The current Bankruptcy Code is a very complex set of rules, many of which are poorly drafted and difficult to understand and apply, even for bankruptcy lawyers and judges. The Internal Revenue Code, considerably longer than the bankruptcy code has long been the subject of criticism for its length, complexity and density. When you put the two together, the complexities are multiplied. Trying to decide whether a given tax liability arising under the tax code is dischargeable under the bankruptcy code is a question that must often be answered through expensive and time consuming litigation. If there were easy answers to this question, we would not need the help of a battery of lawyers and bankruptcy judges to determine whether a tax debt can be discharged in bankruptcy.
Nevertheless, this article will attempt to handle some of the simpler aspects of this conundrum, those which the typical reader might face. Presuming that the majority of readers are plain old taxpayers who owe the IRS a big bunch of money, this article will be limited to the issue of personal income taxes resulting from the filing of a Form 1040, the personal income tax form. It will not cover employment taxes, excise taxes, estate taxes, etc – just personal income tax. Also, it will cover only a chapter 7 bankruptcy, not chapter 13.
WARNING: This material contained in this article is a guide only. It is not legal advice and it should not be relied upon without your consulting an experienced bankruptcy attorney licensed to practice in your state. This is not a substitute for competent legal advice. It is only meant to familiarize you with the current state of bankruptcy law so that when you speak to your attorney you will be better informed.
If you owe the IRS a lot of money and are considering filing a chapter 7 bankruptcy then one of the most important questions you must answer is whether the tax debt will be discharged in the bankruptcy proceeding. In many cases, the decision to declare bankruptcy will depend upon the answer to this question. The Bankruptcy Code provides that when a person files bankruptcy, his debts are compiled in a long list and then divided between secured and non secured debt. The difference is important.
What is secured debt?
The best example of secured debt is a mortgage on a home. If you own your own home then you are probably making payments every month on a mortgage to a bank or credit union. Before the credit union would be willing to lend you $300,000 to buy a home, it is going to demand that you use the house as collateral for the loan, thereby permitting the credit union to take back the house if you do not pay the monthly note. Somewhere in the huge stack of paperwork you signed when you purchased the home was a document that gave the credit union the right to take your home. This is a secured debt, secured by the house. The same arrangement applies with car loans and many large appliance loans. If you read the small print you will find that you are giving the lender a security interest in the asset, whether a house, a Maserati or a refrigerator.
What is unsecured debt?
The best example of unsecured debt is your credit card. If you fail to make the payments on your card, there is little the card company can do except sue you for breach of contract. If you used the card to buy underwear at the mall, the card company cannot come in and repossess your dainties. The debt you incurred to buy the underwear is unsecured.
Tax debt may be secured or unsecured. If the IRS has filed a tax lien in your county offices and has followed all of the rules pertaining to notice, then the debt is secured. However, in the absence of a lien, the debt is unsecured. This article will limit its application to unsecured debt. So if you have a tax lien, you will need to consult an attorney to determine the status of your tax debt in bankruptcy.
The Bankruptcy Code takes the big list of unsecured debt and divides it into two neat categories: ‘priority debt’ and ‘non priority debt.’ Section 507 of the Bankruptcy Code applies to all of the unsecured debt by creating eight categories of debt that will be considered as having priority. Those tax liabilities of an individual that fall within the Section 507 definition of a priority will NOT be dischargeable in bankruptcy. Income taxes fall into the eighth category (Section 507(a)(8)) and are therefore not dischargeable. You will have to pay them. However, there is a large loophole found in Section 507(a)(8) which may apply to you and may make your income tax debt dischargeable in bankruptcy. There is hope!
Section 507(a)(8) grants priority status only to those tax debts that are recent AND that have been assessed within 240 days prior to filing. Now that’s a mouthful. Assessed? Recent? What do these really mean? The answer is not always easy, but I will make it so for purposes of this article.
