Installment agreements and dischargeability of taxes

Here at Shenwick & Associates, many clients, lawyers and accountants have contacted us regarding the discharge of taxes in bankruptcy filings. Many kinds of “old” state and federal income taxes are dischargeable in bankruptcy. In the case of income taxes, they are dischargeable in Chapter 7 if all the following criteria are met:

1. The tax is for a year for which a tax return is due more than 3 years prior to the filing of the bankruptcy petition;

2. A tax return was filed more than two years prior to the filing of the bankruptcy petition;

3. The tax was assessed more than 240 days prior to filing of the bankruptcy petition;

4. The tax was not due to a fraudulent tax return, nor did the taxpayer attempt to evade or defeat the tax;

5. The tax was not assessable at the time of the filing of the bankruptcy petition; and

6. The tax was unsecured.

However, more recent taxes won’t meet these rules.  In that case, the taxpayer can’t file for bankruptcy to discharge these tax debts, and the taxing authorities will start the collections process.

If a taxpayer fails to pay his or her debt to a taxing authority, a lien is created on all the taxpayer’s current and future property.  The taxing authority may also file a notice of the tax lien to give public notice to other creditors and establish the priority of its claim over other creditors.  If the taxpayer still doesn’t pay his or her tax debt, the taxing authority will send a notice of its intent to levy (seize and sell) the taxpayer’s property to satisfy the tax debt.

However, there’s a way to stop liens and levies–by entering into an installment agreement, which is an agreement with the taxing authority to pay the tax debt within an extended timeframe.  In the case of the IRS, entering into an installment agreement will get the IRS to withdraw a Notice of Federal Tax Lien (unless the agreement provides otherwise).  This notices other creditors that the IRS is abandoning its lien priority.  It doesn’t mean that the tax lien is released or that the taxpayer is no longer liable for the tax debt.  In the case of a levy, entering into an installment agreement will release the levy (if the terms of the agreement don’t allow the levy to continue) and the IRS will return previously levied property (unless the agreement provides otherwise). 

However, note that entering into an installment agreement doesn’t affect or impact the statute of limitations on the taxing authority’s time to collect on the debt!

By entering into AND complying with the terms of an installment agreement, the taxpayer can not only have a notice of lien withdrawn, a levy released  and levied property returned, but can also “age the tax debt so that it meets the criteria for dischargeability”.  Then subsequently the taxpayer can file for bankruptcy to discharge the balance of the tax debt.

For more information about the dischargeability of taxes and the collection process, please contact Jim Shenwick.