Discharging Taxes in Bankruptcy



Do You Qualify?


 Morgan D. King, Esq.
Of the California Bar

Originally appearing in the San Francisco Recorder in three parts   

a. Render unto Caesar?

When the Biblical injunction was given, "Render Unto Caesar That Which is Caesar's," it was understood to mean, pay your taxes; but they didn't figure on penalties and interest compounded daily. If they had calculated how large and how devastating an overdue tax bill owed to Caesar could be, they might have changed the admonition to something like, Forget Caesar ... Take Heed of Thy Bankruptcy Attorney.

One of the best kept secrets of the I.R.S. and state income tax collectors is that, yes, taxes can often be wiped out in bankruptcy. And, it would seem, many lawyers (including bankruptcy attorneys) wish to help keep the secret, because they too seldom explore the possibility of a tax discharge with their clients. And all too often those lawyers who do undertake the task botch the case because they really don't know how to do it correctly.

Let's examine the simplest and most common situation ... an overdue federal or state personal income tax claim. In many cases a client will be able to wipe out all or a portion of an overdue tax, together with the interest and penalties, in Chapter 7. And, frequently a tax claim which may not be erased in Chapter 7 may be wiped out, or substantially reduced, in a Chapter 13. So, it is important to be aware of the key differences between 7 and 13 as they pertain to the issue of dischargeability.

b. Two key code sections

Nowhere in the Bankruptcy Code will one find language prescribing when an income tax may be discharged in Chapter 7. Instead, the text is framed in the negative, describing those categories of taxes which may not be discharged.

The key sections of the Bankruptcy Code are 11 U.S.C. § 523, Exceptions to Discharge, and § 507(a)(8), Priorities. Section 523, which is applicable in Chapter 7 cases, describes certain categories of taxes that may not be discharged, and in addition provides that those taxes defined in § 507(a)(8), Priorities, are, as well, not discharged. The corollary is that any tax not falling within the categories described in §§ 523 or 507(a)(8) are discharged, i.e., wiped out, in a simple Chapter 7 bankruptcy. We'll look at the negative text first, and then turn it around and summarize it in the affirmative.

1. Section 523

In brief, 11 U.S.C. § 523 provides that a personal income tax may not be wiped out if the tax return for the year in question was not filed at least two years prior to the filing of the bankruptcy, or where the tax return, if filed, was fraudulent, or where the taxpayer had engaged in a willful attempt to evade or defeat the tax, or where the tax is a priority as defined by § 507(a)(8).

2. Section 507

Section 507(a)(8) provides that a personal income tax is a priority tax (and hence nondischargeable by operation of § 523) where the tax is unsecured and the tax year in question is less than three years prior to the filing of the bankruptcy, or where the tax was assessed less than 240 days prior to the bankruptcy filing.

By reframing this text in the affirmative, we can construct a simple checklist that describes those federal or state personal income taxes which can be wiped out in Chapter 7, to wit:

c. The five rules for dischargeability in Chapter 7


Personal income taxes are dischargeable in chapter 7 if they satisfy all of the following five rules. Note, these rules apply to state income taxes, as well.

Each of the above criteria must be met in order to discharge the tax. 11 U.S.C. § 523(a)(1)(C). (NOTE: If the tax in question fails to satisfy any one of the above rules, it is not dischargeable in Chapter 7; however, it may still be dischargeable in Chapter 13. You may skip the rest of this part and go directly to Chapter 13. But before you give up on Chapter 7, you may want to read on ...)

d. Discussion of the five rules

Now we'll look at each of these to see how they apply.

1. The two-year rule

The tax return must have been filed at least two years prior to the date of the bankruptcy petition. 11 U.S.C. § 523(a)(1)(B). The majority rule in case law provides that for purposes of this section, it is required that the taxpayer himself must have prepared and filed the return ... a substitute return filed on behalf of the taxpayer by the taxing entity does not count. However, under certain circumstances an "agreed" substitute for return, an "agreed" audit, or entering into a voluntary installment plan may be the equivalent of a return and satisfy the two year rule. As a general rule the courts have applied a reasonably liberal interpretation to the meaning of "return" for purposes of dischargeability. As cited below, depending on the jurisdiction courts have found the following kinds of documents to be returns or "constructive" returns within the meaning of § 523;

If the IRS files an unagreed SFR, and then the taxpayer files his tax return, is the taxpayer's return deemed valid, or is it a nullity on account of the prior filed SFR? The rulings generally favor the debtor.

