It depends. It is not unusual for tax debt to send people into bankruptcy. If you find yourself with tax debt you cannot pay you have options. However, not all taxes are dischargeable and figuring out which taxes are dischargeable is confusing and frustrating. Here are three scenarios of real tax problems and how the tax law was applied.
Scenario 1
Tom and Mary have always filed timely tax returns. From 1998-2001, however, Tom and Mary did not have enough withheld from their paychecks. In 2002, they finally corrected the withholding issue, but have a significant tax debt from 1998-2001 that they cannot pay.
The IRS has finally decided to enforce collection of the tax debt through wage garnishment. If Tom and Mary file bankruptcy under chapter 7 in 2015, can they discharge the tax debt?
Yes, Tom and Mary CAN discharge their taxes. Why? Because of what is known as the: “3/2/240″ rule. The 3/2/240 rules applies to taxes that are on or measured by income or gross receipts. 3/2/240 means: 3: the tax return was due at least 3 years BEFORE the bankruptcy was filed. 2: the tax return was filed at least 2 years BEFORE the bankruptcy was filed. 240: the tax claim was assessed at least 240 days BEFORE the bankruptcy was filed. Tom and Mary meet all these conditions.
Scenario 2
Louis was the sole owner of a small business, Village Turf, Inc., that started failing over a series of years and completely shut down in 2006. From 1996 to 2003, Village Turf didn’t pay all or a part of payroll taxes due so that it could continue to pay suppliers that he deemed essential to the business’ continuing operations. Louis’s CPA did file timely returns (with extensions) for Louis and for Village Turf.
In 2007, the IRS assessed penalties against Louis for the failure or Village Turf, Inc. to pay its payroll taxes pursuant to 26 U.S.C. § 6672 (which states that any person required to collect and pay over any tax who willfully fails to collect such tax or willfully attempts in any manner to evade or defeat any such tax shall be liable to a penalty equal to the total amount of the tax evaded).
If Louis files a personal chapter 7 bankruptcy in 2015, can he discharge any personal liability that he has for the tax debt?
No. Louis CANNOT discharge his business’ payroll taxes because payroll taxes are a tax that is required to be collected or withheld for which the debtor is liable in any capacity. Such taxes are nondischargeable not only for the debtor, but also for the individual responsible for withholding and paying the payroll taxes. As the sole owner of the business, Louis was that person. That burden stays with him even though the business is no longer in operation, and he is personally liable for payment of that debt and cannot discharge that obligation in bankruptcy.
Scenario 3
Edson and Liana did not file timely federal income tax returns for the tax years 2000 and 2001. The IRS assessed taxes and penalties for said tax years in 2005 and 2006.
In 2007, disagreeing with the amounts that were assessed, Edson and Liana filed late returns for 2000 and 2001. Based on the information in the late returns, in late 2007 the IRS adjusted the amounts that it had previously assessed.
In 2010, Edson and Liana filed a bankruptcy petition. Are the taxes dischargeable?
No. Edson and Liana CANNOT discharge their tax debt. The law requires the “timely” filing of taxes. Since Edson and Liana filed their 2000 and 2001 returns late they are not eligible, under the law, to discharge their tax debt.
What is the take away from these scenarios?
As a business, ALWAYS, ALWAYS, ALWAYS pay your payroll taxes.
As an individual, ALWAYS, ALWAYS, ALWAYS file your taxes in a timely manner. Filing within the period allowed by any authorized extension is still “timely.”
Remember: your inability to pay does not release you from your responsibility to pay. Ignoring your tax problem will not make it go away, the IRS will come after you, and it only makes your tax problem worse and more costly. Even if you don’t have the $$, you should file your taxes in a timely manner. The IRS is more likely to work with you when you have filed your taxes.
At the Law Office of George “Dave” Giddens, P.C. our attorneys serve Albuquerque, Santa Fe, Taos, Raton, Farmington, Gallup, Grants, Roswell, Los Lunas, Placitas, Belen and the rest of New Mexico. And we have bankruptcy attorneys who offer expert handling of Chapter 7, Chapter 11, Chapter 12 and Chapter 13 bankruptcy cases in New Mexico. The firm represents many debtors and creditors in Albuquerque, Santa Fe, Taos, Raton, Farmington, Gallup, Grants, Roswell, Los Lunas, Placitas, Belen and the rest of New Mexico. Our conveniently located office has ample free parking and is easily accessible by public transportation. We offer flexible office hours upon request. To make an appointment for a consultation about your real estate matter, contact us online by visiting the firm’s website at giddenslaw.com. or call us at (505) 271-1053. Giddens & Gatton Law,amp; P.C. is located at 10400 Academy Road N.E., Suite 350 in Albuquerque, New Mexico
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