Installment Agreements and Offers in Compromise are useful, but there are situations in which these devices are unavailable, inappropriate or inadequate. And in these cases, relief can often be obtained through bankruptcy. Contrary to popular opinion, a properly timed and structured bankruptcy can discharge many federal and state income tax liabilities, thus providing a much needed “fresh start.” Furthermore, bankruptcy can be useful in contesting the amount or validity of a tax when other judicial fora cannot be used.

Generally, all taxes are dischargeable in bankruptcy, subject to the following exceptions:

  • Taxes are non-dischargeable if the return was due less than three years prior to the filing of the bankruptcy petition.
  • Taxes are non-dischargeable if assessed less than 240 days prior to the filing of the bankruptcy petition.
  • Taxes are non-dischargeable if the return was not filed, or was filed less than two years prior to the filing of the bankruptcy petition.

Immediately upon filing, an “automatic stay” arises, and all IRS enforced collection action must cease. If assets are seized by the IRS before the filing of the petition but haven’t been sold, the trustee can demand that they be surrendered to the estate for the benefit of the creditors. This “turnover” power can be extremely useful if the IRS has seized assets necessary for the operation of the taxpayer’s business. As soon as it learns of the filing of a bankruptcy petition, the IRS posts its computer with a “bankruptcy hold” code to avoid inadvertent violation of the automatic stay.

In bankruptcy, the IRS is just another creditor. It can be a secured creditor if a tax lien has been filed, or it can be an unsecured creditor if no lien is filed. The IRS could also be partially secured and partially unsecured if a lien has been filed but the amount owed exceeds the equity in the property covered by the lien.

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