Held, an amended return filed after an SFR was filed nevertheless constitutes a "return" under § 523; In re Savage, 218 B.R. 126 (10th Cir. BAP 1998). Debtor filed a valid tax return for purposes of tax discharge, even though he filed it after the IRS had filed a substitute for return and assessed the taxes; In re McGrath, 217 B.R. 389 (Bkrtcy.N.D.N.Y. 1997). Held, late returns filed after debtor stipulated with the IRS regarding the tax claims constituted returns. In re Pierchosky, 220 B.R. 20 (Bkrtcy.W.D.Pa. 1998).

Held, testimony by debtor that he filed "schedules" after the IRS filed SFRs was sufficient, since IRS had destroyed its files and could not present contrary evidence. In re Ashe, 228 B.R. 457 (C.D.Cal. 1998).

IRS refusal to accept debtor's amended tax returns showing correct amount of tax, following original filing of incorrect return, was arbitrary; debtor's objection to IRS claim in Chapter 13 sustained. In re Weiss, 209 B.R. 571 (S.D.Fla. 1996)

But held in In re Hindenlang, a return filed following an IRS SFR with an assessment of tax serves no legal purpose and is therefore not a "return" for discharge purposes; debtor's actions were not "honest and reasonable effort to satisfy tax law..." Debtor's filed returns contained exactly the same figures as the SFR; "The forms were simply mirror images of the Substitutes for Returns completed by the IRS." In re Hindenlang, 164 F.3d 1029 (6th Cir. 1998).

Although filing a return commences a three-year statute of limitations on the Secretary's authority to enter an assessment, see 26 U.S.C. § 6501(a), a document purporting to be a return but filed after the assessment has already been made is too late to have any effect on this limitation.

Similar ruling, tax return filed by Chapter 7 debtor more than seven years after IRS made assessment was not a "return" within the meaning of 11 U.S.C. § 523 for discharge purposes. In re Mickens, 215 B.R. 693 (Bkrtcy.N.D.Ohio 1997).

But contrary, the court ruled that even though the taxpayer didn't file his returns until nine years after they were due, long after the IRS had filed SFRs and assessed the taxes, the taxpayer's returns were valid for discharge purposes because the Bankruptcy Code includes no requirement that the returns be filed prior to assessment. In re Nunez, 232 B.R. 778 (9th Cir. BAP 1998).

And this may be distinguished from a return filed before an assessment is posted. The reasoning of the above opinion suggests that had the tax payer filed his return after the SFR but before the IRS posted an actual assessment of tax, the return would have qualified as a return for purposes of the two-year rule. It is not uncommon for the IRS to file an SFR but not do an assessment because it has no data upon which to calculate the tax. When this is done the transcript will indicate zero amount with the SFR.

Held, "For the purposes of discharge in bankruptcy, a return does not have to be in a form used by the IRS. If a document discloses data from which the tax can be calculated, is executed by the taxpayer, and is lodged with the IRS, then it is considered a return." In re Ashe, 228 B.R. 457 (C.D.Cal. 1998), citing IRS Revenue Ruling 74-203; Elmore re v. United States, 165 B.R. 35, 37 (S.D.Ind. 1994).

Execution of a Form 870 (Waiver of Assessment) has been deemed the equivalent of the debtor filing his own re turn, as it establishes liability. Carapella v. U.S., 84 B.R. 779 (Fla. 1988). Following an audit resulting in additional taxes, the IRS typically requests the taxpayer to sign a Form 870 which permits the IRS to assess the tax without having to observe formal procedures, including a Statutory Notice of Deficiency.

Providing documents and information in a tax court proceeding may be held to be the equivalent of filing a return; In re Elmore, supra.

