Monthly Archives: August 2015

Can a Taxpayer “Strip Off” an IRS Lien From a Home by Filing Chapter 7?

Did you say Chapter 7 or Chapter 13?  It makes a difference.  Keep reading…

It is not uncommon for a taxpayer’s home to be “underwater,” meaning the fair market value (FMV) of a taxpayer’s home is less than the amount owed on the senior mortgage loan. Sometimes a taxpayer with an underwater home fails to pay income taxes, causing the IRS to file a Notice of Tax Lien against a taxpayer’s property with the Recorder of Deeds for the county in which the real property is located.  This lien gives public notice of a “secret lien” that previously existed pursuant to 26 U.S.C. §6321, which attached automatically to all of a taxpayer’s property and rights to property, both real and personal, upon assessment.

These taxpayers are prevented from filing Chapter 7 bankruptcy and “stripping down” the tax lien value from the full face amount of the tax obligation to the amount that would be recoverable after the senior liens are paid in full.  The U.S. Supreme Court rejected any attempt to “strip down” a lien in a Chapter 7 bankruptcy case in Dewsnup v. Timm. Until recently, the Supreme Court had not decided whether a lien could be “stripped off” in a Chapter 7 case.

So a clever taxpayer in In re Blackburn, 525 B.R. 153 (Bankr. N.D.FL 2015) attempted to reclassify an otherwise impermissible “strip down” of a tax lien into a “strip off” by arguing the IRS’ tax liens were divisible between real property and personal property.  If divisible, the taxpayer argued, then the tax lien could be “stripped off” as to the real property while preserving the tax lien as to the personal property.

The Blackburn court stated the issue as whether the IRS tax liens were divisible. The court ruled that the IRS tax liens were NOT divisible.  Therefore, the IRS’ claim was partially secured by the personal property.  The fact that there is no equity in the taxpayer’s real property over and above the senior mortgage did not render the IRS’ tax lien totally unsecured.  The IRS’ tax lien remained, at least in part, secured by the taxpayer’s personal property.  Consequently, the court rejected the taxpayer’s attempt to “strip off” the tax lien finding the taxpayer was actually attempting to “strip down” the tax lien, which was prohibited by the US Supreme Court in Dewsnup v. Timm.

Practice Pointers:  A taxpayer should attempt to file a Chapter 13 case instead of a Chapter 7 case if the taxpayer’s goal is to “strip down” a tax lien.  It is permissible to both “strip down” and “strip off” a tax lien in Chapter 13 bankruptcy cases.

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

A Taxpayer Can Eliminate Tax Liability Relating to a Late-Filed Tax Return

The courts are divided regarding the dischargeability of tax obligations relating to a late-filed tax return.  An earlier blog discussed the First Circuit’s conclusion that a late-filed tax return is deemed NOT A RETURN for bankruptcy purposes solely because it was filed after the tax filing deadline.  See In re Fahey, 779 F.3d 1 (1st Cir. 2015).

However, a different conclusion was reached by the bankruptcy court in In re Biggers, 528 B.R. 870 (Bankr. M.D.TN 2015).  In Biggers, the court rejected Fahey’s rational and ruled that a late-filed return can be deemed a “return” if it meets the definition of “return” as set forth in Beard v. Commissioner, 82 T.C. 766, 1984 WL 15573 (1984), affirmed 793 F.2d 139 (6th Cir. 1986).  In order for a Form 1040 to qualify as a “return” pursuant to the Beard test: (1) it must purport to be a return; (2) it must be executed under penalty of perjury; (3) it must contain sufficient data to allow calculation of tax; and (4) it must represent an honest and reasonable attempt to satisfy the requirements of the tax law.  In re Biggers, 528 B.R. 870, 872 (Bankr. M.D.TN 2015).

The Biggers court agreed with the IRS and those decisions that define “applicable non-bankruptcy laws” (11 U.S.C. Section 523(a)(*)) as the pre-BAPCPA Beard test and found a Form 1040 is a “return” if it satisfies the Beard test. The court rejected the idea that the reference to “applicable non-bankruptcy laws” relates to the filing deadline imposed by the taxing authority per statute.

