Penalties

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.

Leave a Reply