Do you think that income taxes can be discharged in bankruptcy? They can.
One of the greatest pitfalls that prevents you from being able to discharge at least some of your tax liability in bankruptcy is having a clear picture of your complete tax situation. A crucial step (among many) your tax professional needs to take is to obtain copies of your IRS account transcripts for each year to ensure that you (1) know which years are filed (and when) and (2) if and how much you owe for each year.
Once you have this information, you know where to start. The next crucial step is to review the other information included in the transcripts to determine if there are events that extend (or “toll”) the time necessary to wait before filing for bankruptcy. In order to understand IRS account transcripts, you will need to interpret the codes found therein (see https://www.taxresolutioninstitute.org/member-page/ to find out more).
Here are some questions that will be answered by reviewing the IRS account transcripts, and help determine a person’s eligibility to discharge their taxes via bankruptcy:
- Was the tax return filed timely?
- If so, has three years passed since the due date including extensions?
- If the return was filed late, has at least two years passed since the date of assessment?
- If the return was amended or audited, has at least 240 days passed since the the return as reassessed?
- Did the taxpayer live out of the country for more than 6 months?
- Did the taxpayer submit one or more offers in compromise?
- Was a prior bankruptcy filed?
- Was an appeal filed?
As you can see, there are many questions that need to be answered, before pulling the trigger on a bankruptcy. This is why we complete a Tax Dischargeability Analysis prior to advising our clients on eliminating tax debt via bankruptcy.
If you miscalculate your liability or forget to properly prepare an amended return (i.e. forgot to amend a State tax return after an IRS return was audited and reassessed), it could cost you tens or hundreds of thousands of dollars if not more (see also “40% error rate in IRS tolling event reports).
Below you will find some examples of codes you may see in an IRS account transcript::
- The “Tax Per Return” on the transcript reads zero
This code may indicate that returns have been filed and taxes have been paid. However, DO NOT ASSUME THIS IS THE CASE. It may also indicate that no return has been filed and taxes have yet to be assessed. If there is amount here you still cannot assume a return was filed. The IRS may have prepared a Substitute for Return (SFR) so that they may assess tax. You must research the transcript further for information that paints the full picture.
- The transcript shows a code “460”
This code indicates an extension was requested and granted extending the due date of a return until October 15th. This information is important because extending the due date also extends the time necessary to include the liability in bankruptcy to the extension due date, not the date the return as filed and/or assessed. To illustrate, assume you filed an extension for your 2006 taxes, and subsequently filed your tax return on April 16th, 2007 (1 day after the regular due date). In order to include the liability in bankruptcy you would need to wait at least 3 years after the due date of the extended return. Even though you filed the return on April 16, 2007, you must wait until October 16, 2010 and not April 17, 2010 to include the liability in the bankruptcy..
- Code 420 but NO code 421
A transcript that contains a 420 (but does not contain code 421) indicates that an audit is currently open. Remember that you must wait 240 after the date of assessment from an audited return. This means you cannot even begin to count until you see code 421 on the transcript.
- Code 421
This code indicates that an audit has ended BUT there may be what’s known as a “sleeping assessment” (see above) from any State for which a return has not been amended to match the new IRS assessment.
- Code 520
This code indicates one of three things: 1) a prior bankruptcy was filed, 2) an IRS Collection Due Process appeal was filed, or 3) that tax litigation occurred. If any of the previously mentioned events happened during the 3-year, 2-year or 240-day waiting periods, the additional time that passed during these events plus 90 days must be added to the date in which the bankruptcy may be filed.
- Code 320
This code indicates that a penalty has been assessed in connection with a criminal investigation triggered either by a fraudulent return or by a genuine attempt at tax evasion. This code covers items much too complex to cover here.
- Code 240
This code indicates that a penalty has been assessed for items not covered under code 320. This particular code may be significant as penalties are dischargeable in bankruptcy as long as the event triggering the penalty happened more than 3 years before the bankruptcy filing.
- Code 559
This code usually indicates that a return has been filed by the taxpayer. You need to be careful because the answer is not always clear (i.e. it may also indicate that a Substitute for Return (SFR) was prepared). Or it may indicate that a return has been filed to replace an SFR. You may need to contact the IRS to get a clear picture.
- Code 290 and 300
These codes indicate that additional assessments have occurred as long as a dollar amount appears with the code. If no dollar amount appears they may be ignored.
- Code 275
This code shows that the taxpayer has requested a Collection Due Process (“CDP”) hearing which tolls the waiting period to file.
- A blank line between entries
Blank lines indicate that a prior line contained a code in error (i.e. a criminal proceeding was included erroneously and then whited out).
Adhering to the 3-year rule, 2 year rule, 240-day rule to include taxes in a bankruptcy: although this article is a good starting point, there are numerous pitfalls and complexities not covered here that must be considered before (1) deciding when to file for bankruptcy and (2) actually pulling the trigger. If you are considering bankruptcy you can submit your tax questions to us so that we may either help you with a tax dischargeability analysis or at least steer you in the right direction.
*This article is presented for informational purposes only and should never be considered definitive tax or legal advice. Tax matters have serious financial implications and always benefit from expert counsel due to their depth and complexity. If you need expert tax resolution or audit help please contact the Tax Resolution Institute at (818) 704-1443 for immediate assistance.
An expert on Chapter 7, 11, and 13 Debtor and Creditor Representation while specializing in the discharging of Federal and State taxes, tax attorney Norman J. Kreisman leads the team of attorneys at the Tax Resolution Institute.