By following 5 steps, you can discharge (write off) more of the income taxes you now owe.
The Goal
Use the bankruptcy rules to take appropriate action before you file bankruptcy, so that when you do file you can discharge and will never need to pay taxes that would otherwise you would have had to pay.
The 5 Steps
1. WAIT out the appropriate lengths of time before filing your bankruptcy case.
Most (but not all) types of income tax become dischargeable after the passing of specific periods of time. Much of pre-bankruptcy tax strategy turns on determining with your attorney exactly when each of your tax debts would become dischargeable, and then trying to wait to file bankruptcy until then. Often, because of pressure either from other creditors or from the tax authority(ies) itself (themselves), you can’t wait that long. But, with the active guidance of your attorney, at least you will discharge the maximum amount of taxes possible under your individual circumstances.
2. FILE past-due returns to start the clock running on those as soon as possible.
If you know you owe income taxes for prior years and don’t have the money to pay them, your understandable inclination may be to avoid filing those tax returns as long as possible. But you cannot discharge a tax debt until two years after its tax return has been filed. So file the old returns and get the advice you need about appropriately dealing with the IRS /state tax authority during those two years to protect yourself and your assets.
3. STAY in compliance as much as possible going forward by paying your current taxes.
While you wait to file your bankruptcy case, have the appropriate amounts withdrawn from your current paychecks or pay the appropriate estimated quarterly taxes if you are self-employed. To make sure your tax payments don’t go to the older taxes that you are planning on discharging and not paying, clearly instruct the IRS/state that your tax payments are for the current tax year instead of any older ones. Staying current on present taxes is also usually a necessary step in keeping the IRS/state from taking aggressive action against you, so it usually allows you to wait longer and discharge more taxes.
4. AVOID tax fraud and evasion, and, whenever possible, “trust fund” taxes.
You can’t ever discharge any taxes associated with any fraud, fraudulent tax returns, or tax evasion—no matter how long you wait to file bankruptcy—so you have to completely avoid any of this. If you have questions what these mean in your situation, talk to a knowledgeable tax accountant or attorney.
“Trust fund” taxes are those that an employer withholds from an employee’s paycheck and then is required to send to the IRS/state. Such tax money is seen as having never belonged to the employer but rather having been held “in trust” for the IRS/state. They can never be discharged in bankruptcy. So if you are responsible for any such “trust fund” taxes, try to pay them when due so you don’t owe any when you file your bankruptcy. That may mean prioritizing your scarce resources to keep these current. Otherwise you need to recognize that they will not be discharged in your Chapter 7 case, or will have to be paid in full as a “priority debt” if instead you file a Chapter 13 case.
5. BE AWARE of tax liens.
Tax lien claims have to be paid in full in Chapter 13, with interest, and may survive a Chapter 7 discharge. So try to avoid having the taxing authority record a tax lien against you. Admittedly, you may not have much control over this, but be sure to talk with your attorney or tax accountant about what you may be able to do to avoid the imposition of a tax lien.
As part of that strategy, do what you can do to refrain from building up equity in possessions or real estate that a tax lien could attach to. Although that equity or property is often “exempt,” meaning that it is beyond the reach of your general creditors and of the bankruptcy trustee, it is still subject to a tax lien. So any equity you build up just risks increasing what you would need to pay to the IRS/state on taxes that you might otherwise have discharged altogether.
A Big Caution
Using pre-bankruptcy planning to position yourself in the best possible way to discharge some or all of you tax debts is one of the more sophisticated tasks that bankruptcy attorneys undertake with their clients. Do NOT attempt these strategies—including the five steps outlined here—by yourself, without an attorney highly experienced in bankruptcy. Elsewhere in this website is made clear that you cannot take anything in the website, including what is written in these blogs, as legal advice. That’s especially true in this sophisticated area. What is written here should be seen as the beginning of the discussion you need to have with your attorney.
Also note that today’s blog is the last of a series on income taxes and bankruptcy. It builds on the previous dozen or so. To get a fuller understanding of what you have just read, you might want to look through some of the earlier blogs.
If you live in our area, we look forward picking up the conversation here, so that we can help solve your income tax challenges through the benefits of bankruptcy.