Held that the taxpayer's signing Form 1902-B (individual audit exam changes report) admitting existence of income and resulting tax liability was sufficient to constitute a return. The court held that in cases where the debtor has met with the IRS, signed a form containing sufficient information to calculate his or her tax li ability and admitted owing taxes, the documents signed by the debtor and given to the IRS are properly treated as "filed returns" for purposes of dischargeability in bankruptcy. In re Lowrie, 162 B.R. 864 (Bkrtcy.D.Nev. 1994).

Held, IRS form 4549 relating to income tax examination changes, signed by the taxpayer, may be a filed tax return for purposes of dischargeability; Berard v. U.S. 181 B.R. 653 (Bkrtcy.M.D.Fla. 1995). Held, a document other than a standard IRS tax return may constitute a return within the meaning of the Bankruptcy Code. In re Parker, 199 B.R. 792 (Bkrtcy.M.D.Fla. 1996) (summary judgment for IRS denied; Form 4549 could constitute a "return," and where substitute for return was prepared with taxpayer's cooperation). Said the Court:

The Court ... finds that a "return" for purposes of Section 523(a)(1)(B)(i) is not limited to the traditional Form 1040 re turn prepared by the taxpayer, or by the taxpayer's accountant at his request, and mailed to the Internal Revenue Service. Instead, a "return" for purposes of Section 523(a)(1)(B)(i) may also include other forms initiated by the Internal Revenue Service, provided that the debtor cooperated with the Internal Revenue Service in the completion of the form and furnished the information to the Service which was necessary to compute the debtor's tax liability.

- In re Parker, at 796.

Held, mere fact that tax return was filed late did not disqualify it as a "return" for purposes of § 523. In re Sullivan, 200 B.R. 327 (Bkrtcy. N.D.Ohio 1996).

Held, an SFR followed by a signed voluntary payment agreement and signed 433-D (installment agreement) constitute a "return" for purposes of the two-year rule under § 523. In re Hatton, 216 B.R. 278 (9th Cir. BAP 1997). And see IRC § 6020(a), SFR signed by taxpayer "may be received by the Secretary as a return of such person."

Held, untimely tax returns filed by Chapter 7 debtor after entering into stipulation with IRS regarding his tax delinquency constituted "returns" for discharge purposes. In re Pierchoski, 220 B.R. 20 (Bkrtcy.W.D. Pa. 1998).

Held, taxpayer who was unable to file Form 1040 returns because he was incarcerated in state prison, but who provided information from which tax could be calculated, generally cooperated with IRS, and signed some kind of document (which the IRS could not produce because all documents had been destroyed after seven years pursuant to IRS manual procedures), but who refused to sign a waiver of the statute of limitations for collection, was deemed to have filed a return for discharge purposes. In re Gless, 179 B.R. 646 (Bkrtcy.D.Neb. 1995).

Rev. Ruling 74-203

The courts frequently cite IRS Revenue Ruling 74-203. This was a case where the taxpayers had signed an IRS Form 870, "Waiver of Restrictions on Assessment and Collection of deficiency." This, in essence, waives the running of the statutes of limitations for assessment and collection of the tax, and other formalities. In addition and together with the Form 870, the taxpayers had provided "schedules" that contained the necessary information upon which the IRS could do an assessment. The question was, did the signed Form 870 together with unsigned schedules constitute a valid return? The IRS ruled yes.

The IRS ruled that this constituted a valid return under IRC § 6020(a), which provides that -

... if any person shall fail to make a required return but consents to disclose information necessary for its preparation, the Secretary or his delegate may prepare such return which, being signed by such person (i.e. the taxpayer), may be received by the Secretary or his delegate as the return of such person.

Notwithstanding that the cited tax code section requires the return to be signed by the taxpayer, the IRS ruled that -

The Form 870, although not containing the data from which the tax is computed, is accompanied by certain schedules, made available to the taxpayer, which contain the required data. Accordingly, the executed Form 870 with accompanying schedules is a return under section 6020(a) of the Code...

The Ruling also states "The above conclusion applies equally to a Form 1902-E, Report of Individual Income Tax Audit Changes, and Form 4549, Income Tax Audit Changes, when signed by a husband and wife."