Recent simply means the past three years. Example – Harry owed the IRS $150,000 for tax year 2002 and had credit card debt amounting to another $200,000. (It happens) The calendar says that today’s date is January 8, 2008. If he files for bankruptcy tomorrow, January 9, 2008 will his tax debt be wiped out? We start the analysis with the date of filing of bankruptcy – 1/9/2008. Step 2 – back it up three years to arrive at 1/9/2005. Section 507 says that any taxes due on tax returns due AFTER 1/9/2005 are priority debt and cannot be discharged. You gotta pay, simple as that. So, if Harry owed money on his 2004 returns, which are due to the IRS on April 15, 2005, these debts would be granted a priority and would not be dischargeable on Harry’s January 9, 2008 bankruptcy filing. However we are talking about tax debt for 2002, not 2004. Remember, the 2002 returns are due on April 15, 2003. The law says so. But April 15, 2003 is BEFORE 1/9/2005, not AFTER. Does this mean that this debt is dischargeable in bankruptcy? Is Harry off the hook? Maybe. If you reread the paragraph above you will see there is a two part test, not a one part test. Both parts must be satisfied.
The second part of the test involves a strange concept – assessment. After the IRS has reviewed your tax return and concludes that you owe money, it will send you a letter advising you as such demanding that you pay. If, like most taxpayers, you ignore the letter and place it in a drawer hoping it will disintegrate, you will eventually receive more letters each one increasingly menacing. Finally you will get a letter indicating that since you have not responded to the past half a dozen letters, the IRS assumed that you agree that you owe the money and has then assessed the deficiency against you. This is a formal act in which the revenue agent signs a form, it is approved by a manager and it is entered into your tax record as a debt. You now owe the money. The date upon which the form was signed is the assessment date. You need to know what that date is. It is easy to obtain by simply calling the IRS. They will be happy to tell you.
Armed with that date, you can now perform the second part of the test. If the assessment date is LATER than 240 days before the filing date then you failed. You have to pay the taxes. Remember, the filing date was 1/9/2008. Go back 240 days to May 14, 2007. Call the IRS 1-800 829-1040 and ask – “so, what is the date of assessment on my tax debt?” If the IRS representative says ‘May 15, 2007,’ you are out of luck – of course you can always wait two days to file, right?. However, if she says May 1, 2007, you are now close to the nirvana of tax relief. You have passed the two part test – your tax debt is not “recent” i.e. it is older than three years under the test above, AND it was assessed more than 240 days before you filed your bankruptcy petition. You passed.
If you actually never filed the return you cannot discharge the debt. If the IRS determines that you committed fraud in filing the return it is not dischargeable. If you filed an offer in compromise during the 240 day period and the offer was declined you will have to recompute the 240 day period to compensate for the time the offer was pending. If none of these conditions apply to you, then you might be able to declare bankruptcy and actually walk away from this debt permanently!!
Before you rush out to file bankruptcy you should re-read the warning above and take it seriously. Bankruptcy in 2008 is much more complicated than it was in 2004, now requiring the debtor to comply with a host of new requirements before the debt will be eliminated. An appointment with a bankruptcy attorney in your city is crucial to a successful filing. Most attorneys will work with you on the payments and the filing charges. They know you have no money. After all, if you had money you would not be declaring bankruptcy!
This has been a very simplified treatment of the bankruptcy provisions as they apply to the Internal Revenue Code. The actual application is in many cases far more complex requiring a greater in depth analysis of the factual situation that applies to you.
If you decide that filing bankruptcy is not for you, there are other options, an installment agreement, an offer in compromise or convincing the IRS to declare you as uncollectible. Each option has its advantages and drawbacks. The installment agreement monthly payment may be too high for you. An offer in compromise costs thousands to have professionally prepared and being declared uncollectible does not nothing to wipe out the debt, which will continue to grow as interest accrues.
Arthur Weiss, Esquire
Law Office of Arthur Weiss, P.C.
2135 Grant Rd.
Tucson, AZ 85719
520-319-1124 https://artweisslaw.com
“Final Notice of Intent to Levy” the letter says in bold font. It arrived today via certified mail in an official looking envelope indicating it is from the Internal Revenue Service. Not good news. You have successfully ignored all the other letters you have received nicely asking for payment, but this one is different. The tax man is now doing more than asking, he is now going to take, and take a lot.
