A reader recently wrote me an email with the following facts:
“My husband and I purchased a house and also helped our son to purchase one. Sadly, my husband lost his job, can’t make the mortgage payments, and the house was foreclosed on. I withdrew from my 401K to put a down payment on both houses. To make a long story short, the income/withdrawal was no reported on our joint 2006 and 2007 income tax filing. I now owe $27,000 federal and $10,000 State taxes. I owe because my husband does not want to take responsibility. We have separated and divorce proceedings are undergoing. I lost my 401K, lost the house, now I have mounting debts, no assets except a 1999 car and thinking of filing bankruptcy. Can tax liability be erased when I file bankruptcy?”
Most people mistakenly believe that federal income taxes are never dischargeable in bankruptcy. The myth is wrong. The inter-connection between the Bankruptcy Code and the Internal Revenue Code is often very complex. It is; however, clear that the filing of a bankruptcy case may be an option to get immediate relief by a taxpayer from a serious tax problem. The filing of a bankruptcy petition automatically stops the IRS from levying accounts or do wage garnishments and allows the individual to either obtain a discharge or reorganize his or her tax liabilities.
The Bankruptcy Abuse Prevention and consumer Protection Act of 2005 (BAPCPA) merged the tax discharge rules applicable to Chapter 7, Chapter 13 and Chapter 11 bankruptcies. These rules, however, are very complex and their specific application to a taxpayer depends on the facts of each individual case. In simple terms, most “old” taxes can be eliminated, while “new” tax liabilities are non-dischargeable.
There are 3 general rules that must be met in order to discharge a tax liability: 1. The tax liability must be due three before the filing of the bankruptcy petition. 2. The tax return itself was filed more than two years before the bankruptcy filing; and, 3. The tax liability was assessed more than 240 days before the bankruptcy filing. In addition, it is required that the taxpayer did not file a fraudulent tax return or engage in tax fraud or evasion; and, a tax return was actually filed for the delinquent tax liability.
With the above general requirements in mind, the most common types of taxes eligible for discharge in bankruptcy proceedings are old individual income taxes.
In our reader’s case, it is not clear from the facts given when the tax returns were filed, when the taxes were due and so on. However, it would seem to be clear that the 2007 tax liabilities would not be dischargeable. The 2006 tax liabilities may or may not be dischargeable depending on additional factual information not provided by our reader.
(DISCLAIMER: material presented above is intended for informational purposes only. It is not intended as professional advice and should not be construed as such. Rey Tancinco is a partner at Tancinco Law Offices, a professional corporation with offices in San Francisco, Vallejo, and Manila. The law office website is at: tancinco.weareph.com/old. Rey Tancinco can be contacted at (800) 999-9096 or (415) 397-0808 or via email at: attyrey@tancinco.com.)
