Why Bankruptcy Is Rarely If Ever An Effective Means Of Dealing With A Tax Liability

Posted on: November 1, 2013 | By: dunn_access | Civil Tax Controversies

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By Stephen J. Dunn

Often I express the view that bankruptcy rarely if ever is an effective means of dealing with tax collection action.  Some readers have challenged me on it, and I have promised elaboration.  Here it is, in the form of an excerpt from my forthcoming West treatise Current Federal Tax Controversies:

“Bankruptcy is almost never an effective means of relief from a tax liability.  Once a tax lien attaches to property, it remains until the assessment is paid or becomes unenforceable by the lapse of time, notwithstanding discharge of the property’s owner in bankruptcy

There is no discharge for a tax with respect to which a return was not filed, or was filed after the due date, and within two years before the filing of the bankruptcy petition.  Nor is there discharge for a tax with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.  There is no discharge for income tax for a taxable year ended on or before the date of filing of the bankruptcy petition, for which a return, if required, was last due, including extensions, after three years before the filing of the bankruptcy petition.

There is no discharge for a tax required to be collected or withheld and for which the taxpayer is liable in whatever capacity.   These are the so-called “trust fund” taxes—income tax, Social Security tax, and Medicare tax withheld by an entity from employees’ wages, but not paid over to the taxing authorities.  These taxes are assessable against the entity’s responsible persons, and they are not dischargeable in bankruptcy.

The statute of limitations on assessment of tax against a taxpayer or collection of it is suspended during any period when the IRS is prohibited from assessing the tax or collecting it because of the pendency of a bankruptcy case concerning the taxpayer, and—

(1)   for assessment, 60 days thereafter, and

(2)   for collection, six months thereafter.

Perhaps the most harmful aspect of a bankruptcy is that it subjects the taxpayer to the scrutiny of creditors and the bankruptcy trustee.  In one case, a taxpayer’s Federal income tax accounts were reposing as currently not collectible.  Then the taxpayer filed a chapter 7 bankruptcy.  The bankruptcy was ill-advised, discharging but a few thousand dollars in credit card debts.  The bankruptcy prompted the IRS renew collection action against the taxpayers.   The Revenue Officer assigned to the taxpayer’s accounts had retired. A new Revenue Officer investigated and found a recorded deed which the taxpayer had executed before filing the bankruptcy.  The IRS asserted a nominee lien against the property conveyed by the deed.  The grantee sued the United States under 28 U.S.C. § 2410 to remove the cloud of the recorded NFTL from the property, and the U.S. District Court ultimately upheld the nominee lien.

Installment agreement, currently not collectible posting, and offer in compromise, discussed above, are all more effective than bankruptcy in dealing with tax collection action, and do not involve the risks inherent in bankruptcy.”

Footnotes with legal authorities have been omitted from the foregoing excerpt.  For a version with legal citations, check here.