In Biggers, the taxpayers had filed multiple returns AFTER the filing deadline and AFTER the IRS had already assessed the tax.  The court found that the late-filed returns served no purpose on all but one return because the tax liability disclosed on the late-filed return was less than the amount assessed by the IRS and therefore did not “represent an honest and reasonable attempt to satisfy the requirements of the tax law,” as required by the fourth prong of the Beard test.  However, the court allowed the discharge of tax relating to the one late-filed return that disclosed liability greater than the amount assessed by the IRS.  The Court allowed the discharge as to the tax liability that exceeded the IRS’ assessed liability that return.

Practice Pointer: File all tax returns and perform all other filing obligations on a timely basis. It is a risky landscape on this issue.  The courts are split and no definitive ruling exists for Illinois taxpayers. So, a taxpayer seeking to discharge tax debts in a Chapter 7 bankruptcy should file all returns on a timely basis and then file bankruptcy after the two-year waiting period has expired (plus satisfy all other Section 523 requirements).

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

Can a Taxpayer who Filed a Tax Return After the Filing Deadline Eliminate the Tax Debt in Bankruptcy?

Certainly a taxpayer could file a Chapter 13 bankruptcy case and discharge the tax debt by paying the tax liability through the repayment plan.  The real question is whether a taxpayer who files a tax return after the filing deadline could file a Chapter 7 bankruptcy case and discharge the tax debt without paying the tax liability.

Until recently, the issue appeared clear that the tax debt could be discharged in Chapter 7 if the taxpayer waited to file bankruptcy at least two years after the date the tax return was filed (assuming all other factors being satisfied). The prior court cases usually related to whether the document filed with the IRS was a “return” or some other document filed with the IRS (e.g. protest letter or something less than a statement as to gross and net income).  Another issue related to whether the return was filed by the taxpayer after the IRS had already prepared a substitute for return (aka “SFR”), which rendered a taxpayer’s later-filed return moot.

Now the issue is whether any return filed after the tax filing deadline is deemed NOT A RETURN for bankruptcy purposes solely because it was filed after the tax filing deadline—even one day late.  That issues was addressed by the U.S. Court of Appeals for the First Circuit in In re Fahey, 779 F.3d 1 (1st Cir. 2015).

In Fahey, the court was confronted with taxpayers who had failed to file their Massachusetts income tax return before the deadline imposed by the state statute.  The taxpayers filed their returns late and then waited two years before filing bankruptcy.  The taxpayers sought to discharge their tax obligations by filing Chapter 7.  The Massachusetts Department of Revenue objected arguing that the tax debt was non-dischargeable because 11 U.S. C. §523(a)(1)(B) excepts from discharge any tax obligation relating to a return that “was not filed or given.”  The Department then argued that the late-filed returns were not deemed “returns” for bankruptcy purposes even though the same returns would be considered “returns” for tax purposes.

The Fahey court agreed with the Massachusetts Department of Revenue, holding that the late-filed tax returns could not be deemed “returns” for bankruptcy purposes.  Therefore, the tax obligations would not be discharged in the Chapter 7 bankruptcy because 11 U.S. C. §523(a)(1)(B) excepts from discharge any tax obligation relating to a return that “was not filed or given.”

This case is very bad for taxpayers seeking bankruptcy protection. The only good news is that the U.S. Court of Appeals that incorporates the Chicagoland area has not ruled on the issue. Hopefully, the 7th Circuit Court of Appeals would render a contrary holding and create a conflict between the circuits so the U.S. Supreme Court would decide the issue once and for all.

Practice Pointer: File all tax returns and perform all other filing obligations on a timely basis. The Fahey case may not be limited to filing obligations. It could be interpreted expansively to apply to all tax obligations other than payment obligations. So, a taxpayer seeking to discharge tax debts in a Chapter 7 bankruptcy should file all returns on a timely basis and then file bankruptcy after the two-year waiting period has expired (plus satisfy all other Section 523 requirements).

