Tax debt information from the Judge Joe Lee Bankruptcy Institute

Here are a few more insights gleaned from the 16^th Bicentennial Judge Joe Lee Bankruptcy Institute I attended last week. Professor Jack Williams gave an informative talk on the intersection between tax law and the bankruptcy code. Here are a few bullet points pulled from that talk:

• The tax law, contained in Title 26 of the United States Code contains a key provision related directly to bankruptcy. 26 USC Sect 1398 is a must see when a debtor comes into bankruptcy with significant tax liabilities. One thing this law does is allow a debtor to bifurcate (split) their tax year into two short tax years. One reason this matters is that it would make it clear that tax liability arising from assets of the estate post-bankruptcy remain the liability of the estate rather than the debtor. Another way it may come into play is to insure that priority tax debt derived from pre-filing income will get pulled into and paid in full through the plan in a Chapter 13.
• When looking at tax liability, look at the nature of the taxes. For example, trust fund tax liability that an employer debtor should have paid on behalf of their employees will be imputed as the debtor’s personal liability if the employer owned a pass through single member LLC. This debt never becomes stale – that is, it will never become non-collectable or get discharged. However, personal income tax liability will become non-collectable or get discharged at some point.
• With tax debt, time is usually the debtor’s friend. If a tax return was filed, the IRS has only three years in which to challenge it. And, once a tax is assessed, the IRS only has ten years to collect it unless a bankruptcy, installment agreement, or offer in compromise tolls that time. So, if a debtor can wait it out, they may be better off.
• If, though, a bankruptcy is necessary, the timing of filing still matters greatly. The overly simplified timeline is that when three years have passed from when a tax became due, unless it has been tolled for some reason, then those taxes will be discharged in a bankruptcy. If it has been more than 240 days from when the IRS assesses a tax, then that tax may be discharged in a bankruptcy. So, one must look carefully at these and try to time the filing of a bankruptcy to discharge most or all of the tax obligation.
• It is ALWAYS better to file a tax return even if the debtor cannot pay the tax. Failure to file a return does not stop the obligation from arising. But, filing the return starts the time limitations running on the IRS and stops the IRS from assessing their own version of tax liability, absent deductions, against the debtor.
• The worst tax scenario is the tax debt is non-priority debt but it is not discharged because of some kind of bad act such as fraud. This is because if it is priority tax, then it would get paid first and in full in a Chapter 13 or at least paid first in an asset Chapter 7. But, if it is not priority, then it only gets the same pro-rata share as general unsecured creditors and still hangs around after discharge.

The ringing wisdom of this presentation confirmed the approach I adopt when tax debt is at issue and that is to be patient, thorough, and wait when possible.