice is throughout the United States and he has offices in the entire State of California (Los Angeles, San Francisco, and San Diego). His office has an A+ rating with the Better Business Bureau.
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