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

Can a Taxpayer Keep an IRS Tax Refund Received Shortly Before Filing Bankruptcy?

An Illinois taxpayer received a $10,000 refund about a month before filing bankruptcy.  The taxpayer identified the tax refund in amended Schedule B as “2013 Tax Refund (Earned Income Credit) -$4,989.00; 2013 Tax Income Refund (Child Care Credit)-$3,000.”

The taxpayer sought to keep that money and protect it from seizure by the Chapter 7 trustee.  The trustee wanted to include the tax refund as a non-exempt asset that should be added to the “bankruptcy estate.” The taxpayer attempted to exempt the tax refund from the bankruptcy estate by claiming it was “public assistance benefits” protected under the Illinois exemption statute 735 ILCS 5/12-1001(g)(1).  The trustee did not object to the taxpayer’s characterization of the tax refund as “public assistance benefits.”  But, the trustee objected because the taxpayer received the refund before the bankruptcy filing date, and argued that the Illinois exemption statute cited by the taxpayer did not apply.

The court resolved the issue by sustaining the trustee’s objection to the taxpayer’s claimed exemption, thus causing the tax refund to become property of the bankruptcy estate for redistribution to the unsecured creditors.  In re Frueh, 518 B.R. 881 (Bankr. N.D.IL 2014)(Lynch, J).  The court made a distinction between a taxpayer’s Section 5/12-1001(g)(1) “right to receive…public assistance benefits” in the future and a taxpayer’s Section 5/12-101(h) “right to receive, or property that is traceable to…” an asset.  The Frueh court’s distinction clarified the Illinois legislature’s desire to exempt public assistance benefits to be received in the future and not public assistance benefits already received. The court noted that the legislature knew how to protect already received assets when it wanted to do so (citing Section 5/12-101(h)), and chose not to protect public assistance benefits already received.

Practice Pointer:  A taxpayer anticipating a tax refund relating to the Earned Income Credit and/or the Child Care Credit should file a Chapter 7 bankruptcy case PRIOR to filing the IRS tax return— to ensure the tax refund would be received AFTER the case filing.  If needed, a taxpayer could request from the IRS an automatic extension to the tax return filing deadline to ensure the refund would be received after the bankruptcy case was filed.  To do otherwise results in the loss of the tax refund to the Chapter 7 trustee for re-distribution to the bankruptcy creditors.

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

Does taxpayer have the right to choose which tax years a Chapter 13 payment shall be applied?

That issue was addressed in In re Fielding, 522 B.R. 888 (Bankr. N.D.TX 2014).  In Fielding, a taxpayer filed Chapter 13 bankruptcy owing the IRS approximately $539,000 for multiple tax years.  The taxpayer sold his residence after filing bankruptcy to generate cash to reduce the secured debt owed to the IRS and to make the Chapter 13 plan more affordable.

The issue before the Fielding court was whether the taxpayer may apply, at the taxpayer’s own discretion, proceeds from the sale of an exempt asset to tax debt owed to the IRS.  The taxpayer argued that the taxpayer has the right to allocate sale proceeds to whatever tax years the taxpayer desires.  The IRS maintained that the IRS has the right to apply payments to portions of debt according to the IRS’ existing policies and procedures, including applying payments to the oldest tax liability, including the penalties and interest associated with that liability.

The Fielding court began its analysis by citing the 1990 U.S. Supreme Court decision, United States v. Energy Res. Co., Inc., 495 U.S. 545 (1990), which held that a bankruptcy court has the authority to order the IRS to apply tax payments made as designated by the taxpayer when the designation is necessary to ensure a successful reorganization.  The Fielding court then analyzed the facts of the case and determined that the taxpayer’s allocation was indeed necessary to ensure a successful reorganization.