What can you do now? How about read the United States Constitution – you know, the document drafted so many years ago by men so far away in a small convention hall in Philadelphia in the late 1700’s. Amendment number five of the Bill of Rights to be exact. “No person shall…be deprived of life, liberty or property without due process of law…” This actually means something. These are more than just words mumbled in your high school social studies course! They mean that the IRS cannot take your stuff unless and until it provides you with due process of law. What the heck does that mean? That is simple – notice and a hearing. You have received the notice today via certified mail. Yes, the mail you received today is the first leg of the IRS complying with your Constitutional rights to due process of law before they take your stuff.
The second leg, a hearing, is vitally important and must be understood. If you look inside the envelope containing your notice of levy you will find IRS Form 12153, Request for a Collection Due Process (CDP) Hearing or Equivalent Hearing. The IRS is required by law to send you this form and an explanation of what it means. If this form is not there go to the IRS website at www.irs.gov and look under Forms and Publications. Download the form and instructions. This form is your best defense against the IRS taking your stuff today. By filling it out, you are exercising your Constitutional right to be heard by a neutral hearing officer before your bank account is emptied.
Have you found the form? Yes? Good. Fill it out and mail it in. The front of the form is quite easy containing basically personal information that you should be easily able to provide. The back is a little more complicated with blocks marked Installment Agreement, Offer in Compromise, Innocent Spouse.
In block 5 under Basis for Hearing Request mark Proposed Levy or Actual Levy. Block 6 should be checked as well. This requires some explanation. There are two types of hearings that are available to you depending upon when you are filling out the form – (1) the CDP Hearing and (2) the Equivalent Hearing. The CDP hearing is by far the better of the two. You have thirty days from the date of the Notice of Intent to Levy to request a CDP hearing. If you submit your request on time, i.e. within that thirty day window, the IRS is prohibited from taking your stuff. The levy will stop and you will be provided the opportunity to discuss your case with a neutral hearing officer form the Office of Appeals.
However, if you do not submit your request within the thirty days provided by law, you will not be able to request a CDP hearing and the levy will proceed. Fortunately you can still request a hearing (the Equivalent Hearing) but it will not stop levy action. Sorry.
Checking block six can’t hurt, it can only help. If you have submitted the Form 12153 within 30 days, block six really does not apply. If you submit later than thirty days it is vital.
Block seven is also vital but it can be a little confusing. Let’s start with the block titled “My Spouse is Responsible.” This involves “Innocent Spouse Relief” a concept which is beyond the scope of this article. If you feel that you are being unfairly targeted by the IRS for a tax debt that legitimately belongs to your spouse or ex spouse, do additional research on Innocent Spouse Relief and check this block. If you are not married or if you are married and responsible for the debt, then leave the block unchecked.
Moving on to the space marked “Lien.” Since you have not received a notice of lien, but rather a notice of levy, this block does not apply to you at this time.
The first block in section 7 has two simple choices – Installment Agreement and Offer in Compromise. Check both. This indicates to the IRS that you cannot fully pay the tax debt now and you want to be considered for either an Installment Agreement or an Offer in Compromise. If you are like most taxpayers, you certainly cannot pay the full amount now and at best can pay some of it over time. Alternatively, you might want to offer the IRS some amount less than the full extent of what you owe. That is called the offer in compromise. By mailing this to the IRS within thirty days, you will stop the levy action and give yourself the opportunity to discuss the debt with an IRS representative.
If you mail it later than the thirty day window, then you will be requesting an Equivalent Hearing and not a CDP hearing. While the actual meeting and hearing are basically the same, the single important difference is that the IRS will continue with their levy action. You can try to stop the levy action by contacting the IRS and discussing a 120 day hold on the levy while you go through the hearing process. The IRS is not bound by law to put the levy on hold for 120 days, but if you can present a good reason for failure to pay your taxes, they may stop the levy to give you time to explore collection alternatives with the hearing officer.
All of the above presumes that you do not dispute the fact that you owe the money. However, if you feel that the IRS has made an error and that you do not owe what they claim you do, then there are other avenues, in addition to the above that you should pursue. Those avenues are outside the scope of this article.
Arthur Weiss, Esquire
Law Office of Arthur Weiss, P.C.
