Tim’s Tax News on the Tenth – November 2024

The high inflation of the past couple of years coupled with economic aftershocks from COVID-19 has created a great amount of economic uncertainty in many people. Our office has been contacted by numerous individuals and businesses about how to handle their debts, which for many include IRS debt. Over the years, our firm has helped numerous clients with tax debts via an Offer in Compromise, Abatement of Penalties, or favorable Installment Agreements. We have also in the right circumstances helped taxpayers by filing bankruptcy for them to eliminate (or greatly reduce) their tax obligations. Yes, some taxes can be discharged in bankruptcy. 

Income taxes can be discharged if the liability meets a four-part test.

The First Test is: if the tax year is older than three years (for example 2020, which was due without an extension on April 15, 2021), you add three years to that filing due date arriving to April 15, 2024, therefore 2020 and earlier years could be discharged, provided that there was no extension. If, however, there was an extension, then October 16, 2024, would be the operative date, provided the next three tests are met.

Second Test: The return must be filed at least two years before the bankruptcy filing date. A fairly straightforward and simple test, however, if the IRS were to prepare a return for the taxpayer (called a Substitute for Return – SFR), then that would prevent this test from being met for the client. Assuming that no SFR was prepared, and the return was filed more than two years before, then that year’s liability could be discharged, provided the next two tests are met.

Third Test: The bankruptcy is filed at least 240 days after the IRS makes its assessment for that tax year. This simple step (but very critical) can be verified by reviewing IRS transcripts in a pre-filing due diligence step necessary to ensure the taxpayer’s taxes can be discharged.

Fourth Test: The last test is not as objective as the above three tests. The final test boils down to this question: “was the liability accrued as a pattern of fraud?” Again, like the first three tests, this test requires a thorough understanding of the client’s case, as well as being able to argue the merits of why the liability accrued in the manner it did by the taxpayer.

The above four-part test is for both federal and state income taxes. Unfortunately, employment tax (trust fund) and sales and use tax are not dischargeable in bankruptcy.

Our firm has helped many of our clients to meet the four-part test requirements and ultimately to successfully have both their federal and state income taxes discharged in bankruptcy. Or if bankruptcy is not an option help them with a penalty abatement, installment agreement or offer in compromise.

If you would like more details, please do not hesitate to call our office. Our office has been successful in helping taxpayers with IRS and IDOR collection problems for over 30 years. If you have a tax or debt problem, please contact me at 847-705-9698 or thughes@lavellelaw.com and find out how we can help you.

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