Does Filing for Bankruptcy Really Give You Tax Relief?

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When times get desperate and tax liabilities pile up – filing for bankruptcy is an option many people consider.  Taxes are “dischargable” in bankruptcy, but there are important rules you need to know.

TIMING

Taxes are only dischargable if they have reached a certain vintage.  Here are the basic rules:

  1. More than three years must have elapsed since the tax return was due.
  2. Taxpayer must have filed his/her tax return  more than two years earlier than the bankruptcy petition.
  3. At least 240 days must have elapsed since the date of an IRS assessment.

Lots of things can extend these time periods including various administrative remedies with the IRS – like filing an offer in compromise.

Bottom line – you need to get IRS Account Transcripts and carefully calculate each time frame to make sure you qualify.

FRAUD EXCEPTION

Taxpayers must also beware of the fraud exception to dischargability in bankruptcy.  Taxes are not dischargeable if the person “willfully attempted to evade the tax.”  This doesn’t mean that you have to be a criminal to lose your ability to discharge the tax.

An example of this came recently out of the 10th Circuit in the Vaughn case (114 AFTR 2d 2014-5191).    Apparently, James Vaughn was a successful businessman who made millions from the sale of his company.  Instead of paying the tax owed, he got into a “BLIPS” tax shelter that was marketed by KPMG.

The Court thought, in my words:

  • He was a sophisticated guy and he should have known that the BLIPS transaction was not legitimate.
  • The IRS put him on notice that the transaction was not legitimate through IRS Notice 2000-44.
  • He depleted his assets through extravagant purchases (expensive homes, cars, jewelry, etc).

These things were enough to push him from the negligent category to the “willful” category.  I’m not sure I agree with the entirety of what the court decided, however.  The taxpayer did seek advice of a highly regarded accounting firm in KPMG.  Additionally, he also went through a divorce and much of his wealth went to his ex-wife.

The bottom line is you cannot purposefully avoid a tax, spend like crazy to dissipate your assets, then file for bankruptcy.  If you do so, not only will you not get your taxes discharged in bankruptcy, but you will likely be looking at going to jail.

Topics:  Consumer Bankruptcy, Income Taxes

Published In: Bankruptcy Updates, Tax Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Gray Reed & McGraw, P.C. | Attorney Advertising

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