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Columns: Bankruptcy Adviser
Justin Harelik Expert: Justin Harelik
Bankruptcy Adviser
Eliminating delinquent taxes in Chapter 7 bankruptcy
Bankruptcy Adviser

Chapter 7 and delinquent taxes

Dear Bankruptcy Adviser,
How much of an Internal Revenue Service past debt can or will be cleared when declaring Chapter 7 bankruptcy?
-- Joe

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Dear Joe,
It is possible to eliminate all delinquent taxes in a Chapter 7 bankruptcy. In general, there is a multiple-step test to determine whether tax debt can be eliminated. First, you should order tax transcripts directly from the IRS. Depending on your tax situation, you might want to order transcripts for the past 10 years.

More importantly, Joe, you cannot be afraid of the IRS. I know most people consider the IRS to be like any other debt collector. This could not be further from the truth. In my experience, the IRS is easy to work with. Whether it is because they do not have the same pressures as debt collectors or whether the government simply hires more patient people, I don't know. But the IRS is the only debt collector that does not get angry when told "I cannot pay right now."

Unlike a debt collector who will try to corner you into a position and demand payment so that your delinquent account can be resolved, the IRS is not going anywhere. Instead, the agent simply wants to know what is going on. Communication is the key to working with the IRS. Hiding from the IRS is counterproductive and usually will result in more problems.

Here are the significant parts of the step-by-step analysis attorneys use before advising a client about the status of delinquent taxes. Please note that there are exceptions to each of the following points:

Filed tax returns: You must have filed all tax returns. You may have requested an extension for filing; this could affect your ability to eliminate the delinquent taxes.

Taxes are at least three years old: The taxes you include in the petition must be at least three years old. For example, if you filed your tax returns on time and still owe taxes from 2003, then it is possible that these taxes can be eliminated.

No IRS assessment in the past 240 days: This is a very important part in determining whether the delinquent taxes are dischargeable. As you can imagine, the IRS does not just sit back hoping you'll pay. Unfortunately, there are too many issues to discuss in this column regarding tax assessment and the categorization of the taxes. But at a minimum, you can review the tax transcripts to determine whether the IRS has assessed your tax returns in the last 240 days.

You did not try to evade the IRS: This issue must be considered on a case-by-case basis. Even though you can pass the other three tests, the IRS could challenge your bankruptcy. The above tests do not apply if the IRS believes that you have tried to avoid paying taxes and can prove that you had money available to pay.

For example, I heard a story from the IRS in which a debtor owed delinquent taxes and earned a good income. However, the debtor decided to deposit all his paychecks into his girlfriend's checking account in order to show that he personally had no income. The IRS discovered this fact and challenged his bankruptcy on the grounds that he was intentionally evading his obligations. The IRS won. As a result, the debtor now has a bankruptcy on his record and thousands in tax debt that must be paid back, with interest and penalties.

Additionally, I once was hired by a debtor who filed a bankruptcy five days too early and could not eliminate a significant amount of IRS debt. As a result, the debtor was forced into a Chapter 13 bankruptcy rather than eliminating all his delinquent taxes. Had an attorney reviewed the transcripts prior to filing, these taxes may have been eliminated.

You do not need a bankruptcy attorney to determine whether your IRS taxes are dischargeable. However, an attorney would let you know whether it is likely that the taxes can be eliminated. Even if you do not hire one to file your bankruptcy, it may be worth the cost to have an attorney review your tax transcripts.

Bankrate.com's corrections policy-- Posted: Jan. 1, 2008
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