In the ruling the IRS cites as support United States v. Olgeirson, 284 F. Supp. 655 (D. N.D. 1968) which held that the signing of a Form 870 by a husband and wife, under circumstances similar to those that were the subject of the Revenue Ruling, made them jointly and severally liable.

For additional discussion of what may or may not be construed to be a tax return, go to www.DischargeTaxes.com and click on ARTICLES. Scroll down and click on the article, "King: What Is A Tax Return?" and "King: Unsettled Issues In Tax Discharge."

2. The non-fraudulent return rule

The tax return must be non-fraudulent. 11 U.S.C. § 523(a)(1)(C). In other words, the Form 1040 tax return (or its equivalent) must have been complete, honest, reasonably accurate, and signed by the taxpayer. The facts suggestive of a fraudulent tax return are sometimes confused with those evidencing attempted tax evasion, and there are relatively few cases dealing strictly with a fraudulent return.

The court in In re Peterson, 160 B.R. 385 (D.Wy 1993) described "badges of fraud" to include understatement of income, failure to file tax returns, late returns, implausible behavior by tax payer, failure to cooperate with I.R.S. In U.S. v. Toti 149 B.R. 829 (E.D.Mich 1993) the court held that the debtor need not have engaged in any affirmative act in order to be found guilty of tax fraud (failure to file, depositing in come in girlfriend's account, under stated his income on returns). See In re Berzon, 145 B.R. 247 (N.D.Ill. 1992), fraud found where tax returns were not filed or filed late and understatement of income, debtors excuse of being on cocaine was overruled. For other "badges of fraud" see Spies v. U.S. 317 U.S. 492 (1943); In re Peterson, 132 B.R. 68 (D.Wy 1991) where the court held innocent spouse was not guilty of willful attempt to evade the tax, and ruled that rule applies only to attempt to evade tax, not payment of the tax.

A fairly extensive analysis of fraud and evasion pertaining to tax claims in bankruptcy is found in In re Graham 1994 Bankr. LEXIS 1256 (Bkrtcy.E.D.Pa 1994).

Held, tax court finding that debtor had invested in a tax shelter that was fraudulent is not res judicata in the debtor's bankruptcy case as to debtor's tax fraud; there was no finding in the tax court that debtor had personally and knowingly filed a fraudulent return in connection with the fraudulent tax shelter; thus debtor could litigate fraud issue in bankruptcy court. In re Mickle, Jr. 1997 Bankr. LEXIS 1997 (Bkrtcy. M.D.Fla. 1997).

Held, tax court's finding that Chapter 7 debtor was guilty of fraud was binding on bankruptcy court, and tax claim attributable to the fraud was excepted from discharge. In re Palmer, 203 B.R. 460 (Bkrtcy. D.Mont. 1966).

Held, where debtor admitted that he made false statements in tax collection in formation forms which substantially underreported his income available to pay his tax liabilities, taxes were held not discharged in Chapter 7. In re Childers, 846 F.2d 74 (4th Cir. 1988).

Taxpayer claimed invalid coal mining loss deductions on his tax return based on advice of geologists and engineers. Held, an affirmative act evidencing intent is required to find fraud or evasion; debtor's reasonable reliance on advice of professional is a defense. In re Zimmerman, 204 B.R. 84 (Bkrtcy.M.D.Fla. 1996).

3. The three-year rule

The tax year in question must be at least three years prior to the filing of the bankruptcy. 11 U.S.C. § 507(a)(8)(A)(i). This time period starts on the most recent date the tax return is due for the year in question. Hence, for the year 1988, if the return was due on April 15, 1989, the three year rule would be met on April 16, 1992. If an extension to file the return had been filed extending the due date to August 15, the three year period would be met on August 16, 1992.

Be alert to the due date falling on a weekend or holiday - this extends the due date to the next business day, and the three-year period would begin then.

The question has been asked, what if the tax payer fails to file his return by October 15, or fails to pay the tax in full? Does this invalidate the extension, and if so does the starting date for the 3-year rule revert to August 15? In other words, what is the effect of an invalid extension to file?

