Tax Motivated Bankruptcy

If you are consumed with back taxes, obtain experienced legal counsel prior to considering a tax motivated bankruptcy. I am David W. Klasing, an experienced tax attorney and CPA. My legal team and I are committed to helping business owners and professionals obtain a fresh start when consumed with back taxes.

During an initial consultation, we will evaluate your situation to help you determine the most effective way to get your finances back on track, such as:

• Paying any back taxes
• Working out a payment plan
• Making an offer in compromise
• Filing Chapter 7, Chapter 13 or Chapter 11 bankruptcy

Discharging debt through bankruptcy is often misunderstood. Not only can certain tax debts be wiped away, but filing bankruptcy can also stop IRS collection efforts. This is a highly complicated area of this law. Whether you are consumed with income taxes, payroll taxes or sale taxes, entrust my law firm to evaluate your situation and determine if filing for bankruptcy is the right solution. Contact my law firm today to schedule a consultation with a highly skilled Orange County bankruptcy tax lawyer at my law office in Los Angeles or Irvine, California.

Need help or have a Tax Question? Contact us!

Put an Experienced Tax Debt Bankruptcy Attorney to Work in Your Case

If you are faced with a tax lien, you are likely worried about losing your hard-earned assets. My legal team and I have the skills and experience level to help you navigate through the bankruptcy system, while negotiating to have any tax liens removed.

Before becoming a  tax attorney, I worked for nine years as an auditor in public accounting. I then gained a master’s degree in taxation and became a Certified Public Accountant (CPA). I work directly with tax attorney John A. Harbin (CPA – Retired), who is particularly skilled in tax bankruptcy. He has handled more than 500 tax-motivated bankruptcies in federal tax court, district bankruptcy courts, and before the state of California Administrative Appeals Board. As a legal team, we have the skills and experience level to help you determine if filing for Chapter 7, Chapter 13 or Chapter 11 bankruptcy is the right solution for you.

Benefits of Gaining a Fresh Start Through Filing for Bankruptcy

Pursuing debt relief through filing for bankruptcy provides taxpayers with several benefits, such as:

• Stops the IRS from collecting back taxes starting the day bankruptcy was filed
• Discharges eligibles tax debt and any penalties or interests associated with the back taxes
• Wipes away other dischargeable debts, allowing taxpayers to pay off other tax debts that were not discharged
• Allows taxpayers to establish a repayment plan to pay off their principal tax debt

Before obtaining tax relief through filing for bankruptcy, you must prove that your last four tax returns have been filed with the IRS. Our firm can expertly prepare any delinquent returns for you. My legal team and I are committed to preserving your financial interests, while guiding you through the bankruptcy process. To get started, we will need to evaluate your financial statements, balance sheets, income statement and tax returns.

 

Does Filing for Bankruptcy Get Rid of Tax Debt?

Bankruptcy is a complex subject with implications for virtually every imaginable aspect of business and personal financial planning, such as credit scoring, homeownership, loan eligibility, and of course, debt.

Unfortunately, while most taxpayers realize that the chief purpose of bankruptcy is to help alleviate business or consumer debt, few people appreciate the potential benefits of bankruptcy when it comes to relieving tax debt.

To help our readers gain a better understanding of how tax debts may be affected by filing for bankruptcy in California, our bankruptcy tax attorneys present this simple “Q&A.” In it, we discuss some critical bankruptcy tax issues for debtors (and their representatives) to be aware of, such as the three-year, two-year, and 240-day rules for discharging income tax debt.

What Are Some Common Bankruptcy Terms I Should Know?

Before we begin, it’s important to clarify a few terms that are frequently used in discussions of bankruptcy:

• Creditor – A party to whom the debtor owes payment, such as a lender or the IRS
• Debtor – The party filing for bankruptcy
• Dischargeable Debts – Debts that may be wiped out by the bankruptcy
• Non-Dischargeable Debts – Debts that may not be relieved by bankruptcy
• Trustee – The party appointed to oversee the debtor’s bankruptcy case

What is Bankruptcy?

Bankruptcy is a legal process that enables the debtor to eliminate or reduce various personal or business debts. To accomplish this successfully, the debtor must file certain documents (such as the bankruptcy petition and supporting schedules), adhere to federal bankruptcy requirements (such as the requirement to undergo credit counseling), and, depending on which type of bankruptcy is being filed, follow a long-term repayment or “reorganization” plan.

