24 Oct IRC 108 Tax Obligations in Bankruptcy
First off regarding income, do not include a canceled debt in gross income if any of the following situations apply:
- The cancellation takes place in a bankruptcy case under the U.S. Bankruptcy Code.
- The cancellation takes place when the debtor is insolvent, and the amount excluded is not more than the amount by which the debtor is insolvent.
- The canceled debt is qualified farm debt.
- The canceled debt is qualified real property business indebtedness.
- The canceled debt is qualified principal residence indebtedness (applies to debt canceled between January 1, 2007, and December 31, 2009). IRC section 108(a)(1)(E).
Remember that you must reduce tax attributes in other assets by the amount of debt that is cancelled. This is something that I’ve blogged about before and will blog about again as it can be very confusing to calculate.
Some other things I’ve learned include:
1. A tax lien attached to a bankruptcy estate’s property generally takes effect after property or proceeds transfers back to the debtor presuming the tax is not discharged.
2. The IRS may file a proof of claim in the bankruptcy court the same way as other creditors even if the taxes have not yet been assessed or are subject to a Tax Court proceeding.
3. If the IRS filed a notice of federal tax lien before the bankruptcy petition was filed, the IRS will have a secured claim to the extent the lien attached to equity in the debtor’s assets and will be treated as such in the bankruptcy case.
4. Relief from the failure-to-pay or timely file penalties are generally not available for a failure to submit tax withheld from others under obligation to the U.S. Treasury exists such as employer ‘trust fund’ employment tax obligations.
5. The period of time for collection of tax is generally 10 years from the date of assessment. This is extended for the period during which the IRS is prohibited from collecting due to bankruptcy plus 6 months.
6. The same exceptions to discharge that apply to individuals in chapter 7 cases apply to individuals in chapter 11 cases. A corporation in chapter 11 may receive a broad discharge when the plan is confirmed but secured and priority claims must be satisfied under the plan.
7. If a tax is discharged, the discharged tax may still be collected from the debtor’s previous bankruptcy property if the IRS filed a Notice of Federal Tax Lien before the bankruptcy petition was filed mostly because perfected liens generally pass through bankruptcy unaffected, even if the debtor’s personal liability for the debt is discharged.
8. Keep in perspective that not all tax debts may be discharged via bankruptcy. In fact many tax debts are excepted from the bankruptcy discharge. According to the IRS in chapter 7 taxes entitled to “eighth priority” treatment include;
a. taxes assessed when no return was filed,
b. taxes for which a return was filed after 2 years before the bankruptcy petition was filed,
c. taxes for which a fraudulent return was filed.
9. Ultimately taxes associated with a willful attempt to evade are not discharged. Penalties however can be discharged if a reasonable cause threshold is achieved – unless of course the penalty relates to a tax that is not discharged.