Discharge of Tax Shelter Liability in Bankruptcy
| Jurisdiction | United States,Federal |
| Citation | Vol. 17 No. 1 Pg. 245 |
| Pages | 245 |
| Publication year | 1988 |
1988, February, Pg. 245. Discharge of Tax Shelter Liability in Bankruptcy
Congress has recently taken issue with tax shelter investments and has enacted legislation to frustrate their development and use. At one point it stated:
"So long as tax shelters are permitted to erode the federal tax base, a low rate system can provide neither sufficient revenues, nor sufficient progressivity to satisfy the general public that tax liability bears a fair relationship to the ability to pay.(fn1)
The judicial branch of government also appears to be concerned with tax shelters, as evidenced by its recent crackdown on abusive tax shelters. The Tax Court decision in Freytag v. Commissioner,(fn2) a case involving "straddle" investments (discussed in this article in greater detail), is an example of this judicial hostility. As losses from tax shelter investments increasingly are being disallowed, more and more investors are being forced into filing bankruptcy.
In this context, the issue arises as to whether the tax liability created by the disallowance of tax shelter losses is dischargeable in bankruptcy. This article discusses the numerous problems that can arise when attempting to meet the requirements for discharging a tax liability in bankruptcy, particularly when that liability is as a result of the disallowance of a tax shelter loss.
The objective of bankruptcy from the standpoint of the debtor is to gain a fresh start. A discharge in bankruptcy protects the debtor from any further liability on discharged debts. Generally, three requirements must be met for an individual's unsecured tax liability to be dischargeable in bankruptcy:
1) the tax returns were due and filed more than three years prior to the filing of the bankruptcy petition;(fn3)
2) the tax has been assessed more than 240 days prior to the filing of the bankruptcy petition;(fn4) and
3) the income tax liability does not relate to a fraudulent return or a willful attempt to evade tax.(fn5)
Only liabilities resulting from returns due and filed more than three years prior to the filing of the bankruptcy petition are dischargeable. The three-year period is measured from the last due date of the return, including extensions.(fn6) For example, if a taxpayer claimed losses with respect to a tax shelter on his or her 1981 return, the taxpayer's return would be due on April 15, 1982, assuming no extensions were filed. If the other requirements are met, and if the taxpayer files the bankruptcy petition on or after April 16,1985, the liability is dischargeable in bankruptcy.
The tax return must have been due and filed more than three years prior to the filing of the bankruptcy petition. If no return was filed, or a return was filed late within two years of the filing of the bankruptcy petition, the tax liability is non-dischargeable.(fn7)
A tax...
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