Category Archives: 240-Day Assessment Rule

Can a Merchant Discharge Unpaid Sales Taxes by Filing Bankruptcy?

We all have paid sales taxes when purchasing consumer items.  But where does that money go?

In most states, a merchant selling consumer products is required to collect sales tax from customers and hold that money in trust for the government.  Periodically, the merchant is required to report the amount of sales taxes collected and to tender the tax money to the government.

However, some merchants fail to tender the money to the government when business is bad and use the trust fund money as a cash infusion to keep the business afloat.  It’s a terrible idea from a bankruptcy attorney’s point of view, but merchants struggling to keep their doors open sometimes grab any life-line they can reach.

Such was the case in Cooper v. Miss. Dep’t of Revenue (In re Cooper), 2015 Bankr. LEXIS 3261, (Bankr. S.D.MS 2015).  Cooper was audited by the Mississippi Department of Revenue for a three year period and assessed almost $60,000 in unpaid sales taxes.  MDOR filed a lien to secure its claim and started collection efforts against Cooper.

Two years later, Cooper responded by filing Chapter 13 bankruptcy and then initiated an adversary proceeding alleging the sales tax debt was dischargeable.  However, the court noted that Cooper failed to site any Bankruptcy Code sections or case law supporting Cooper’s position. MDOR filed a motion for summary judgment asserting that there are no factual issue in dispute and MDOR is entitled to a judgment that the sales tax debts are non-dischargeable.  MDOR’s claim had increased with interest to approximately $70,000.

The Court granted MDOR’s motion and held that the sales tax debts were non-dischargeable pursuant to 11 U.S.C. §§523(a)(1)(A) and  507(a)(8)(A).  The court’s reasoning for nondischargeability was limited to a one paragraph declaration.  Interestingly, MDOR did not allege that the taxes were nondischargeable pursuant to § 507(a)(8)(C), which would have been harder to discharge.  But MDOR’s attack on a  §507(a)(8)(A) basis opened a dischargeability door for Cooper to walk through, but Cooper failed to take advantage of this strategic opening and had to suffer the consequences of having $70,000 worth of tax debts rendered non-dischargeable.

Practice Pointer:   The taxpayer missed an opportunity to discharge the sales tax debt.  According to the Cooper court, the sales taxes were a §507(a)(8)(A) tax.  This type of debt could have been discharged if the taxpayer had waiting the required time periods set forth in 11 U.S.C. §§523(a)(1)(A) and  507(a)(8)(A).  Cooper should have considered before filing bankruptcy  the 3-year due date rule, 2-year filing date rule, and the 240-day assessment rule.  But Cooper failed to time the filing correctly, which resulted in Cooper not discharging the $70,000 claim.  Cooper should have made the investment and paid a little more to acquire expert legal advice.

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

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Can Income Taxes be Eliminated if the IRS Still Has the Right to Assess a Deficiency?

No, income taxes cannot be discharged or eliminated in bankruptcy if the taxing authority still has the right to assess a tax.  Section 523(a)(1)(A) of the Bankruptcy Code identifies certain types of income taxes that are non-dischargeable in bankruptcy by incorporating §507(a)(8)(A) of the Bankruptcy Code.  Section 507(a)(8)(A) excepts from discharge any income taxes that are assessed within 240 days of the bankruptcy filing, or are assessable under applicable non-bankruptcy law after the bankruptcy case is filed.

The US Court of Appeals for the Seventh Circuit addressed this issue in U.S. v. Frontone, 383 F.3d 656 (7th Cir. 2004).  In Frontone, a taxpayer had filed a tax return and paid the tax owed as required by the IRS Code.  However, the IRS made an error and wrongly tendered a tax refund to the taxpayer.  The IRS later realized its error and issued a supplemental assessment for the deficiency caused by the tax refund.  The IRS compounded the error by making another error—namely, issuing a supplemental assessment without issuing a notice of deficiency.

The taxpayer filed bankruptcy in an effort to discharge the tax debt caused by the tax refund.  The Frontone court denied the taxpayer’s quest for a discharge because the tax obligation was assessable at the time the bankruptcy case was filed. First, the court found that the IRS’ supplemental assessment was in error because it had not followed a “notice of deficiency.”  But that did not save the taxpayer because the court found that the IRS eventually filed the required notice of deficiency within the time period allowed as provided by the IRS Code (even if it was after the bankruptcy filing).  Therefore, since the notice of deficiency was finally issued correctly, the Frontone court found the tax refund obligation non-dischargeable because the tax debt was “assessable” on the date the bankruptcy case was filed.

Practice Pointer:   Best practices requires a careful analysis of the tax filing deadlines and the Bankruptcy Code’s statutory waiting periods.  Taxpayers must wait to file bankruptcy at least 240 days after the IRS assesses the tax, AND wait beyond the statutory assessment period if the IRS has not yet assessed a tax so that the tax becomes non-assessable.

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When are Income Taxes Assessed by the Government?

Income taxes are dischargeable by filing bankruptcy if the taxpayer waits more than the amount of time set forth in the Bankruptcy Code.  One of the requirements is that the taxpayer must wait to file bankruptcy more than 240 days after the date the taxing authority “assesses” the tax.  See 11 U.S.C. §523(a)(1) incorporating §507(a)(8)(A)(ii).

But when are income taxes deemed “assessed” such that the 240-day clock starts ticking? This issue was addressed in Harnden v. United States of America (In re Harnden), Nos. 08-B-71909, 10-A-96039 (Bankr. N.D.IL 2011), where the IRS had audited the taxpayer and determined that the taxpayer had underreported his income by about $30,000.  The IRS sent the taxpayer Form 4549 (Income Tax Examination Changes) requesting that the taxpayer agree to the proposed increase in tax and waive any appeal rights.  The taxpayer signed the form in August of 2006, which stated “I give my consent to the immediate assessment and collection to any increase in tax and penalties.” The IRS, however, did not officially assess the tax until February of 2008.  The taxpayer filed the bankruptcy case in June of 2008, less than 240 days after the IRS had officially assessed the tax.

The Harnden court rejected the taxpayer’s argument that the IRS had effectively assessed the tax upon the taxpayer signing and returning the Form 4549 Income Tax Examination Changes.  The court found that neither the notice the IRS sent nor the taxpayer’s signature and return of the tax examination changes form constituted an “assessment” of the additional tax.

The Harnden court found that the assessment of federal income tax is “made by recording the liability of the taxpayer in the office of the Secretary [of the Treasury] in accordance with rules or regulations prescribed by the Secretary.” 26 U.S.C. §6203.  Those regulations delegate authority to “assessment officers” and state that the “assessment shall be made by an assessment officer signing the summary record of assessment. … The date of the assessment is the date the summary record is signed by an assessment officer.” 26 C.F.R. §301.6203-1.

Practice Pointer:   Best practices warrant obtaining proof from the taxing authority of the official assessment date.  For IRS debt, tax professionals must obtain copies of the IRS’ account transcript for each year that a taxpayer desires to discharge a tax obligation.  The tax transcript can assure counsel that the taxpayer has waited the appropriate time to pass the various time sensitive rules.

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