Good Reason to Delay Filing Bankruptcy until Now: Write Off More Income Taxes

If you owe income taxes, not only can you write off most older ones, you may have some control over which taxes you can write off.

 

Two Items of Very Good News

First, bankruptcy can permanently write off (“discharge”) certain income taxes, generally ones that are older.

Second, you may be able—through the help of an experienced and conscientious bankruptcy attorney—to increase how much taxes you can discharge.

Putting Bankruptcy Timing Laws to Work for You

So much of bankruptcy law has to do with timing. This is particularly true in determining what income taxes can be discharged. That’s why with wise tactical decisions you may well be able to discharge more of your tax debts.

What’s important is getting good advice about the timing laws and how they apply to your unique circumstances.

The Timing Laws for Discharging Taxes in Bankruptcy

An income tax debt qualifies for being discharged in bankruptcy if it meets a series of conditions. In most cases the only conditions that matter are these two:

1) The three-year rule: The tax return for the income tax in question must have been due more than 3 years before the bankruptcy case is filed, including any extra time for extensions for filing that tax return.

To illustrate, consider a tax debt of $5,000 owed to the IRS for personal income taxes for the 2010 tax year. The applicable tax return was due—assuming no extension was requested—on April 15, 2011. To meet this first condition, the bankruptcy must be filed more than three years after that date, so on or after April 16, 2014.

2) The two-year rule: The tax return must have been received by the IRS or state tax authority more than 2 years before the bankruptcy case is filed. 

To illustrate this with the same $5,000 income tax debt for 2010, assume that the tax return for that tax was not sent to and received by the IRS until June 30, 2012. Then the bankruptcy must be filed more than two years after that date, so on or after July 1, 2014.

The Immediate Lesson

Both of these conditions must be met in order to discharge an income tax debt in bankruptcy. To use the illustration provided, as of April 16, 2014 the first condition would be met, but only as of July 1, 2014 would both conditions be met. So the lesson here is that to be able to discharge that $5,000 tax debt of the 2010 tax year, one would need to wait to file until July 1, 2014. Filing even a day earlier would mean that you would continue owing that tax in spite of filing bankruptcy.

The Broader Lesson

The other lesson here is that it’s crucial to know accurately and precisely the facts upon which these conditions rely. A minor mistake can cost thousands of dollars. Work carefully with your attorney to get these facts from reliable sources.

Consider a twist on the above illustration, one in which you thought that you had sent the IRS the 2010 tax return on June 30, 2011, and so thought you’d met the two-year rule as of July 1, 2013. But in fact you had not sent it in until a year later, on June 30 2012, so that you would not meet that two-year rule until July 1, 2014. So if you then filed your bankruptcy case on April 16, 2014 thinking that as of that date both conditions were met, you would find out that you filed too early. As a result you would continue to owe the full $5,000 tax debt instead of discharging it.

Other Seldom-Occurring But Potentially Crucial Conditions

Besides the two conditions discussed above, bankruptcy law does contain a few more. These don’t often come into play but cause real problems if they apply in your case.  

These other conditions are beyond the scope of this blog post. They involve the timing of tax “assessments,” offers in compromise to settle the tax, a possible prior bankruptcy, fraudulent tax returns, and tax evasion. The lesson here is that although these other conditions seldom pertain, you need the experience of a knowledgeable attorney to determine whether or not they do to you.

Timing Tactics Are Delicate

It’s a major accomplishment to know with great confidence when your bankruptcy should be filed in order to discharge as much income taxes as possible. But if that means waiting a few months or even longer to file your case, doing so will often require very delicate tactical decisions. Your attorney will help you decide how to deal in the meantime with other creditors and their collection efforts against you. In addition, while you are waiting for the optimum time to file your bankruptcy case, the IRS and/or state agencies may be able to jeopardize your efforts by recording a tax lien against your real estate and/or personal property. Depending on your circumstances, that could turn a debt that you planned to discharge into one that you must pay in full or in part.

Balancing the benefit of waiting to file until a tax debt can be discharged must be weighed against the various possible detriments of waiting.

Clearly, when dealing with this complicated arena of income taxes and bankruptcy, you truly need excellent legal advice to make good choices and execute on them safely.

 

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