“But I thought bankruptcy couldn’t eliminate IRS taxes…”
I hear this often when I suggest bankruptcy as a source of resolution. I heard it again today during a telephone conversation with a new client. Here is what I explained to the client:
Under the bankruptcy code, the answer is “Yes” to bankruptcy as a means of IRS resolution if you owe income taxes, you filed your returns, and the returns were filed so that they are what I call “a little bit older.” This means that the returns were actually filed with the IRS more than 2 years before the bankruptcy is commenced, and they were due to be filed with the IRS more than 3 years before the bankruptcy. In other words, income taxes that are a little bit older can be eliminated in a bankruptcy.
If you owe taxes from an IRS audit, then the result of the audit has to be final on the IRS books for more than 240 days before the bankruptcy is filed, in addition to the returns needing to be a little bit older.
A big “No” to a Chapter 7 bankruptcy if the taxes are more recent, meaning the return was due to be filed within the last 3 years, or was actually filed within the last 2 years. This “more recent” rule applies to any type of tax – if it is recent, bankruptcy will not eliminate the taxes. Add a “No” to employment taxes withheld from your employees’ paycheck regardless of when the returns were filed. These employment taxes are known as trust fund taxes, and cannot be eliminated in a bankruptcy.
A Chapter 7 bankruptcy will usually not eliminate income taxes if you failed to file a return, and the IRS filed a substitute return for you estimating your tax liability. This is not a return at all for bankruptcy purposes. If the IRS audits you, and can prove fraud, bankruptcy won’t make it go away.
No one wants to file bankruptcy, but sometimes it can really help and end the problem.