2135 Grant Rd.
Tucson, AZ 85719
520-319-1124 https://artweisslaw.com
Harry Jones has not filed his federal tax return since 1999. When he finally got around to filing in 2007, his tax debt with penalties and interest was over $100,000. He called one of those late night TV tax relief companies who promised to reduce his debt “up to 90%.” Is this possible? The good news is that it may be possible. However, the likelihood of reducing the debt by even 1% is very slim. Theoretically it is possible that the moon will collide with the earth on Thursday. The likelihood is nil. It is the same thing with tax debt.
What does it take to reduce tax debt? The IRS will consider reducing your tax debt if they feel that the reduction is in the best interest of the government and if they determine that your offer is the best they can get from you within the timeframe they have to collect your tax debt.
Let’s get more specific and complicated. Harry owes $100,000 from nine years of tax returns that he just had filed. He certainly does not have that kind of money and will never have it. A single man with no children, Harry works as a bus driver for the city and makes only $45,000 a year. After expenses he has little left. He figures he can pay $10,000 by borrowing from relatives and cashing in a small retirement account. Will the IRS accept this?
The first step in the analysis involves something the IRS calls the CSED – the collection statutory expiration date. Since Harry just filed the returns, the IRS has a very long time to collect this debt, approximately ten years (120 months) under federal tax law. The IRS is going to look at Harry’s income and expenses to see if there is anything left over from Harry’s monthly pay that the IRS can take. In this case, Harry takes home $3,200 a month after payroll taxes. The IRS determines that his allowable expenses are $2,800 a month including the usual stuff, rent, utilities, gas, car payment, etc. This leaves $400 a month left ($3,200 – $2,800). The IRS will conclude that Harry can pay $400 a month for the next 120 months for a total of $48,000. Why would the IRS accept Harry’s meager offer of $10,000 when they know they can get almost five times that by waiting? The answer – they won’t.
Harry also had to report his assets and liabilities – what he owned and how much he owed. Turns out Harry owns a house worth $235,000 but only owes $100,000 on it. The IRS will use certain formulas to determine that the house can be used to pay off part or all of the tax debt. Add the equity in the home to the $48,000 that Harry can pay from his salary every month and the IRS will conclude, rightfully so, that Harry can fully pay the tax debt over time. The IRS will then notify Harry that his offer of $10,000 is rejected and that he should immediately start making $400 payments while arranging for an equity loan on his house. As if the above was not a gloomy enough picture, Harry bought a car three years ago and is making payments of $455 a month. He has two years of payments left on the five year loan. This means that in 24 months Harry’s ability to pay the IRS will increase by $455 a month. This is referred to as ‘future income’ and the IRS will want it.
The important thing to note in trying to answer the question in the title to this article is this: The IRS will only reduce your tax debt if they determine that the reduction is the best they can do within the CSED. The IRS uses precise calculations to determine how much you can pay and cannot vary from those numbers. The tax relief companies lure you into thinking they can “negotiate” with the IRS on your behalf to reduce the debt. Hogwash. Ninety percent reduction in your debt – maybe if you are living in a tunnel below the freeway with only $37 to your name. Then the IRS may accept the $37!
Be careful when using the services of any company that promises a reduction in your tax liability or the elimination of interest and penalties. These reductions are rare and only arise if the IRS determines that the government cannot do better.
Arthur Weiss, Esquire
Law Office of Arthur Weiss, P.C.
2135 Grant Rd.
Tucson, AZ 85719
520-319-1124 https://artweisslaw.com
There is some good news and bad news here. The good news is that you are not alone. You are in the company of thousands of Americans who have, for whatever reason, failed to file returns for multiple years. The IRS refers to these taxpayers as chronic non-filers. The IRS knows that if you fail to file for the past few years, you are more likely not to file in the future, fearing retribution from an angry horde of revenue officers. You need not worry. The IRS wants you to file the past returns and to timely file your future returns. No one is angry and no one is pounding on your door looking to take your house away from you.
Step One –
Figure out what years you are missing, those years for which you have not filed. A simple call to the IRS will get you the answer. Most people are afraid of calling the IRS for fear that it will “wake them up” and they will now know you have not filed. Believe me, they already know. Call 1 800-829-1040. You will have to wait awhile, but hold on, the end result will be worth it. When the operator comes on the line let them know that you need to find out what years are open in your account. You will need to give them basic identification data, but once they have adequately identified you they will answer your question – you have not filed for 2002 through 2006.
