Taxpayer Fail On Discharging Taxes Through Bankruptcy

I have an IRS notice sitting on my desk. I meant to call the IRS about it on Friday, but it got away from me. I will call on Monday. It disgruntles me, as I have already called and considered the matter resolved.

There you have why practitioners get upset with the IRS about hair-trigger or bogus notices: one has only so much time.

My partner brought in this client. They were chronic nonfilers, and we prepared the better part of a decade’s worth of returns for them. I lost humor with them when the husband insulted one of my accountants. Granted, it is unlikely that a younger accountant would know what I know, but the incident was uncalled for. The husband and I had a very different and blunt conversation.

They spoke with my partner about discharging the taxes through bankruptcy, which is one reason I was brought in.

Short answer: forgetaboutit, at least for a while.

There are four basic requirements to discharging taxes in bankruptcy. I have not often seen the fourth reason, but I was recently reading a case involving that elusive fourth.

Here are the four requirements:

(1)  The taxes were due at least three years ago. Obtain an extension and you must include the extension period in the three years.

(2)  Fail to file and the taxes are not dischargeable until at least two years after filing.

(3)  The IRS must have assessed the taxes at least 240 days before filing for bankruptcy.

(4)  The return must not be fraudulent, and the taxpayer(s) cannot willfully have attempted to avoid the tax.

Let’s go through an example.

(1)  Let’s say we are talking about your 2016 tax return. If you filed on April 15, 2017, the first rule gives you a minimum date of April 15, 2020.

(2)  Let’s say you filed that 2016 return on July 21, 2018. The second rule gives you a minimum date of July 21, 2020.

(3)  Let’s say the IRS posted (that is, assessed) the 2016 return shortly after filing – perhaps July 31, 2018. There is no problem with the 240-day rule.

(4)  Let’s also say there was no attempt to evade tax. It was irresponsible not to file, but there is nothing there other than irresponsibility.

Seems to me that the earliest you can file for discharge via bankruptcy would be July 22, 2020 – the latest of the above dates.

Let’s talk about a case involving the fourth requirement.

There is a doctor. Her husband was a CPA – he lost his license after a conviction for tax evasion.

She let her husband prepare the returns for years 2004 through 2014.

I would not have done that, but - to me – a CPA losing his license for tax evasion is a HUGE dealbreaker, husband or not.

The entered into a payment plan. They missed some payments.

Like night follows day.

They were living the high life. They had an expensive house (Newport), but they wanted a more expensive house (Dwight). They bough Dwight on a land contract, hoping to sell Newport.

They then carried two houses, as Newport did not sell.

Now they were tight on cash, and they fell behind with the IRS.

Mind you, that did not stop them from sending their kids to a private school, racking up $325,000 in the process. They also took trips to Mexico and Puerto Rico, as well as parking a Jaguar and a Lexus in the driveway.

Newport was foreclosed.

In 2016 we have the bankruptcy.

The IRS moved to exercise its lien on the Dwight property.

Husband came up with a brilliant scheme.  He sold Dwight for a swan song to a former client.  He would pay the IRS the few dollars that came his way from the “sale,” and he and his wife would rent the Dwight property back from the former client.

Puuhleeeese, said the IRS.

The Court agreed with the IRS. It spotted a willful attempt to evade or avoid, thereby nixing any discharge of taxes although the couple had filed for bankruptcy.

Why? They failed the fourth requirement.

The case for the home gamers is re Harold 2020 PTC 58 (Bankr. E.D. Michigan 2020)