* CPAs can provide essential services to clients facing bankruptcy by advising them and their bankruptcy attorney on tax debts and their disposition in a bankruptcy estate. CPAs should therefore be familiar with bankruptcy law and procedure as they relate to tax debts, along with administrative methods of resolving them.
* How tax debts may be discharged in bankruptcy depends on the type of proceeding. Chapter 7 ("straight bankruptcy") liquidates the debtors' nonexempt assets and apportions the proceeds among unsecured creditors, including the IRS. Chapter 13 and 11 cases establish a payment plan of up to five years, after which certain remaining tax debts can be discharged.
* Generally, tax debts that may be discharged in bankruptcy are income tax debts that are not recent-from returns due more than three years before the bankruptcy filing, or, for filed returns, those more than two years old. Assessments from audit adjustments or amended returns must be at least 940 days old. Payroll tax withholding and related trust fund liabilities, along with state sales taxes and certain excise taxes, are not dischargeable.
* CPAs should explore strategies for managing fax debts to best advantage when clients are considering bankruptcy. Such strategies can include timing considerations and use of administrative resolution methods such as installment payments, collection due process proceedings and offers in compromise.
With the downturn in the economy and massive job losses, personal bankruptcy filings have exploded. According to the National Bankruptcy Research Center (tinyud.com/2ac4xpr), approximately 1.4 million bankruptcies were filed in 2009, a 32% increase over 2008. They included Chapter 7 bankruptcy filings, which increased 42%, and Chapter 13 filings, which increased 12%. Bankruptcies in 2010 may be fewer than last year. However, in early January, The Wall Street, Journal reported (tinyurl.com/yefapru) that bankruptcy attorneys had not yet experienced a slowdown in their workload.
CPA clients may be among those needing bankruptcy protection. Many of these clients may benefit from including federal tax debts in their petition. CPAs can play a key role by assisting clients and their attorneys in determining if and when bankruptcy is a viable alternative for resolving federal tax liabilities, by determining the composition of tax amounts owed and which tax liabilities might be dischargeable, and by exploring the many bankruptcy alternatives for dealing with tax debts. Besides being aware of the tax resolution options of bankruptcy described in this article, CPAs should be familiar with administrative tax resolution methods, which the client should pursue first. These include innocent spouse relief, a request for abatement of penalties, an installment agreement or an offer in compromise (OIC).
If those options are insufficient, bankruptcy may be the best way for your clients either to secure a reasonable payment plan (Chapter 11 or Chapter 13) or to liquidate their assets to pay off all or a portion of their tax debt (Chapter 7). Using administrative tax resolution methods instead of bankruptcy may help clients avoid having a "black mark" on their credit history. However, a federal tax lien listed on the debtor's credit report may damage his or her credit rating as much as a bankruptcy notation. Clients who may benefit from bankruptcy protection should be promptly referred to an attorney who specializes in bankruptcy law.
NOT ALL TAX DEBTS DISCHARGEABLE
To be dischargeable, individual income tax liabilities must meet the following "mechanical" rules of 11 USC [section][section] 523(a)(1) and 507(a)(8):
* More than three years must have elapsed since the tax return generating the liability was due, including extensions. Various acts such as prior bankruptcies, collection due process (CDP) hearings, innocent spouse relief and tax assistance orders can extend the three-year time frame.
* The tax return must have been filed more than two years earlier than the bankruptcy petition (generally applicable to late-filed returns). Note, however, that IRS-prepared "substitute for returns" are not considered filed returns for this purpose, and thus a tax liability assessed from them would not be subject to discharge (IRC [section] 6020(b)). Therefore, it is almost always advisable for the client to...