There are only a few published opinions in the bankruptcy cases on this is sue; In re Brustman, 217 B.R. 828 (Bkrtcy.C.D.Cal. 1997), In re Hermann, 221 B.R. 944 (Bkrtcy.N.D.Okla. 1998) and Gidley v. United States, 138 B.R. 298 (Bankr.M.D.Fla. 1992). Brustman basically says the extension is presumed valid for bankruptcy purposes unless the IRS exercises its discretion to invalidate the extension, even if the taxpayer fails to pay the tax by the extended due date. It is not made clear, in the event the IRS did invalidate the extension, whether or not the extension date would revert to Aug. 15 for purposes of 11 U.S.C. § 523(a) (1)(B). Accordingly, the fact that the taxpayer failed to file or pay the tax by October 15 does not automatically cause the due date to revert to August 15. The opinion does state, however, that "... it would be inequitable to declare the extensions invalid after the Debtor benefited from them." The rulings in Hermann and Gidley are similar.

It would appear that the prudent rule to follow is that the three-year period starts at the extended date, regardless of whether or not the taxpayer qualified for the extension or whether or not the IRS invalidated it.

4. The 240-day assessment rule

The tax must have been assessed at least 240 days prior to the filing of the bankruptcy. 11 U.S.C. § 507(a)(8)(A)(ii). For I.R.S. taxes, assessment is a discrete, formal act that takes place internally within the I.R.S. This date is ordinarily the date Form 23-C is signed and placed in the taxpayer's file (IRC § 6201 et seq.). The blue Notice of Federal Tax Lien sometimes mailed to the taxpayer ordinarily lists the dates of assessment.

For state taxes, the precise date of assessment may be less clear. In California, the tax code does not provide a clear and specific act constituting an assessment, In the 9th Circuit the courts have ruled, as in In re King, 122 B.R. 383 (BAP 1991) that a state tax is assessed at the point it is deemed final and collectible by the taxing entity. Under the California Tax Code the claim becomes final 60 days after the date of the notice of proposed assessment.

Where for a particular tax year the client filed the original tax return more than two years ago but less than three years ago, there could be a post-bankruptcy audit giving rise to a non-discharged tax following the bankruptcy. Here is the hypothetical situation:

In this situation, the original tax claim is dischargeable in Chapter 7. However, note that at this point in time the statute of limitations for audit and assessment has not expired because the tax return was not filed more than three years ago. This gives the IRS up to one more year in which to do an audit for the discharged year and assess additional taxes.

Following the final discharge of the bankruptcy, could the IRS conduct an audit of the discharged year and discover additional taxes owing? If so, would the additional assessment be non-discharged by the bankruptcy because it was not assessed more than 240 days prior to the filing? The answer is yes.

CAVEAT - the "sleeping assessment" - where the return was filed more than two years, but less than three years ago, the tax shown on the return has met the two-year rule; but the IRS has the remainder of its three-year statute of limitations [26 U.S.C. § 6501(a)] to audit and assess additional tax for that tax year, and the additional tax would not be discharged in the bankruptcy. The client should be forewarned of this possibility.

See for example, In re Depaolo 45 F.3d 373 (10th Cir. 1995), a Chapter 11 case where the IRS did a post-confirmation audit on a year for which the taxes were being paid through the plan, and assessed additional taxes. The court allowed it, rejecting the debtor's estoppel arguments. In that case the tax year was less than three years old, making the taxes priority taxes. However, the author can see no reason why the result would be different for dischargeable taxes, or why it couldn't happen in a Chapter 7.

In Chapter 13 a possible defense might be the dischargeability of assessable but unassessed claims if they are § 523 claims.

The point is that the client should be counseled that such a "sleeping assessment" could happen, and the client should sign an acknowledgment that he has been advised of possible additional assessments following discharge.

5. The no willful attempt to evade the tax rule

The taxpayer must not be guilty of a willful attempt to evade or defeat the tax. 11 U.S.C. § 523(a)(1)(C).

The issue of what, exactly, constitutes a willful attempt to evade or defeat the tax is unresolved. At best, it could be said that the courts are totally lost; the opinions vary widely and one has the feeling that every judge is simply grasping for some thing to hang his hat on, with very little concrete guidance from the statutes, legislative history, or each other. In such an unsettled environment, this is a risky issue that needs special attention by debtor's counsel.

