I received this referral this week about eliminating taxes in bankruptcy:
I was audited for my 2005 taxes and owe $55,000 to the IRS as a result. I owe other debt in addition to the IRS liability, and was considering bankruptcy even before an IRS Revenue Officer came to my house and left her card in my door. Can I include the IRS in my bankruptcy?
Yes, a Chapter 7 bankruptcy can “discharge” taxes from IRS audits if certain “timing” rules from the bankruptcy code are followed. Those rules are:
1. The bankruptcy must be filed 3 years after your 2005 return was due to be filed (the return was due to be filed on 4-15-06, so three years is 4-15-09); and
2. The bankruptcy must be filed 2 years after your 2005 return was actually filed (the return was filed on time, on 4-15-06, so two years is 4-15-08); and
3. The bankruptcy must be filed 240 days after your audit result became final (the audit was finalized on 10-15-07, so 240 days later is 6-15-08).
To determine our bankruptcy filing date to wipe out the audit result, we look for the latest of these three dates. The latest of 4-15-09, 4-15-08 and 6-15-08 is 4-15-09. That is the date when the audit liability would be eliminated in bankruptcy.
Until then, we will cooperate and negotiate with the Revenue Officer, which most likely means providing financial statements to her, to prevent any IRS levy action until next spring (4-15-09) when bankruptcy will eliminate the liability.
For more detail on discharging taxes in bankruptcy, see my recent article in the Journal of the National Association of Enrolled Agents, “But I Thought You Can’t Eliminate Taxes in Bankruptcy.“
With more money sitting delinquent in the US Treasury than the government has resources to collect, this is a great question. All of that “quiet” debt does go eventually go away.
The IRS has 10 years to collect a tax debt. The IRS refers to this as a “Collection Statute Expiration Date.” Internally, IRS personnel call it by the acronym “CSED” (pronounced “see-said”).
The 10 years begins when an act is taken to create the debt. That is usually the filing of a tax return with an unpaid balance, resulting in an ‘assessment” by the IRS of the liability. The collection timeframe can also start from the “assessment” of a balance due from an audit.
After 10 years, the IRS will clear the account balances to zero. Transcripts can be obtained from the IRS as verification. The transcripts will show an IRS entry reading “Balance cleared to zero – expiration of statute collection date.” Any tax liens that were filed will also expire and become legally unenforceable.
“Running out” the collection statute expiration date is a strategy that must be implemented carefully, understanding when it is an appropriate remedy and what actions taken by you can inadvertently extend the timeframe (i.e., offer in compromise, bankruptcy, collection appeals). If you take an action to give the IRS more time to collect, make sure it is worthwhile.
More on the “CSED” from the Internal Manual 5.1.19, Collection Statute Expiration, can be found here. Legal reference can be found in Internal Revenue Code section 6502.
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.
IRS enforced collection activity continues to heat up. Compromise settlements are down by 70% while bad debt accounts continue to accumulate. Here are the numbers:
1. 779,000 taxpayer accounts were assigned to the IRS collection queue.
2. The number of offers in compromises accepted by the IRS declined by 70% from 2001 (38,643) to 2007 (11,618).
3. 40% of withdrawn and rejected offers in compromise are ultimately written off as uncollectible.
4. The number of IRS levies against wages and bank accounts increased from just over 500,000 in 2000 to 3.7 million in 2007.
5. The number of IRS seizures against property like real estate, automobiles and business equipment increased from 74 in 2000 to 676 in 2007.
Source: Annual Report of the IRS Taxpayer Advocate Service
IRS collection letters often look similar, and all seem intimidating. But they are not.
I get calls from my clients all the time who have received IRS collection letters and are in a state of anxiety. I ask them to read me what the heading of the letter says, and fax a copy over so I can advise them if the letter puts them in any jeopardy.
The IRS issues collection letters in this order:
CP 14 Balance Due
CP 501 Reminder, We Show You Still Owe
CP 503 Important – Immediate Action Required
CP 504 Urgent Notice – We Intend to Levy on Certain Assets, Please Respond Now
CP 90/CP 297 Final Notice of Intent to Levy and Notice of Your Right to a Hearing
CP 91/CP 298 Final Notice Before Levy on Social Security Benefits
This cycle can take several months to complete. Each notice is usually issued about five weeks apart. In high dollar cases or for businesses, the IRS may sometimes skip the complete cycle and go to the final notices.
Of the notices, only two are a true source of anxiety. Those are (1) the Final Notice of Intent to Levy and Notice of Your Rights to a Hearing (CP 90/297) and (2) the Final Notice Before Levy on Social Security Benefits (CP 91/298). These notices are the only ones that permit the IRS to start proceedings to take wages, bank accounts, automobiles, real estate and business assets.
The Final Notice of Intent to Levy contains important legal rights, including being able to file an appeal to have a hearing to settle the case, and take the results to U.S. Tax Court if they are not acceptable. No collection action occurs while the appeal is pending provided it is filed within 30 days from the issuance of the notice.
Do not be confused by the other notices, they may be important and urgent, but they are not threatening. Only the “final notices” gives the IRS legal rights.
1. You are pretty much broke. In a compromise, the IRS must be convinced that they will be unable to collect the amount of money you them in the timeframe they have to do it (10 years). Every $100 that the IRS determines you can pay them results in $6,000 compromise value (i.e., if you can pay the IRS $200 per month, then the value of your cash flow in a compromise is $12,000).
2. You have minimal equity in assets. If the IRS took your assets, and paid off any loans against those assets, what would be left to be applied to your tax debt? The IRS usually reduces the valuation of cars and real estate by 20% in a compromise. Most of your personal household goods will be considered out of reach by the IRS. Add in the value of retirement plans, less taxes to liquidate. So, what is left?
Note: You can submit an offer in compromise if you are not “broke” and if you do have equity in assets; it just increases the value of the compromise.
3. You have considered how long an offer in compromise can take. Figure six months to a year for the IRS to complete an initial investigation of the compromise. If the IRS is unwilling to accept the amount offered, you then have the right to then file an administrative appeal stating your disagreement with the initial findings. Figure another six months to a year for the appeal. If you can reach an agreement with appeals, the IRS will allow you to pay the settlement over up to two years. It is not until the final payment is made that your offer is considered complete.
4. You have considered the timeframe the IRS has left to collect the tax. The IRS has ten years to collect a tax liability. Submitting an offer in compromise extends the collection timeframe. For example, if a compromise is unsuccessful after a two year investigation, those two years are added back into the timeframe the IRS has to collect. Careful consideration should be given to whether it is advantageous to submit an offer if the IRS is running out of time to collect. Be careful that the offer sends you forward to resolution, not back in time.
5. You have considered other options. Bankruptcy can eliminate taxes, and requires no negotiation with the IRS. A Chapter 7 bankruptcy can be completed in six months. The IRS also has a program known as “uncollectible,” where they write-off debts that cannot be collected. If the collection timeframe is ticking, what is the best way to run it out? An installment agreement? Uncollectible? What is the best option under the circumstances?