Granting the taxpayer relief on an alternative theory, the Fielding court found that the taxpayer’s payment of the sale proceeds constituted a “voluntary payment” which allowed the taxpayer to allocate payments to any tax year of the taxpayer’s choosing.  The court rejected the IRS’ position that the payment was “involuntary” because it was part of a bankruptcy proceeding.  The court pointed to the voluntary nature of a Chapter 13 case versus an involuntary Chapter 7 case.  Plus, the court noted that the sale proceeds were exempt under Texas law and that the application of the payments to the IRS would not violate the “best interest of the creditors” text of 11 U.S.C. §1325(a)(4) because the unsecured creditors were not entitled to the exempt funds.

Practice Pointers:  The taxpayer should have attempted to sell the homestead prior to filing bankruptcy so that there would be no question that the sale proceeds were “voluntary payments” to the IRS.

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

Can a Doctor File Bankruptcy and Eliminate Unpaid Business License Fees Assessed Against Professionals?

That issue was addressed in In re Perry, 521 B.R. 370 (Bankr. N.D. AL 2014).  In Perry, a medical doctor sought a determination that the $46,461 business license fees assessed against the doctor were discharged when the doctor received the Chapter 7 general bankruptcy discharge.  The City assessing the business license fees argued that the fees constituted an “excise tax” that was excepted from the general discharge and had to be paid after the bankruptcy.

The Perry court started its analysis by noting the language in 11 U.S.C. §523(a)(1) excepts certain tax obligations from the general bankruptcy discharge.  This U.S. Bankruptcy Code (“Code”) section incorporates a different Code section that identifies which types of taxes are excepted from the general bankruptcy discharge, including the “excise tax.”  See 11 U.S.C. §507(a)(8)(E).

The first issue raised is whether the business license fee was a “tax” as used in the U.S. Bankruptcy Code.  However, the term “tax” is not defined in the Code.  The U.S. Supreme court considered a tax to be a “pecuniary burden laid upon individuals or property for the purpose of supporting the government.”  United States v. Reorganized CF & I Fabricators of Utah, 518 U.S. 213, 220 (1996).  Therefore, a court must look to the substance of the statute or ordinance that establishes the obligation to determine whether the obligation bears the characteristics of a tax.  The statute’s mere characterization of the obligation as a “tax” is not controlling.  A measure is considered a “tax” when the enacting statute or ordinance’s purpose is to raise revenue and not to regulate and not to defray costs of a specific service.

The Perry court found that the business license fees assessed against professions like the debtor-doctor were “taxes” since the revenues raised by the license were placed in the City’s General Fund to be used for the City’s general obligations and not set aside to defray the costs of a specific service.

The second issue raised is whether the tax was and an “excise tax” as contemplated in 11 U.S.C. §507(a)(8)(E).  The Code does not define “excise” either.  But, the Perry court incorporated the definition used in Black’s Law Dictionary as a tax imposed on the performance of an act or the engaging in an occupation.  Doctors are definitely professionals and the court found that the license fees were excise taxes.

The third issue raised by the doctor is whether the excise tax was an “excise tax on a transaction” as contemplated in 11 U.S.C. §507(a)(8)(E).  The debtor-doctor argued that the business license fee was an occupation tax calculated on the doctor’s gross revenues and was not based on any “transaction.”  The court disagreed and found that debtor’s medical practice involved multiple transactions, from receiving payment for the care and treatment of patients to employing and paying others to work for the doctor.  The court chose to interpret the term “transaction” broadly.

Consequently, the court found the business license fees not discharged by the doctor’s bankruptcy because the fees were “excise taxes on a transaction” as contemplated in 11 U.S.C. §507(a)(8)(E).

because the fees were “excise taxes on a transaction” as contemplated in 11 U.S.C. §507(a)(8)(E).

Practice Pointer:  A proper analysis of the dischargeability of certain license fees begins with an analysis of the statute or ordinance that creates the fees.  The purpose of the legislation should be examined as well as the utilization of the collected fees.  Are the fees earmarked for a special purpose or deposited into the General Revenue Fund?  Next, examine whether the fees are an “excise” tax and also whether the tax related to a “transaction” or merely a status (e.g. license fee assessed against retired doctors who no longer practice would probably NOT be a “transaction” tax).

