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Arizona Bankruptcy – Basic Tax Discharge Requirements and the “Lien” Caveat

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Yes. Income tax debt can be wiped away in bankruptcy.

The catch? The following requirements:

Basic Requirements:

1. The taxes must have become due more then three years prior to the bk filing. This means that you should count forward 3 years from the date the return was actually due. (Think April 16th plus 3)

2. The original return must have been filed more than 2 years before the bankruptcy. 2003 return filed June of 2007? The two year date would end up in June of 2009. What constitutes an “original return” can be a complicated issue so if the IRS filed a “substitute” return before you filed your own return, make sure and tell this to your lawyer.

3. The IRS must have “assessed” the tax more than 240 days before the actual filing of the bankruptcy. Assessment means that they entered it in their system as due and owing.

4. No fraudulent tax return. This will kill the dischargeability.

5. No effort to evade the tax. This may as well.

Many of my clients have serious tax debt as a result of late filed returns. Despite other options (offer in compromise) bankruptcy often ends up being the best option overall.

Even if the tax debt is considered dischargeable one big caveat remains. The IRS lien.

The IRS will typically record a tax lien with the County in which you or your property “resides”. If the property has value, the lien remains “attached” to it after the bk (chapter 7) or during the bk (chapter 13). In a chapter 7, the lien still has value after the case is over.

In a chapter 13, the value of the lien must be paid through the plan.

Often, the result in both cases is that the underlying tax debt is gone, but the lien is worth as much as the IRS was owed to begin with.

If you are getting ready to file for bankruptcy and have tax debt, make sure and have your attorney review the lien(s) and compare them to your asset values to avoid a surprise.

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