Contrary to the popular belief, income taxes may be dischargeable with the help of a bankruptcy attorney and federal bankruptcy tax planning. The rules of discharge are that at the time of bankruptcy filing the tax year must be three years old; if the return was filed late, it must have been filed for two years; if there is a deficiency assessment, it must have been assessed for 240 days; and there must be no fraud associated with the return. The 240-day period may be extended by the pendency of prior bankruptcy proceedings, offers in compromise, or collection due process hearings.
The credit card industry in 2005 gave us a bankruptcy bill that uses means testing to force debtors having principally consumer debt and an ability to make a modest monthly payment into Chapter 13 arrangements. In a Chapter 13 the debtor pays creditors for a period of five years rather than obtaining an immediate discharge and getting a fresh start in a Chapter 7. With proper planning it may be possible to arrange a debtor’s affairs in a way that allows for a Chapter 7 discharge of income taxes.
High income debtors whose debts are not more than 50% “consumer debts” face the further challenge that the U.S. Trustee or the Court may move to dismiss a Chapter 7 case if granting a discharge would be an abuse of the bankruptcy system.
This is an extremely sophisticated area that requires detailed factual work up and multi-year planning. Paying debt is hard: payment of $1 in tax or credit card debt over 5 years requires about $2 in cash flow when the cost of interest, penalties, and income taxes on the income used to pay the debt are included. This places a high value on the ability to discharge the debt and get a fresh start. I do the planning working in this area but refer my clients to bankruptcy counsel for the execution of a bankruptcy case.