If the IRS rejects your Offer in Compromise, if you have no means with which to make an Offer, or if you are overwhelmed by other debts, you may wish to file bankruptcy in the event that the IRS is continuing collection actions. Most taxes are potentially dischargeable in bankruptcy, assuming:
NOTE: Trust taxes (including the Trust Fund Recovery Penalty) are nondischargeable
Bankruptcy Code Section 362(e) stays IRS collection activity and shifts issues related to the legality of a tax into the Bankruptcy Court, which is generally considered the most favorable forum for taxpayers.
If you intend to discharge tax debt in bankruptcy, and want to declare bankruptcy on the earliest possible date (three years and one day later), it is recommended you file the return by the original due date. If you wait to file until the IRS has prepared a substitute return (SFR) for you, the tax debt is usually non-dischargeable.
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 requires that an actual return be filed at least two years before a bankruptcy petition is filed attempting to discharge that debt. Most courts, including the Fourth Circuit, deny discharge even if an actual return is filed after a substitute for return.
Throughout this process, it is recommended that you not live an extravagant lifestyle as the IRS will challenge discharge of tax liabilities (usually with success).
High Income taxpayers are required to repay portions of their consumer debts over five years per the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. (Note: Tax debts are not considered “consumer debts.”) A lien by IRS against exempt property is unaffected by a bankruptcy as the discharge is only of the person.
In Wadleigh v. Commissioner, 134 TC No. 14, the Tax Court determined that IRS could levy on a pension post-bankruptcy as it was not an asset of the bankruptcy estate.
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