While bankruptcy procedures are primarily governed by federal laws, there are some variations from state to state, such as variations in which bankruptcy “exemptions” are available to help the debtor protect assets. The bankruptcy laws we follow today stem from a major legislative overhaul that occurred in 2005, when Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA).

Are There Different Types of Bankruptcy?

To put it simply, there are several different types of bankruptcy.  The various forms differ from each other in terms of when they can be employed, what they stipulate, and how they will impact the declarer.  Each type of bankruptcy is known as a bankruptcy “chapter.” Most bankruptcy cases in California, and throughout the U.S. generally, involve one of the following chapters:

• Chapter 7 Bankruptcy – Chapter 7 is also called “liquidation” or “straight” bankruptcy. Chapter 7 is the fastest, simplest, and most popular form of bankruptcy. In Chapter 7, the debtor’s assets may be sold (“liquidated”) by the bankruptcy trustee, though assets can often be protected using exemptions. The resulting sale proceeds are used to help repay the debtor’s creditors. The timeline for a typical Chapter 7 case is approximately four months.
• Chapter 13 Bankruptcy – Chapter 13 is also called “reorganization” or a “wage earner’s plan.” In Chapter 13 bankruptcy, the debtor enters a reorganization plan, which lasts from three to five years, depending on the case. During this period, the debtor makes regular payments to the trustee, who then distributes the funds to the debtor’s creditors as appropriate. Once the plan has been completed successfully, the remaining dischargeable debts may be wiped out by the bankruptcy court.
• Chapter 11 Bankruptcy – Chapter 11 is also called “reorganization,” not to be confused with Chapter 13. While both individuals and businesses can potentially file for Chapter 11, due to the associated cost and complexity, this type of bankruptcy is seldom used in comparison to the aforementioned chapters. (For context, bankruptcy statistics from the U.S. Bankruptcy Court for the Central District of California show that 27,574 Chapter 7 cases were opened in 2017, compared to 9,299 Chapter 13 cases – and just 361 Chapter 11 cases.) Similar to Chapter 13, Chapter 11 requires the debtor to complete a repayment plan in order to obtain a discharge.

While there are several other kinds of bankruptcy, these are utilized only under narrow circumstances that do not apply to most debtors. These lesser-known forms of bankruptcy include Chapter 9 (which is aimed at municipalities), Chapter 12 (which is aimed at farmers and fishermen), Chapter 15 (which is aimed at foreign debtors), and “Chapter 20” (a term for filing Chapter 7 and Chapter 13 in succession).

Can I Get Rid of Tax Debts by Filing for Bankruptcy?

Bankruptcy has the power to relieve the debtor of liability for numerous dischargeable debts, including two of the largest sources of debt in many American households: credit card and medical bills. In addition to medical and credit card debt, other dischargeable debts in bankruptcy generally include past-due utilities, past-due rent, business debts, certain court judgments, and – under narrow circumstances – student loans meeting certain criteria (the “Brunner Test”).

Less straightforward is the issue of whether tax debts are dischargeable in bankruptcy. The short answer is that it depends on the circumstances, particularly with regard to four factors:

1. The type of tax debt is in question
2. Which type of bankruptcy the debtor is filing for
3. The timing of the bankruptcy filing in relation to the pertinent tax return
4. Whether the debtor engaged in tax fraud (i.e. tax evasion)

Type of Tax Debt

Tax debt is how we refer to any taxes that you owe the federal or state governments after your most recent filing deadline, regardless of when you filed or how much you paid when you filed.

Let us address the widely held misconception that tax debts are non-dischargeable. In reality, this does not necessarily apply to state or federal income taxes owed by the debtor. That being said, other types of tax debts generally cannot be discharged, such as debts connected to sales or payroll taxes (“FICA taxes,” “trust fund taxes”).

Whether you can discharge bankruptcy tax debt depends on what kind of tax debt you hold and which type of bankruptcy you file for.  For instance, Chapter 7 bankruptcy will only discharge tax debt connected to income taxes.  Property tax and trust fund tax debt will not be impacted in any way by a Chapter 7 bankruptcy.  For this reason, it is critical that you speak to a bankruptcy tax attorney before determining which type of bankruptcy you will pursue.  For a more complete discussion on the types of bankruptcy for which you may elect to file, keep reading below.

Type of Bankruptcy

In Chapter 13, the debtor is responsible for repaying all “priority” debts. As the name might suggest, “priority” debts are debts whose repayment receives “priority” under federal bankruptcy laws. Federal law chooses certain debtors to prioritize out of certain pre-determined public policy interests that should be apparent for each law.

