Often bankruptcy clients believe they will be stuck with their income tax debt after filing bankruptcy. That is not always the case. You may discharge income taxes in bankruptcy. However, you must satisfy four requirements in order to do so. Fail to satisfy any one of the requirements and the income tax debt will not be discharged.
- INCOME TAX DUE
The first requirement relates to when the income taxes came due. For the income taxes to be dischargeable in bankruptcy, they must have become due at least three years before the bankruptcy case filing. Income taxes ordinarily become due on April 15th. However, there were extensions during the COVID-19 Pandemic.
For instance, 2019 income taxes were due on July 15, 2020. These income taxes came due within the last three years. As such, they would not yet be old enough to discharge in Bankruptcy.
- Tax Return File Date
The second requirement relates to when the tax return was filed. The tax return must be filed at least two years before filing the bankruptcy case filing. The tax return may be filed late so long as it was filed two years before the bankruptcy was filed.
For example, the tax return for the 2018 Tax Year was due on April 15, 2019. However, the 2018 tax return may be filed as a late March 22, 2021, and still satisfy this requirement.
You may obtain from the IRS the date on which a tax return was filed. You may do so by requesting an “Account Transcript” at www.irs.gov.
- Assessed Date
The third requirement relates to when the taxes were assessed. The income taxes cannot have been assessed within 240 days of filing the bankruptcy case filing in order to be discharged. Income taxes are ordinarily assessed when the tax return is filed. However, the assessment date could be a later date if the IRS conducts an audit and determines that you owe more taxes.
You also may obtain from the IRS the date on which an income taxes were assessed. This information would be reflected in an “Account Transcript.”
- Fraudulent Return
The income taxes may be satisfy the three above-mentioned requirements and still be nondischargeable if they are the result of a fraudulent return. However, the IRS has the burden of proof. The IRS must prove the following by a preponderance of evidence:
- Debtor had knowledge of the falsity of the return,
- Debtor had an intent to evade the taxes, and
- There was an underpayment of taxes.
Courts look at the totality of the circumstances when determining the second requirement – Intent. Further, courts may consider “badges of fraud” when determining intent. The badges of fraud include: large understatements of income made consistently over time,
- large understatements of income made consistently over time,
- failure to keep adequate records,
- failure to file tax returns,
- implausible or inconsistent behavior by the debtor,
- concealing assets,
- failure to cooperate with tax authorities,
- and the sophistication of the debtor.
Income taxes are also nondischargeable if debtor attempted to evade or defeat the taxes. The attempt to evade or defeat the taxes must be willful. And, debtor must have engaged in conduct evidencing his intent to evade or defeat the taxes.
Willful attempt to evade or defeat tax – the IRS must prove by a preponderance of evidence that:
- debtor had a duty to file income tax returns and pay tax,
- knew he had such a duty, and
- voluntarily and intentionally violated that duty.
Courts again look at “badges of fraud” to determine whether debtor intended to violate the duty to pay tax.
Evasive Conduct – IRS must show debtor’s failure to pay is coupled with an affirmative act evidencing his attempt to evade or defeat payment. Courts may look for the following conduct: transfers of property for little or no consideration, concealing assets, or using significant income to maintain an extravagant lifestyle.
Self-Executing Discharge and Adversary Proceedings
Income taxes are discharged if they satisfy all of three above-referenced requirements and the IRS does not claim they resulted from a fraudulent return. No action is required by the Debtor other than filing the Bankruptcy Case.
However, the IRS may disagree about whether all of the requirements have been satisfied. Or, the IRS may claim the income taxes are the result of a fraudulent return. Under those circumstances, Debtor will need to file a lawsuit in the Bankruptcy Case against the IRS.
The lawsuit is called an Adversary Proceeding. The Bankruptcy Court will decide whether all the requirements have been satisfied and whether the taxes are the result of a fraudulent return. However, the IRS will have the burden of proof in the Adversary Proceeding. The IRS will have to show by a preponderance of evidence that Debtor failed to satisfy one of the requirements discussed above, or the taxes are the product of a fraudulent return.
Conclusion
Discharging income taxes in bankruptcy can quickly become a complicated process. If you have any questions about the process or bankruptcy in general, feel free to call the Law Office of Brent M. Myer PLLC at 727-487-9030.