Step Two
In order to complete the tax returns you will have to reconstruct your income and expenses for those years. The IRS can help you with some of the information you will need if you ask. When talking to the IRS representative ask her or him to mail (or fax if you have a fax machine nearby) to you the “wage and income transcripts” for the years that you have not filed. Caution – if you go back further than seven years, they will not be able to get you information back that far as it has been removed from the active system. They will, however, let you know how to obtain that information.
Step Three
Now that you have your income information, you need to assemble your deductions. There is some good news here. The biggest decision on the tax return is whether to use the standard deduction or whether to itemize. For most taxpayers, that decision will hinge upon whether you own your personal residence or not. If you own your house then the mortgage interest that you paid will be a tax deduction and will likely lead to your itemizing your deductions. Fortunately the amount of interest that you paid in that year will be reflected in the wage and income statement you received from the IRS. So really, unless you have some complications, the vast majority of the information you will need to file will be in the transcripts you receive from the IRS. Of course you will also need information (name, date of birth, social security number) about your spouse and children, if any.
Step Four
Once you have the wage and income transcripts you should prepare to either do the tax returns yourself or hire a local accountant to do so. If you wish to do them yourself, you can download old forms from the IRS website and fill them in by hand, or you can go to websites of commercial tax preparation software, like Turbo Tax, and purchase their software for only the years that you need.
Step Five
If you choose to have an accountant (does not need to be a CPA) do your returns then gather the transcripts and any other pertinent information and make an appointment. If you choose to do it yourself, then set aside one evening to do nothing but tax returns. This is tough, but it needs to be done. If you have no experience in preparing tax returns then ask a knowledgeable friend to help. Once you have done two of the years you will catch on and the remaining years will not be so difficult.
Believe it or not, you can actually call the IRS for help! Just dial the same number as above and ask them for assistance. You will get it and it will be fair and balanced.
Step Six
Once the forms are prepared make sure you sign them and prepare them for mailing to the IRS. If you need the mailing address you should refer to the IRS website or call. If you owe money on any of the returns you should try to pay it when you file the return. It is vital, though, that you DO NOT DELAY mailing the return if you do not have the money to pay the amount owed. Either pay what you can or, if you can pay nothing, simply send in the return.
Step Seven
In a few weeks or months the IRS will send you a letter telling you that you filed these returns late and that you owe penalties and maybe some interest. In an ideal world you would pay these amounts and move on with your life. However, if you cannot afford to pay the penalties and interest or if you could not pay the original debt on the tax return, you will have to make arrangements to pay over time – an installment agreement. In some cases, the amount owed for all of the years (including penalties and interest) is far beyond your ability to pay the full amount. For example, if you owe $75,000 and your salary is $37,500 and you have two children, a mortgage and medical expenses, you may want to consider making an offer in compromise to the IRS for an amount less than what you owe.
CAUTION: If you are SERIOUSLY in debt and the amount far outweighs your ability to pay, you will be tempted to call one of those tax relief companies that advertise on TV or on the internet. Do not do so. If you need professional help, go to a tax accountant or tax attorney licensed to practice in your state. They will have the experience to guide you and the cost will be far less. Also, you will have the state bar or accountancy board to complain to if you are not happy with their services.
If you have followed all of the steps above, your tax filings are now current and you are either fully paid up, making monthly payments or are trying to negotiate a lower amount to pay. Either way, you can now sleep at night and stop worrying about what might happen. You are in control and the matter is on its way to resolution. It isn’t easy, but in the end you will be glad you did it. Good luck.
Arthur Weiss, Esquire
Law Office of Arthur Weiss, P.C.