Finally, an issue not raised in the Perry case should be considered.  The business license fee found to be non-dischargeable  by the Court could have been discharged if the debtor-doctor had waited to file the bankruptcy case.  An “excise tax on a transaction” is excepted from discharge only if it’s a tax on a transaction occurring before the date of the bankruptcy filing for which a return, if required, is last due, less than three years before the date of the bankruptcy filing.  See 11 U.S.C. §507(a)(8)(E)(i).  Stated in reverse, an excise tax is discharged if the tax return that reports the excise tax was due more than three years before the bankruptcy case was filed.

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

Is the IRS “failure to file” penalty discharged in bankruptcy?

A taxpayer can discharge an IRS “failure to file” penalty assessed per 26 U.S.C. §6651(a)(1) for failure to file a tax return.  A taxpayer has two choices.

Option 1: A taxpayer with income can choose to file a Chapter 13 bankruptcy case and establish a repayment plan addressing all creditors, including the IRS.  The IRS “failure to file” penalty would be treated as an unsecured claim and paid on the same level as credit card debt, medical debt, and personal loans.  The IRS and other unsecured creditors could receive as little as 10 cents for every dollar owed and less in some jurisdictions.  At the completion of the repayment plan, any unpaid unsecured debt would be discharged and the IRS penalty obligation eliminated per 11 U.S.C. §1328(a).

Option 2:  A taxpayer without income or with insufficient income to fund a Chapter 13 bankruptcy case, instead, could file a Chapter 7 bankruptcy case.  No repayment is required in a Chapter 7 case and the IRS could be entitled to distribution from property of the bankruptcy estate on a prorate basis with all other unsecured creditors.  However, there is typically no property to distribute in a normal Chapter 7 case.

At the conclusion of a Chapter 7 case the taxpayer would receive a general discharge of debts pursuant to 11 U.S.C. §727(a).  This general discharge does not necessarily cover the IRS’ “failure to file” penalty because 11 U.S.C. §523(a)(7) creates an exception for penalties payable to a governmental unit. So a deeper analysis is required.

The exception to the bankruptcy discharge applies “to the extent such debt is for a fine, penalty, or forfeiture payable to and for the benefit of a governmental unit.   11 U.S.C. §523(a)(7).  The IRS is clearly a governmental unit.  But this exception to discharge is limited when it relates to a “tax penalty.”

Section 523(a)(7)(B) provides that the exception to discharge does not apply and the IRS tax penalty is discharged if it was “imposed with respect to a transaction or event” that occurred more than three years before the bankruptcy petition.  Therefore, a taxpayer may not be discharged of an income tax penalty imposed less than three years before the bankruptcy petition is filed.  But, a taxpayer would be discharged of an income tax penalty imposed more than three years before the bankruptcy petition is filed.

So the question becomes: “when is an income tax penalty “imposed with respect to” a failure to file penalty imposed by the IRS pursuant to 26 U.S.C. §6651(a)(1)?”  That issue was addressed in  In re Wilson, 527 B.R. 635 (Bankr. N.D.CA 2015).  In Wilson, a taxpayer was granted a filing extension for his 2008 tax return from April of 2009 to October of 2009.  That taxpayer did not file the return until 2011.  The taxpayer filed for bankruptcy in July of 2012, which was more than three years after the April 2009 filing deadline and less than three years after the October 2009 filing deadline.

The taxpayer argued that the penalties should be discharged because they were imposed with respect to his 2008 tax liability, due April of 2009, and therefore were more than three years old when he filed his bankruptcy.  The IRS argued that the penalties should not be discharged because they were imposed in October of 2009, when the taxpayer missed his extended filing deadline, and were therefore less than three years old when the bankruptcy petition was filed.

