This time of year many people get an unpleasant surprise when they do their returns....what to do if they've been underwithholding and now have a tax liability? Often it is due to the fact that they've experienced some financial distress and took distributions from IRA's, 401Ks or other pension. Maybe there was some unemployment and they neglected to do withholding from that income source. Perhaps there are multiple years worth of tax liabilities and now the IRS or the state tax authority is threatening wage garnishment, bank levy or liens against business or personal property.
What to do?
If one can work out a manageable payment plan with the tax authorities...of course that is one way to handle it. Offers in compromise are often brought up in conversations like these but my experience has been that while many people would like them...they are as hard to find as hen's teeth.
Bankruptcy can offer a solution. Some tax debts are discharged in chapter 7 depending on their nature, age and the status of the filed returns.
The general rule is that to be discharged in bankruptcy the taxes have to be at least 3 years old and the returns have to have been on file (and filed by the debtor) for at least 2 years.
There are exceptions to that rule. They have to be income taxes (so sales tax, employee withholding or anything else which would fall under the "trust tax definition will never be eligible for discharge). They can't have been assessed within the past 240 days. Plus....there are events which can "toll" the 3 year aging...such as prior bankruptcy filings or other such situations that prevents the taxing authorities from acting in a collection mode if they chose....like the aforementioned "offers in compromise" or an appeal from an assessment, etc. It is important to note as well that where there has been fraudulent returns filed those taxes will not be eligible for a discharge either.
If there are liens filed...then they are not dischargeable even if they were old enough and the tax returns had been filed on time as they are now considered a SECURED debt and secured debts are not discharged in bankruptcy. However, often as there is no equity in any of th debtor's property the liens are essentially unenforceable and so the taxing authority may choose to release them on that basis.
In Chapter 13 even if they are not dischargeable they can be paid as a priority debt in the chapter 13 plan of reorganization. One of the requisites for confirmation of a chapter 13 plan is that it provides for full repayment of any priority tax debt (which would be the non dischargeable tax debts...see the standard recited above for what can be discharged and what can't be). A significant benefit of paying the priority debt through a chapter 13 case is that as of the date of the case filing no more interest or penalty will accrue on the balance. In chapter 13 you have up to 5 years to pay the debt as that is the maximum length allowed for a chapter 13 under the bankruptcy code.
In summary....there may be something you can do in terms of filing a bankruptcy for relief from your debt problems. Many tax professionals, interestingly, are not aware of the advantages that the bankruptcy can provided overburdened tax payers.
If you are a Minnesota resident and get a jaw-dropping surprise from your CPA or tax preparer give us a call and we can find some workable solutions for you.
David D. Kingsbury
Attorney at Law
(952) 432- 4388
Offices in Apple Valley and Rochester, MN.