Whenever bankruptcy is considered to deal with IRS income tax debt, it is important to understand the nature and type of the IRS tax debt involved, the status of the IRS tax debt within the infrastructure of the Internal Revenue Service, and what actions have been taken by the IRS and the taxpayer with respect to each IRS tax debt.
Although the primary focus herein will be the tax bankruptcy discharge of IRS income taxes, generally, the same tax bankruptcy rules apply to FTB State income taxes. However, instances where California State income taxes are treated differently are noted throughout this guide on how to get rid of income taxes via bankruptcy tax discharge.
In a Chapter 11 or 13 Bankruptcy case, the priority taxes to the IRS or FTB must be paid in full under the Chapter 11 Plan or Chapter 13 Plan for taxes unless the taxing authority consents to different treatment of their tax claim. In general, the tax payment scheme within a tax bankruptcy plan is that all secured debts (secured via tax liens filed by IRS or FTB) receive payment first, followed thereafter by unsecured debts in the order of priority set forth in U.S. Bankruptcy Code 11 USC §507.
As stated in our tax bankruptcy discharge guide, 11 USC §507 provides at least ten specific classes of claims that are afforded priority status including taxes. The eighth priority is for unsecured taxes of governmental units. First priority is to administrative expenses, including any taxes (State or Federal) incurred in the administration of the bankruptcy estate, for example, income taxes for tax years ending after the date the petition in bankruptcy was filed.
Although a thorough review of taxpayer’s IRS tax file should be analyzed before filing a tax bankruptcy case, people or businesses that owe taxes may be able to get rid of taxes if the income taxes at issue are not claimed to be secured or priority taxes by the IRS or FTB. In the context of trying to resolve tax debts, tax bankruptcy can be a viable legal option to eliminate IRS or FTB tax debt along with other collection alternatives and offer in compromise.
So what are priority taxes and how does the IRS categorize which taxes should be given status as secured tax, priority tax or general unsecured tax in a tax bankruptcy case?
Important Note: The Bankruptcy Code fails to make any distinction between IRS- Federal, State (California FTB) or local taxes in describing what constitutes a priority tax debt claim.
Important Note: Caution - the tax or bankruptcy lawyer should not rely on information of an IRS agent or IRS revenue officer over the telephone but rather should secure written documentation in support of the information he or she seeks before tax bankruptcy analysis.
Important Note on IRS Offer in Compromise: The taxpayer is advised to refrain from filing an IRS offer-in-compromise during the 240 days following the date of IRS tax assessment. Instead, the taxpayer should attempt to negotiate an installment agreement with the IRS or FTB in an effort to prevent enforced IRS tax collection such as tax levies and tax liens, which will not in any way prohibit the tax debtor from later initiating a tax bankruptcy filing.
Moreover, if the IRS requests the taxpayer to execute an IRS Form 900, Waiver of the Statute of Limitations for Collection of the Tax, in order to obtain an IRS tax installment agreement, the taxpayer may do so after consulting their lawyer without fear of any detrimental consequences to his or her ability to later file tax bankruptcy.
FTB State Adjustments: States compute their tax liability on the basis of the information provided on the IRS tax return with special additions and subtractions thereto. Accordingly, any change by the IRS to the Federal income tax return will necessarily occasion a change to the State FTB tax return. In fact, Congress and various states, including California FTB, have exchange of information agreements in an effort to monitor this system of adjustments. California Revenue and Taxation Code §18622 provides that if a California taxpayer fails to report a Federal adjustment(s) to the State of California within 90 days of the date of the IRS tax assessment then the California taxpayer revives the four year statute of limitations; thus, it is important to coordinate the timing of all assessments prior to any tax bankruptcy filing.
IRS & FTB Tax Audits & Tax Amendment Reporting Requirements for California Taxpayers in Tax Bankruptcy:
Provisions concerning income tax reporting of IRS audits or changes or corrections were amended by the California state Legislature over the years. Former California FTB Tax Legislation Sections 18451, 18586.2, 18586.3 and 19053.6 of the California Revenue and Taxation Code and the updated sections found in 18622-19059 extend the periods of time within which the FTB taxpayer must notify the California Franchise Tax Board of a change or correction to the taxpayers Federal IRS Income Tax Return. This California FTB tax legislation also amended the period of time in which a taxpayer must file an amended State income tax return with FTB and within which the Franchise Tax Board may issue a tax deficiency assessment on the basis of the Federal IRS changes, audits or tax corrections.
Under former CRTC 18451 and updated CRTC 18622 the California FTB taxpayer must report the changes or corrections within six (6) months after the final federal IRS tax determination as a result of tax audit or other tax examination procedures. Previously, the law allowed a taxpayer only ninety (90) days in which to report the changes or corrections.
Under former CRTC Section 18586.2 and updated CRTC section 19059(a), if the California FTB taxpayer fails to report a Federal IRS tax change or correction, a Notice of Proposed Assessment may be mailed to the taxpayer at any time after the change or correction is reported to the Federal Government. Previously the Franchise Tax Board could send a Notice of Proposed Assessment for a period of up to four (4) years if the taxpayer failed to report a federal change or correction that affected the state income tax return.
Former CRTC Section 18586.3 and updated CRTC section 19059(b) provides that if a taxpayer does report a change or correction to the Franchise Tax Board or files an amended state return within the prescribed period of time a Notice of Proposed Assessment may be mailed to the taxpayer within two (2) years. Previously the Franchise Tax Board was limited to a period of six (6) months in which to issue a Notice of Proposed Assessment to the taxpayer.