Bankruptcy and Taxes. My #1 Tip!

Taxes

You can find a lot of advice online regarding taxes this time of year. Even if you restrict your search to “bankruptcy and taxes,” you’ll get over 50 million results. I’m devoting this post to my number one tax tip in the exciting world of bankruptcy!

Disclaimer: I’m not a tax attorney, I’m not saying that this tip will make sense for anyone who isn’t filing bankruptcy, and this is not intended as legal advice for your specific situation. Ask your bankruptcy lawyer if this tip is right for you (sort of like those drug ads on TV.)

With that out of the way, here’s the tip: File your tax returns on time, even if you owe money and can’t afford to send payment. (If you’re due a refund, this won’t apply.)

Fascinating, isn’t it? It may seem simple, but many people fail to file their returns when they think they may owe the I.R.S. or state Department of Revenue. That can be a problem if you later decide to file bankruptcy. Here’s why:

Filing late (or not at all) isn’t going to change the amount of tax you owe. The debt is there whether or not you file the return. There’s no benefit to not filing the return; hiding from the taxing authorities just doesn’t work.

If you need to file bankruptcy three years or more down the road, those taxes may be dischargeable in your bankruptcy, but only if you filed the return. One of the rules for discharging taxes in bankruptcy is that the taxes have to be at least three years old (that’s the simplistic version of Section 523(a)(1)(A) of the Bankruptcy Code). The rule that is relevant for the purposes of this article is found in § 523(a)(1)(B). It says that the tax is not dischargeable unless the return was filed more than than two years prior to filing the bankruptcy petition.

In other words, if you don’t file the return, the tax owed will never be dischargeable. If you file the return, even if you can’t send the money you owe, the tax *might* be dischargeable 2-3 years later, depending on if the other dischargeability rules are met.

Furthermore, there are court decisions that say if the I.R.S. files a Substitute For Return or if the taxpayer files a return late, that late-filed return “isn’t a tax return” for purposes of § 523. According to these rulings, filing a late return is the same as not filing at all. And as I’ve discussed above, that means that the tax will never be dischargeable in a bankruptcy. (I won’t get into why I think those cases are wrongly decided.)

The takeaway here is that you should always file your returns on time, even if you owe money and can’t afford to pay. Filing a return without sending along a check won’t affect the amount of tax you owe, but it might allow you to discharge those taxes if you need to file bankruptcy in the future.

As with all my blog posts, this is general information only and is not intended as legal advice. For advice specific to your particular situation, you need to speak with a local attorney.

Image credit: 401(k) 2013/flickr

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One Comment

  1. Hawaii Bankruptcy attorney Stuart Ing made a similar post here and added some good points: http://www.bankruptcyhi.com/2013/04/1-tax-tip/

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