This is the fourth post in the Collection Options series. This series is dedicated to presenting individuals and businesses with options for dealing with outstanding tax obligations.

Bankruptcy. We encourage anyone interested in filing a petition for relief in bankruptcy to meet with a skilled bankruptcy attorney to evaluate their situation and options. This post is designed to help a taxpayer understand some of the issues involved in discharging tax obligations and help prepare them for a meeting with the bankruptcy attorney.

Chapter 7 Bankruptcy. Income taxes (not trust-fund or withholding taxes) are dischargeable in a Chapter 7 Bankruptcy if certain conditions are met. To start, you should examine the following elements to determine if bankruptcy is an option:

Three Years. Has it been more than three years since the original due date, including extensions, for the Return? If not, the taxes are not dischargeable.

Two Years. If the Tax Return was filed after the original due date, has it been more than two years since the late Return was filed? If not, the taxes are not dischargeable.

240 Days. Has it been more than 240 days since the taxes were assessed? If not, the taxes are not dischargeable.

Fraud/ Misrepresentation. Are the tax obligations due to the taxpayer’s fraud or misrepresentation. If so, that may render the taxes not dischargeable in a Chapter 7. Interestingly, the fraud penalty itself may still be dischargeable.

Service Filed Returns. Is the tax obligation the result of the Internal Revenue Service filing returns for the taxpayer because the taxpayer failed to file? If so, the taxes may not be dischargeable.

Liens. While liens don’t effect the dischargeability of the tax, the lien may survive the bankruptcy thereby making the discharge practically ineffective. If the taxpayer files the bankruptcy prior to the Internal Revenue Service filing Tax Liens, then the taxpayer will have the opportunity to completely avoid the tax claims. However, if the Internal Revenue Service filed Tax Liens against the taxpayer prior to filing bankruptcy, the bankruptcy may discharge the debt, but those Tax Liens may continue to encumber the taxpayer’s property. For example, if the IRS Tax Lien encumbered the taxpayer’s homestead which had $20,000.00 of equity, the Internal Revenue Service’s underlying tax may be discharged, but the Internal Revenue Service would still have a lien against the home for the equity that the taxpayer had at the time he filed bankruptcy. If the taxpayer has no equity in any assets, then the lien loses its importance but must still be removed from the county and state records after the bankruptcy. This can be accomplished with an Application for Release of Federal Tax Lien.

Chapter 13 Bankruptcy. A Chapter 13 Bankruptcy is not designed to discharge all debts completely. Instead, it is a way to force the taxpayer’s creditors into a long-term installment arrangement (for example, five years). A Chapter 13 bankruptcy may be appropriate for taxpayers who do not want to file a Chapter 7 bankruptcy, or whose taxes would not be entirely discharged in a Chapter 7 bankruptcy. Often, a portion of the taxpayer’s tax obligation can be discharged under a Chapter 13 bankruptcy and the balance of nondischargeable taxes can be paid over time.