The Wilson court agreed with the taxpayer and found that §523(a)(7)(B) is to be applied according to its plain meaning, so that a penalty imposed on unpaid taxes accruing more than three years before the filing of the bankruptcy petition is dischargeable.  Interestingly, the court stated that “penalties imposed on account of failure to file a return are computed by reference to the tax obligation itself,” and not by reference to the filing date. Id. at 638.

Practice Pointer:  A tax professional should have counseled the taxpayer to postpone the bankruptcy case filing date from July of 2012 to a few months later and after October 16, 2012 to ensure the case was filed more than three years after the due date.  The tax professional would have saved the cost of litigation had the taxpayer strategically timed the bankruptcy filing date.

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

Can a Bipolar Disorder Protect a Taxpayer from Being Accused of Willful Failure to Pay Taxes?

Taxpayers generally have the right to discharge certain income tax liability relating to old tax returns. For example, a taxpayer may have the right to discharge in bankruptcy income tax liability relating to tax returns due and filed more than three years before the bankruptcy case was filed. An exception to that rule exists when the taxpayer “willfully attempted in any manner to evade…” paying the taxes. See 11 U.S.C. §523(a)(1)(C).

That exception was explored in United States v. Stanley, 595 Fed App. 314 (5th Cir. 2014). In Stanley, an osteopathic doctor filed Chapter 7 bankruptcy in an effort to discharge income taxes due more than three years prior to the date the bankruptcy case was filed. The United States objected to the discharge alleging the tax liability was non-dischargeable because the doctor willfully attempted to evade paying the taxes.

The doctor argued that he suffered from Type II bipolar disorder and was thus incapable of forming the requisite “willful” mental state. At trial, the doctor called a psychologist as a witness to testify that the doctor suffered periods of depression and irresponsible conduct. However, the psychologist also stated that the doctor had other periods when the doctor was functioning normally.

Pursuant to 11 U.S.C. §523(a)(1)(C), a discharge in bankruptcy does not discharge tax liability where the debtor “willfully attempted in any manner to evade” the tax liability. This provision ensures that the Bankruptcy Code’s “fresh start” policy is only available to honest but unfortunate debtors.

The 5th Circuit employed a three-pronged test to determine willfulness in the tax evasion context, considering whether the debtor (1) had a duty to pay taxes under the law, (2) knew he had that duty, and (3) voluntarily and intentionally violated that duty. The court held that the third prong could be satisfied by either an affirmative act or culpable omission that, under the totality of the circumstances, constituted an attempt to evade or defeat the assessment, collection, or payment of a tax.

The Stanley court noted that a mere failure to pay the tax did not automatically constitute “willfulness,” since a taxpayer may not have the financial wherewithal to pay the tax. However, the failure to pay combined with the ability to pay may constitute “willfulness.” The court reviewed many factors before determining that the doctor in the case at bar “willfully” attempted to evade paying the tax liability, including: ability to successfully carry out duties in a demanding profession, maintaining a lavish lifestyle, major purchases made by the doctor, payment of other long-term debts obligations, forming corporations, and transferring money to the doctor’s spouse who did not share the tax liability. Consequently, the court found the tax liability non-dischargeable because the doctor willfully attempted to evade paying the taxes.

Practice Pointers: Before filing bankruptcy, a practitioner should identify a taxpayer’s job status, disposable monthly income, major purchases since the tax liability was incurred, history of paying other long-term obligations, ability to pay the tax liability since the tax liability was incurred, and choices made to utilize net income in manners other than paying tax liability. If factors weigh against a taxpayer, then the practitioner should consider an installment agreement to demonstrate a taxpayer’s desire to repay the tax liability. Then installment payments should continue until a pattern is shown demonstrating a desire to pay taxes.

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

Can the IRS Levy against a Creditor Entitled to Receive Bankruptcy Plan Distributions?

Sometimes the IRS takes aggressive action to collect unpaid taxes. The “levy” is a common tool used by the IRS to force a third-party to help collect unpaid taxes. The levy is tendered to the third-party holding money or property of the taxpayer and demands that the third-party tender the money or property to the IRS.