To be more precise, the Code states -

For a tax or customs duty ... with respect to which the debtor ... willfully attempted in any manner to evade or defeat the tax.

The construction of the sentence seems to mean that for the tax to be excepted from discharge under this rule, the willful attempt to evade or defeat the tax must have been as to the particular tax year in question. That is, if the debtor was guilty of a willful at tempt to evade the tax for year "x" such conduct would not render the tax for year "y" to be excepted from the discharge, unless the debtor was guilty of evasion as to that year, as well.

The rule that the debtor must not have "willfully attempted in any manner to evade or defeat such tax" has been liberally applied in favor of the debtor's discharge in some cases.

For example, in Gathwright v. U.S., three returns had been due more than three years before the debtor had filed for bankruptcy. Due to a pattern of conduct by the taxpayer the IRS assessed fraud penalties for the years in question. His offenses included failures to file returns, omissions of income and claims of unallowable deductions, some of which were egregious. On the other hand, he did not refuse to turn over his books and records, or destroy them, and did not hide income in undisclosed accounts. The court found that the conduct was insufficient to support the charge of willfully at tempting to evade or defeat the income tax. Although it did support a finding of negligence, the court held that the IRS had not proved that the debtor fell within the offending conduct and the tax was held dischargeable. Gathwright v. U.S., 89-1 USTC §9346; In re Gathwright, 102 B.R. 211 (Or. 1989).

But the opposite result appeared in a case, In re Carapella, 105 B.R. 86 (Fla. 1989), holding that the debtor's conduct was fraudulent and the tax non-dischargeable where the debtor filed a fraudulent tax return showing income of $2,310 when in fact it was $278,803, had created shell corporations to carry on mail fraud scheme, had failed to keep records of income, and advised the IRS of actual income only after learning of government's offer of leniency. See also In re Griffith 161 B.R. 727 (Bkrtcy.S.D.Fla. 1993) where the court found the debtor's willful attempt to evade the tax by concealing and transferring assets to protect them from execution or attachment; held "willful" did not require affirmative act of fraud with evil motive, but merely intentional, knowing and voluntary acts by debtor. But see also In re Williams 164 B.R. 352 (Bkrtcy.M.D.Fla. 1994) where the court held that willful evasion requires a finding of specific intent.

And explicitly rejecting the liberal Gathwright opinion, the court in In re Lawson 156 B.R. 43 (9th Cir. BAP 1993) held that attempts to evade collection of a tax, as well as attempts to defeat the assessment of a tax, are evasion within the meaning of the bankruptcy code, thus rendering the tax nondischargeable, and cited other cases holding similarly.

Mere failure to file return held non-fraudulent, other "badges of fraud" must be found, In re Carmel 134 B.R. 890 (N.D.Ill. 1991). The court in In re Peterson, 132 B.R. 68 (Wyo. 1991) held that merely filing bankruptcy to wipe out a tax debt is not willful evasion of a tax within the meaning of the Code.

A word for the tax / bankruptcy professional representing debtors in consumer bankruptcy cases: Given the unsettled situation in connection with the notion of intentional attempt to evade or defeat a tax, it is wise to explore with meticulous care the client's tax history, with an eye looking for any kind of conduct, however benign appearing, that may be used as a basis for a charge of fraud or evasion. This will involve a somewhat time-consuming interview with the client. Below is a list of questions that should be explored with every potential tax discharge client. Each question is directed to a type of conduct that could conceivably be a "red flag" or be deemed by a court to constitute a "badge" of fraud or evasion:

1. Membership in a tax protest organization?

2. Engaged in a pattern of unfiled returns? Why?

3. Filed a fraudulent, frivolous, blank or incomplete return?

4. Repeatedly understated income or overstated deductions on returns?

5. A serial failure to pay taxes? Why?

6. Concealed, gave away or traded away valuable assets, or transferred title?

7. Sold assets way below fair value? (especially to insiders such as family members, employers, business associates, etc.)

