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For Whom the Tax Tolls: Significant Events That Extend IRS Collection Rights
By Michael S. Fried and Zachary S. Fried
Discharge of Taxes in Bankruptcy
As opposed to the trust fund recovery penalty, however, individual income taxes are often dischargeable in either a Chapter 7 bankruptcy (sometimes referred to as a 'straight bankruptcy') or a Chapter 13 bankruptcy (an individual payment plan bankruptcy), or a combination of the two (the serial filing of a Chapter 7 and a Chapter 13 is often called a 'Chapter 20'). Use of these bankruptcy 'tools' will often be the most efficient, most predictable and least costly alternative to solve or mitigate delinquent income tax liabilities. Although slightly different timing rules apply to the ability to discharge a tax in a Chapter 7 versus a Chapter 13 bankruptcy, the ability to discharge a tax in bankruptcy, and selection of the proper bankruptcy chapter, is primarily determined by four dates:
- The date on which the taxpayer's return was due for the year of the delinquent tax
- The date the taxpayer filed the applicable return
- The date the tax was assessed by the IRS
- The proximity of the foregoing three dates to the taxpayer's bankruptcy case filing date
These time requirements are found in the Bankruptcy Code.
The bankruptcy discharge of a personal income tax liability is governed by the lapse of certain time periods measured from the taxpayer's tax return due date, filing date or tax assessment date, until the date of the taxpayer's bankruptcy filing. Thus, these periods can be thought of as three separate statute of limitations periods governing the ability to discharge a delinquent tax in bankruptcy. Once these periods have expired, a delinquent tax will convert from a priority (nondischargeable) tax to a nonpriority (dischargeable) tax that may be abated in either a Chapter 7 or Chapter 13 bankruptcy case. In Chapter 7, an income tax can be discharged (subject to certain bad conduct rules) if all of the following time periods have expired:
- The taxpayer's return was due (including all extensions) more than three years before the bankruptcy filing (the three-year look-back rule).
- The return was filed more than two years before the bankruptcy filing (the two year filing rule).
- The tax was actually assessed more than 240 days before the bankruptcy filing (the 240-day assessment rule).
In a Chapter 13 case, only the three-year look-back rule (tax return due date) and the 240-day assessment rule apply to determine if the tax can be discharged for less than full payment, not the two-year filing rule (return filing date). In a Chapter 13 case, the taxpayer's return for the applicable tax year must have been due more than three years before the bankruptcy filing, and the tax to be discharged must not have been assessed within the 240-day period prior to the Chapter 13 case filing; however, there is no requirement that any tax return has been actually file, or that the tax was assessed, before the bankruptcy filing in order for the delinquent tax to be eligible for discharge in a Chapter 13 case.
There are two significant advantages of Chapter 13 in connection with a tax discharge case: (1) the bad conduct rules do not apply, and a tax can be discharged in a Chapter 13 case even if the taxpayer engaged in fraud or a willful attempt to evade payment of the tax; and (2) the two-year filing rule is not applicable. In Chapter 13, the taxpayer's return can be file at any time, e.g., the day before or even the day after, the taxpayer files for Chapter 13 relief. There are only two timing requirements to discharge a tax in Chapter 13: (1) the taxpayer's return was due more than three years prior to the bankruptcy filing; and (2) the tax was not assessed within the 240-day window prior to the Chapter 13 filing. The 240-day assessment rule will be satisfied if the tax to be discharged was assessed either more than 240 days prior to the bankruptcy or the assessment occurred after the bankruptcy case was filed. In either case, assessment occurred outside of the window beginning 240 days before the bankruptcy filing and ending on the date of the filing.
Akin to the statute of limitations for collection, the taxpayer's right to discharge a tax in bankruptcy, whether in a Chapter 7 or Chapter 13 case, and the IRS's right to continue collection of a tax after bankruptcy, are governed by the lapse of time; the running of these bankruptcy discharge time periods can be extended, or tolled, by many of the same events that toll the running of the collection statute of limitations. For example, a prior bankruptcy stops the clock, or tolls, the running of the two-year filing and three-year look back periods; an offer in compromise will often, but not always, toll the running of the 240-day assessment period; and the collection due process appeal of a proposed assessment will toll the commencement, and hence, the running of the 240-day period.
Substantial amount of litigation and attention has recently been focused on the events that toll or extend these bankruptcy time periods, and often, the results have been favorable to the taxpayer. However, the various time and limitation periods controlling the collection statute expiration date and the ability to discharge a tax in bankruptcy, and the possible occurrence of events that may toll the running of these limitation periods, are among the most important considerations in planning for and implementing strategies to solve delinquent tax problems. The remainder of this article will focus on these limitation periods and the most significant events that toll their expiration.
Table of Contents
- Statute of Limitation on Collection
- Discharge of Taxes in Bankruptcy
- Hypothetical Client Case / Situation
- Collection Statute Expiration
- Bankruptcy Solutions and Tolling Issues
- 1998, 1999 and 2000 Tax Liabilities
- 1997 Tax Liability
- Two Hundred and Forty Day Assessment Period
- Application of Three-Year Look Back Rule and Two-Year Filing Rule to 1997 Tax
- LTR 200404049
- Application to 1997 Tax Liability
- 1987 to 1996 Tax Liabilities
- Endnotes & Sources