In the case of In re Elrod, 523 B.R. 790 (Bank. W.D. TN 2015), the IRS sent a levy to the Chapter 13 trustee demanding that money designated by the plan to be sent to a creditor-taxpayer instead be sent to the IRS. To be clear, the IRS was attempting to collect a tax from a creditor who was otherwise eligible to receive plan distributions. The IRS was attempting to intercept the trustee’s payments and force the trustee to tender to the IRS that creditor-taxpayer’s share.

The Chapter 13 trustee objected claiming it was a violation of the automatic stay, 11 U.S.C. §362(a). The court agreed with the trustee and found that the IRS had violated the automatic stay because the property held by the trustee was “property of the bankruptcy estate” as defined by 11 U.S.C. §541(a)(1) and §1306(a). The levy was quashed.

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

Must All Tax Returns be Filed Prior to Filing Bankruptcy?

A common question asked by tax professionals is whether an individual taxpayer is eligible to file Chapter 13 bankruptcy if that taxpayer has failed to file any IRS 1040 tax returns. The quick answer is a taxpayer is eligible to file bankruptcy even if that taxpayer has unfiled tax returns. However, a longer answer provides more guidance.

The US Bankruptcy Code does NOT require a taxpayer to be in compliance with all filing requirements as of the day the bankruptcy petition is filed. The taxpayer has time after the bankruptcy case is filed to tender to the IRS any missing tax returns. Section 1308(a) of the Bankruptcy Code, 11 U.S.C. §1308(a), requires a taxpayer to file all tax returns for the four years prior to the bankruptcy filing date; the submission deadline is not identified by statute as a certain number of days after the bankruptcy case is filed. Instead, the deadline is set as no later than the day before the Section 341 meeting of creditors, which is approximately 30-45 days after the bankruptcy case is filed.

Therefore, a taxpayer can file bankruptcy for immediate protection from creditors even though that taxpayer is delinquent on tax filings on the bankruptcy filing date. But the Court, trustee, and creditors will be watching closely to determine if the taxpayer files the missing IRS tax returns prior to the deadline of one day before the Section 341 meeting of creditors. Some trustees will refuse to conduct the Section 341 meeting of creditors if the returns have not been filed. Other trustees could conduct the meeting despite objections from the creditors.

The taxpayer’s bankruptcy case is in jeopardy if the taxpayer fails to file the missing tax returns before the bankruptcy deadline. The case is subject to dismissal if the deadline is missed. That was the case in In re Mohamed, 523 B.R. 287, 290 (D.D.C. 2014). In Mohamed, the taxpayer filed bankruptcy in October of 2013 even though the taxpayer had never filed the 2012 tax return. The Chapter 13 trustee moved to dismiss the case because the taxpayer had failed to file the missing tax return before the bankruptcy deadline. At trial, the taxpayer’s witness stated that the 2012 tax return was filed, but the witness had no proof of filing and could not remember whether the return was filed prior to the bankruptcy deadline. On the other hand, the trustee testified that the taxpayer himself had admitted at the Section 341 meeting of creditors that the 2012 tax return was never filed. Also, the trustee introduced into evidence the IRS’ proof of claim that stated the 2012 tax return was never filed.

The bankruptcy court repeated that the taxpayer was required to file all tax returns for the past four years no later than the day before the Section 341 meeting of creditors. Then, the court found that the taxpayer did not timely submit the 2012 tax return and that the court was therefore required to dismiss the bankruptcy case pursuant to 11 U.S.C. §521(e)(2)(B) and §1307(e). The taxpayer appealed. The appellate court affirmed the bankruptcy court’s ruling and dismissed the bankruptcy case.

Best practices: File all unfiled tax returns before filing the bankruptcy case. If emergency protection from creditors is required, then a bankruptcy case should be filed to obtain an injunction against the creditors. But, the taxpayer and the tax professional must strive to file the missing tax returns as quickly as possible after the bankruptcy case and prior to the deadline of one day before the Section 341 meeting of creditors.

For follow-up questions, contact attorney Robert V. Schaller by clicking here.