FEDERAL BANKRUPTCY PLANNING

Contrary to the popular belief, income taxes may be dischargeable with federal bankruptcy tax planning.  The rules of discharge are that at the time of bankruptcy filing the tax year must be three years old; if the return was filed late, it must have been filed for two years; if there is a deficiency assessment, it must have been assessed for 240 days; and there must be no fraud associated with the return. The 240-day period may be extended by the pendency of prior bankruptcy proceedings, offers in compromise, or collection due process hearings.

The credit card industry in 2005 gave us a bankruptcy bill that uses means testing to force debtors having principally consumer debt and an ability to make a modest monthly payment into Chapter 13 arrangements. In a Chapter 13 the debtor pays creditors for a period of five years rather than obtaining an immediate discharge and getting a fresh start in a Chapter 7.  With proper planning it may be possible to arrange a debtor’s affairs in a way that allows for a Chapter 7 discharge of income taxes.

High income debtors whose debts are not more than 50% “consumer debts” face the further challenge that the U.S. Trustee or the Court may move to dismiss a Chapter 7 case if granting a discharge would be an abuse of the bankruptcy system.

This is an extremely sophisticated area that requires detailed factual work up and multi-year planning. Paying debt is hard: payment of $1 in tax or credit card debt over 5 years requires about $2 in cash flow when the cost of interest, penalties, and income taxes on the income used to pay the debt are included. This places a high value on the ability to discharge the debt and get a fresh start. I do the planning working in this area but refer my clients to bankruptcy counsel for the execution of a bankruptcy case.



Kemble White, Attorney

Practice Limited to Tax Controversy Matters