8. Set up "abusive" trust or sham tax shelter and transferred assets to it? An abusive trust probably exists if debtor was facing tax debt at time offset-up, and he maintains control of, or benefit use of, assets of the trust. Issues to explore:

9. Created a corporation and transferred assets to it?

10. Changed bank or bank account frequently?

11. Closed bank account and conducted business in cash only?

12. Added another person's name to bank account?

13. Deposited income in another's bank account?

14. Used a foreign bank account?

15. Changed name? Changed spelling of name?

16. Changed SSN?

17. Had an altercation with a revenue officer?

18. Engaged in money laundering?

19. Withdrew cash from bank and hid it? See In re Bernard, 96 F.3d 1279 (debtor simply withdrew $64,000 from bank account in order to keep away from levy - held, fraudulent transfer and discharge denied!)

20. Claimed incorrect number of exemptions on tax return?

21. Purchased property in someone else's name?

22. Refused to cooperate with a revenue officer, or deliberately obstructed audit or investigation

23. Lost, concealed or destroyed financial documents?

24. Maintained inadequate records?

25. Concealed actual residence address or business address?

26. Traded valuable assets for less valuable assets?

27. Devising clever schemes such as divorcing his wife and directing all income to her and renting a room in her house, thus eliminating most income that could be traced to husband to satisfy husband's tax claims.

28. Living a "lavish lifestyle" knowing that delinquent taxes had not been paid.

Most of the items in the above list have been specifically cited in case opinions, and they are also list in the Internal Revenue Manual at IRM § [5.9] 4.8.2.

e. Trap for the unwary: Tolling events

1. The clock may stop on the time periods

It is extremely important to be aware that certain events may stop the clock for the time periods described above (three-year rule, two-year rule, 240-day rule). I refer to these events as Tolling Events. The three most common found in consumer bankruptcy cases are 1) an extension to file the return, 2) a prior bankruptcy filed or pending during any of the time-periods, and 3) an offer in compromise made during the 240-day assessment period.

2. Extension to file the return

Where the debtor has filed an extension for filing the tax return, this delays the start of, and in a sense stretches out the 3-year period, because the period begins only on the last date the return was due.

3. Prior bankruptcy

Where the debtor has been in a previous bankruptcy that overlaps any of the time periods, the clock stops as to that time-period, and does not resume until the automatic stay in the bankruptcy case terminates. This has now been established as the rule by the U.S. Supreme Court in Young. v. United States 122 S.Ct. 1036 (2002)] [note: some cases had held that the clock does not resume until the case terminates, plus an additional six months; the IRS no longer takes that position due to the ruling in Young v. United States; per the opinion of the IRS Office of Chief Counsel, Notice CC-2002-023 (May 9, 2002)]. The tolling occurs only for the period the automatic stay of the previous bankruptcy overlaps with the tax time period. Thus, a prior bankruptcy that began and ended before the start of the tax time period has no effect, as well as a bankruptcy that begins after the time periods have already expired.

4. An offer-in-compromise

The making of a formal offer-in-compromise as to an I.R.S. claim stops the clock, which resumes when the offer is withdrawn, rejected or accepted, plus 30 days. 11 U.S.C. § 507(a)(7)(A)(ii). An offer made before the start of the 240-day period does not toll the period, even if it overlaps into the time period. Likewise, an offer that has terminated before, or was filed after, the running of the time period does not toll it. CAVEAT; it is not clear whether the time an OIC is "pending" includes the time during which a rejection of an OIC is being appealed administratively. See, In re Aberl, 78 F.3d 241 (6th Cir. 1996).

f. Discharging penalties

The dischargeability of a tax penalty is much simpler than the tax itself. In brief, under the majority rule a tax penalty may be discharged in Chapter 7 if the penalty is a punitive penalty (which most tax penalties are), and it is either attached to a tax which is dischargeable, or it is attached to an event which took place more than three years prior to the bankruptcy. See, McKay v. U.S., 957 F.2d 689 (9th. Cir. 1992).

g. Discharging interest

The rule regarding the dischargeability of interest is that the interest follows the tax. In other words, where the tax itself is dischargeable, the interest is also dischargeable. Where the tax is non-dischargeable, the interest, as well, is not dischargeable.

Next, go to Discharging Taxes in Chapter 13

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