Bankruptcy and taxes – Monterey Herald
Q. The pandemic destroyed my business and my personal finances. I am working with a local bankruptcy attorney to potentially file for Chapter 7 bankruptcy personal protection. I have not filed income tax returns in the past two years (2019 and 2020) due to the high amount of taxes I owed and couldn’t afford to pay as I tried to run my business. Can I claim my tax debts as a liability in my bankruptcy filing and avoid paying taxes?
A. Debts are divided into two categories: dischargeable and non-dischargeable. Releasable debts are those which the debtor is no longer personally liable to pay after the conclusion of the bankruptcy proceedings. Non-dischargeable debts are those that are not canceled due to bankruptcy proceedings. The debtor remains personally responsible for their payment.
Generally, there is no discharge for you as an individual debtor on closing a bankruptcy case for most taxes, or for taxes for which no return, a late return filed in both years after the bankruptcy petition was filed, a fraudulent return was filed. However, claims against you for other taxes that predate the bankruptcy application by more than three years may be voided. Social charges are fiduciary taxes and are not dischargeable.
Simply, if the tax debt meets the following five rules, then the tax debt is dischargeable in Chapter 7 and Chapter 13 bankruptcy petitions:
• The due date for filing a tax return is at least three years.
• The income tax return was filed at least two years ago.
• The tax notice is at least 240 days old.
• The tax return was not fraudulent.
• The taxpayer is not guilty of tax evasion.
The fact that you are eligible for Chapter 7 bankruptcy protection indicates that you may be a prime candidate to file an “Offer in Compromise” with the IRS to negotiate an acceptable agreement for open (non-canceled) years. ) as well as unpaid social charges.
If a debt is canceled or forgiven, other than as a gift or bequest, the debtor must generally include the canceled amount in gross income for tax purposes. Debt includes any debt for which the debtor is responsible or which relates to property he owns.
There are several exceptions and exclusions to including forgiven debt in income. The exceptions include:
1. The cancellation of a student loan for a student called to work for certain employers.
2. Debt cancellation (accrued mortgage interest) that would have been deductible if paid.
3. Debt reduction by the seller of the property (foreclosure) if the debt arose out of the purchase of the property (non-recourse debt).
4. The reduction or release of principal residence debt in accordance with the Mortgage Debt Relief Act 2007 (and subsequent extensions of the provisions of the law).
The following are “exclusions”. You do not include a forgiven debt in gross income if any of the following apply:
1. Cancellation takes place in a bankruptcy case under the US Bankruptcy Code.
2. Cancellation occurs when you are insolvent (your liabilities exceed the fair market value of your assets) and the excluded amount does not exceed the amount of your insolvency.
3. The canceled debt is an eligible farm debt (debt incurred for the operation of a farm).
4. The canceled debt is a qualified business real estate debt (certain debt related to a business building).
Generally, debts, if discharged in bankruptcy, will have no tax consequences for you. As per the above, you will need to file all of your income tax returns and then wait two years to file for bankruptcy in order to pay taxes.
Barry Dolowich is a Certified Public Accountant and owner of a full service accounting and tax firm with offices in Monterey. He can be reached at 831-372-7200. Please direct your questions to PO Box 710, Monterey 93942 or email: firstname.lastname@example.org.