2135 Grant Rd.
Tucson, AZ 85719
520-319-1124 https://artweisslaw.com
Federal Tax Levy
For taxpayers in serious debt to the IRS, the most feared weapon in the IRS arsenal is the tax levy. Using the powers granted to it in the Internal Revenue Code, the IRS can levy upon wages, bank accounts, social security payments, accounts receivables, insurance proceeds, real property, and, in some cases, a personal residence. Under Title 26, Section 6331 of the Internal Revenue Code the Internal Revenue Service can “levy upon all property and rights to property” of a taxpayer who owes taxes to the Federal government. The IRS can levy upon assets that are in the possession of the taxpayer , called a seizure, or it can levy upon assets in the possession of a third party, a bank, a brokerage house, etc. All future statutory references will be to the Internal Revenue Code unless noted otherwise.
Procedural Requirements of a Tax Levy
The Fifth Amendment of the Constitution forbids the government (whether state or federal) from taking an individual’s property without due process of law. This applies to an IRS levy as well. To comply with the US Constitution, the IRS must provide the taxpayer notice of the coming levy and an opportunity to be heard. (Section 6330) Under §6330(a)(2) the IRS must send to the taxpayer a notice via either personal hand delivery, through certified mail or left at his or her usual place of business. The notice must arrive at least thirty days prior to the levy taking place. The “Notice of Intent to Levy” must include “in simple and nontechnical terms the right of a person to request a hearing during the 30 day period” before the levy will be effective. This hearing is referred to in IRS correspondence as the “Collection Due Process” or CDP hearing. The notice will include the IRS Form 12153 which the taxpayer can fill out and mail in to request a hearing. A taxpayer is entitled to one CDP hearing for each tax period (tax year) to which the levy applies. The hearing must be before a neutral, impartial hearing officer “who has had no prior experience with the respect to the unpaid tax…” §6330(b)(3).
At the hearing the taxpayer may raise challenges to the collection actions, may seek innocent spouse relief, and may present alternative collection actions such as installment agreements or an offer in compromise. Under certain circumstances the tax debtor may challenge the underlying tax liability.
If the taxpayer is unhappy with the decision at the CDP hearing she may appeal the decision to the US Tax Court or federal district court.
Post procedural matters
If none of the above procedures effectively stops the levy then the IRS can proceed to take the property of the taxpayer. While the IRS can take just about any of his property, there are limits. Section 6334 imposes limits on what the IRS can and cannot levy. Unfortunately for the tax debtor, the list of property exempt from levy is short and will probably not apply to the average taxpayer. Once the IRS has the “green light” to levy, it can then demand that employers send a portion of the wages to the IRS. It can order the bank to send the proceeds in bank accounts to the IRS. Social security proceeds and state and federal tax refunds can be levied easily.
Levy upon a personal residence
Under §6334(e) a levy is allowed on principal residences under certain circumstances. In order to take a principal residence the IRS must go to court and seek the permission of a federal magistrate to levy a house in which the taxpayer lives. However, under no circumstances can the IRS levy on a personal residence if the total amount owed is equal to or less than $5000. §6334(a)(13).
Garnishment of Wages
The IRS can demand of an employer that a portion of the wages of a tax debtor be sent directly to the IRS. Section 6334 does allow for an exempt amount that must remain outside of the levy, however that amount is very small, leaving the taxpayer with hardly enough to satisfy her regular living expenses. A levy or garnishment upon wages is considered to be a continuous levy, i.e. it needs to be enacted only once and will be applicable to future wages until either released by the IRS under §6343 or the debt is fully paid. So as future wages are earned, no additional levy action is necessary by the IRS to take a large portion from them. Distinguish this from a bank account levy. Once the money in the bank account has been sent by the bank to the IRS, any future deposits can only be reached with additional levy action by the IRS.
Effect of an offer in compromise on an IRS levy
Under federal tax regulation §301-7122-1(g)(1) – “The IRS will not levy against the property or rights to property of a taxpayer who submits an offer to compromise… during the period the offer is pending, for 30 days immediately following the rejection of the offer and for any period when a timely filed appeal from the rejection is being considered by Appeals.”
Once the IRS decides that your offer is process-able, that it includes all the paperwork and forms properly filled out, then it must stop levy actions under §6331. However, if the offer is missing documents or forms, the IRS can return it to the debtor as un-processable and can then levy or garnish her property.
Arthur Weiss, Esquire
Law Office of Arthur Weiss, P.C.
2135 Grant Rd.
Tucson, AZ 85719
520-319-1124 https://artweisslaw.com