Examples of priority debts include child support-related debts, alimony-related debts, and “priority tax debts.” Most tax debts are considered “priority,” including payroll, excise, and employment tax debts, in addition to more recent income tax debts.

For this reason, some taxpayers may prefer to file Chapter 7. Chapter 7 bankruptcy is dangerous because filers take the risk potentially liquidating their assets. However, some may prefer Chapter 7’s lack of a requirement to enter a reorganization plan.

Unfortunately, there is a common misconception that high-earning taxpayers cannot qualify for Chapter 7 bankruptcy. This is likely due to the fact that, under the BAPCPA, debtors who wish to file Chapter 7 must pass a “Means Test” comparing their incomes against the applicable median: an effort by the BAPCPA to curb abuse of bankruptcy laws.

The reality is that even high-earning debtors can potentially utilize Chapter 7 by filing a non-consumer case, which does not require means testing. It may be possible to file a non-consumer case if more than half of the debtor’s debts are deemed non-consumer. Significantly, taxes are categorized as non-consumer debts.

For more information about whether filing Chapter 7 may make sense for you, speak to one of our bankruptcy and tax lawyers about the bankruptcy tax implications that each variation may carry in your particular case.

Timing of Filing and Age of Tax Debt

As our IRS tax debt attorneys noted above, tax debts are generally treated as non-dischargeable (and, in Chapter 13 cases, must typically be repaid). However, some exceptions can arise around income taxes, depending on when the tax in question was due:

• Three-Year Rule – The pertinent tax return must have been due a minimum of three years prior to the bankruptcy filing date. This includes any tax filing extensions the debtor might have obtained.
• Two-Year Rule – The debtor must have filed the pertinent tax return a minimum of two years before filing for bankruptcy.
• 240-Day Rule – The IRS must not have assessed the debt within the 240 days preceding the debtor’s bankruptcy. (For context, 240 days is slightly less than eight months.) Keep in mind that some events can extend this window of time, such as the debtor making an offer in compromise (OIC).

Due to these timeframes, more recent income taxes may be impossible to wipe out through bankruptcy. However, older income tax obligations that meet these criteria could be eligible for discharge.

Tax Fraud Issues

Debtors should be forewarned that income tax debts cannot be discharged if the associated returns were in any way fraudulent. Unfiled returns, delinquent returns, underreported income, and the improper claiming of tax credits are some common examples of tax fraud indicators, or “badges of fraud,” that can signal willful tax evasion to the IRS. Willful tax evasion is a more substantial charge than simple non-willful noncompliance, and the government tends to chase down signs of intentionally deceptive tax activities vigorously.

Of course, encountering a problem when filing for bankruptcy should be the least of a debtor’s legal concerns if he or she has truly engaged in tax fraud. Tax evasion is a federal crime, meaning the debtor could be at risk of prosecution. In addition to criminal penalties that include prison time, high fines, and often, periods of supervised release, tax evasion can also trigger a hefty civil fraud penalty – to say nothing of any IRS restitution that may be ordered by the court.

Those contemplating an eventual bankruptcy that have a history of committing tax fraud or who suspect they may have substantially fallen out of compliance might consider first going through a domestic / offshore voluntary disclosure. This process can allow for a taxpayer to have all prior years properly assessed and then enter an eventual properly timed (aged) bankruptcy. However, this approach cannot be guaranteed, considering the admission of tax fraud that typically takes place when one elects to engage in a voluntary disclosure. You should never attempt to engage in a voluntary disclosure process prior to filing for bankruptcy without first seeking the counsel of an experienced tax attorney like those at the Tax Law Offices of David W. Klasing.

This issue is likely to arise in (or following) a high-risk / high-stakes divorce. Taxpayer’s with a history of non-filing may be tempted to file all delinquent returns, get them properly assessed and properly aged and then enter a properly timed (aged) bankruptcy but this approach cannot be guaranteed as well. Be sure to seek a consultation with a competent criminal tax defense counsel if you are in either of these scenarios.

Our dual-licensed Bankruptcy Tax Attorneys and CPAs have the knowledge and experience in every aspect of tax dealings to give you the help that you need. Whether you are concerned about potential tax fraud charges stemming from filing for bankruptcy or are already in the heat of a state or federal investigation, our bankruptcy lawyers will work tirelessly to ensure that you are thoroughly protected.