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Eliminating Income Taxes In Bankruptcy (Part 2)

You Can't Discharge a Pre-Existing Federal Tax Lien in Chapter 7 Bankruptcy

If your client's taxes qualify for discharge in a Chapter 7 bankruptcy case, the victory may be bittersweet. Why? Bankruptcy won’t wipe out prior recorded tax liens. Chapter 7 bankruptcy will wipe out a personal (in personam) obligation to pay the qualifying tax and prevent the IRS from going after your client's post-petition wages. But if the IRS recorded a tax lien on their property before the bankruptcy filing, the lien will remain on the property (what we refer to as “in rem” liability, the liability remains attached to “the thing” (the property)).

If your client is willing to surrender the property to the trustee or the IRS, then maybe you and your client don’t care. But if you do care, here are some things to know:
  • In many cases, the Insolvency Unit will simply release the lien sua sponte (on its own). You should wait about 60 days post-discharge then contact the Insolvency Unit at 800-973-0424, ask them to confirm the taxes were discharged, and inquire if they will be releasing the liens.
  • If not, you can negotiate a buy-out of the lien with the Insolvency Unit. The author’s experience is that the IRS will frequently release the lien for 10-15% of the equity in an asset if it is an asset that would be “exempt” in bankruptcy (such as homestead equity, IRAs, etc.). Why? Because the IRS knows it’s unlikely to seize that property anyway. However, experience shows that this may work best when the case is still assigned to the Insolvency Unit so do not wait for the case to leave the Insolvency Unit and go back to the Collections Division.  

If neither of these approaches works, the other option is just to live with the lien. Typically, that would be a lien on the home. The statute of limitations on collections will expire (generally) ten years from when the assessment was made plus the entire time the debtor was in bankruptcy, plus 6 months (there are other tolling rules as well). So, as long as your client does not sell or refinance the property before the SOL expires, the lien won’t affect the property. Once it expires, the lien will expire and the client is free to do whatever he or she wishes with that property.

Managing Tax With Chapter 13 Bankruptcy

Managing the filing of your client's tax return might not be as burdensome as it seems, once you realize that using Chapter 13 bankruptcy to manage their tax debt can be a smart move. Here’s why:

  • Dischargeable taxes (generally those due more than three years ago for which returns have been filed more than two years ago) might be forgiven without any payment at all, depending on the amount of disposable income you have after your reasonable and necessary expenses are deducted from your pay.
  • Dischargeable taxes won’t incur additional interest or penalties (but you’ll pay interest on nondischargeable tax).
  • Your clients can satisfy an IRS tax lien through the Chapter 13 plan.
  • The IRS is obligated to abide by the plan as long as you include all of their outstanding income tax and they keep their tax returns and post-petition tax obligations current during their Chapter 13 plan.

Bear in mind that any non-dischargeable tax debts ("priority”) taxes that won’t go away in bankruptcy must be paid in full during the three- to five-year Chapter 13 plan. When it’s over, your client will be caught up on taxes and most or all of their other debts.

Unlike Chapter 7, in Chapter 13, you can discharge a credit card balance incurred due to paying off a nondischargeable tax debt.

This is the second part of a 3-part article on eliminating income taxes in bankruptcy. Part 3 will be featured in the next TDD newsletter. I hope you're finding this material helpful and useful. If this article raises any issues or questions that you'd like to discuss – or if you have any questions about the TDD tool in general, please feel free to email me at larry@taxdischargedeterminator.tax or you can call me at 833-879-9210.



About the Author Larry Heinkel

As a tax law expert, I speak nationally via seminars and webinars to CPAs, Bankruptcy Attorneys about tax debt resolution and bankruptcy. I aim to instruct my audiences on how they can add to their bottom line by adding tax debt solutions to their practices. For bankruptcy attorneys, I created Tax Discharge Determinator, an affordable, easy-to-use, online tool to determine when tax debts are dischargeable in bankruptcy. They can avoid malpractice and create a new revenue stream.

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