What is forgiveness of debt income? When you owe money and do not pay the full amount of the debt the lender is required to file a 1099 form with the IRS showing that you had phantom income in the amount the creditor forgave. This is referred to as ‘forgiveness of debt’.
Please Note:
This area is intended for the exclusive use of attorneys. You know the drill – do your own due diligence. We make no representations as to the accuracy or current status of any information cited herein.
If you are NOT an attorney it is important to educate yourself, but this is not the place to do it. You must obtain legal advice from an experienced attorney familiar with your unique situation. Fixing unintentional errors will cost far more than doing it right the first time; if it can be fixed at all.
The information in this web site is not intended to constitute legal advice or to create an attorney-client relationship.
WARNING TO ALL VISITORS: I AM NOT A TAX ATTORNEY, DO NOT RELY ON ANY TAX ADVICE ON THIS SITE. OBTAIN ADVICE FROM A COMPETENT TAX ATTORNEY WHO UNDERSTANDS BANKRUPTCY LAW. THIS OFFICE RARELY FILES A CLIENTS’ BANKRUPTCY WITH TAX ISSUES WITHOUT FIRST CONSULTING A VERY GOOD TAX ATTORNEY WITH EXPERTISE IN BANKRUPTCY. IT WOULD BE WISE FOR YOU TO DO THE SAME.
IMPORTANT: This firm makes NO representations as to the accuracy or current status of any law, case, article or publication cited herein or linked to.
Warning – some of these references are pre-BAPCPA.
RESOURCES
Overview of Bankruptcy
Chapter 11
Chapter 7 – consider talking to a tax expert about waiting to file the bankruptcy until after 3 years since due, 2 years since filed and 240 days since assessed. Exception: chapter 13 – supposedly 2 year rule not applicable. WARNING – Again I am not a tax attorney. Get competent advice from someone who is.
TAX ASSISTANCE - SOME FREE
VITA (Volunteer Income Tax Assistance, at 800-906-9887) or TCE (Tax Counseling for the Elderly at 888-227-7669 operated by an AARP foundation). I believe that generally VITA has offices operating through an October date and TCE through April. For the current information – put in your zip code here: https://irs.treasury.gov/freetaxprep/
If there is one organization in the entire world with which you never want to skimp on a single penny, it’s the IRS. Because of this, people get talked into a free consultation and then pay hundreds of dollars to professionals to file their taxes. So, if someone offered you a free tax-filing service, you might consider it a scam. What if that “person” was the IRS? The IRS offers free tax-filing software for individuals filing incomes below $66,000. If you make more than $66,000, no worries. The IRS offers free fillable tax forms for you to use.
IRS VIDEOS, including OFFER IN COMPROMISE and many OTHERS
Many helpful videos at the IRS website (remember that the IRS may change policies which are not reflected in older videos).
Offer in Compromise (through King tax Hotwire)
UNDERSTANDING OFFER-IN-COMPROMISE (notes from IRS FREE WEBINAR – beware you MUST talk to an experienced tax attorney)
Morgan King, 7/20/19 (originally telecast 7/18/19)
(also at IRS videos at website: https://www.irs.gov/newsroom/videos) www.IRSVideos.gov. Use the most recent revision of the OIC.
3 bases for Offer in Compromise (OIC):
OIC is a contract between TP and IRS for settlement of less than amount owed.
(see materials for recent results).
Dispositions:
Objectives:
Partial payment option – TP pay installment payments of less than full amount within collection limited period.
Compliance:
IRS PRE-QUALIFIER TOOL: to see if OIC is a viable option. If atty has a POA – at IRS.gov, use keyword search: OIC
This is only a guide and does not provide a definitive answer. Only qualifies as to doubt of collectability. Completely anonymous. And what an acceptable offer might be.
Review of OIC pre-qualifier tool (only for individuals, not corporate):
IRS uses allowable living expenses national standards (food, clothing, misc., out-of-pocket medical)
If do not qualify – will get a ‘no’ screen, but will be directed to an alternative screen. There are some exceptional “special circumstances”.
Reasonable Collection potential (acceptable offer amount) – how much the IRS wants – future income (based on current time on collection statute – usually 10 years), plus asset equity. If tax debt cannot be paid in the 10-year period (some rare exceptions) then do not qualify for OIC.
Form 656 b – payment options:
SPECIAL CIRCUMSTANCES THAT MAY IMPACT OIC:
Helpful hints (the more you include in the package up front the less time it will take or dealing with additional requests:
National Standards only for US and Puerto Rico – foreigners would have to use actual expenses.
TP is not required to make an installment agreement or payment plan during OIC, but DO HAVE TO make proposed cash payment or monthly payment which is part of the OIC offer. If OIC is rejected, then IRS will reinstate the installment agreement.
KEYPOINTS:
Anna – OIC is a great business and tax policy under appropriate circumstances. Use the Pre-Qualifier.
Richard –
1099 FORGIVENESS IRS PUBLICATION
IRS’s Publication 4681 is a very helpful tool to explore the different ways taxpayers can exclude mortgage indebtedness and other types of 1099 forgiveness.
PRACTICAL NOTES
In order to be certain that a tax is discharged according to a local IRS attorney wait 4-5 weeks after the discharge is entered then order a transcript or call the agent assigned to the file. It is likely that the appropriate taxes will be discharged. Otherwise, file an adversary in the bankruptcy to discharge the debt. This gives us an order that the IRS has to follow. IRS no longer uses the efficient and logical administrative procedure regarding dischargability of income taxes in chapter 7 bankruptcy cases that they used for so many years where we could write to them and they would tell us if they agreed that the tax was dischargeable. In the adversary, IRS will usually stipulate to the order if the times are correct. This gives the debtor ironclad proof of the dischargeability.
Regarding the extension, look at the transcript. An entry for “Code 460, Extension of time to file” certainly shows an extension. Also, look for the Code 150: “Tax Return Filed”. This will show a date. A date before August 15 usually indicates an April 15 filing; IRS just logs it in late. If the case is still open, you could still file the adversary. Or, go the the IRS local office now and try and get them to agree that the tax is discharged
As of 1997 the information below was the law on how to discharge taxes after a bankruptcy has been filed. It may have dramatically changed since this writing. This should be included in every client letter of a person who owes back taxes to the Federal Government.
As a result of Bankruptcy Code Sections 523 and 507 the following taxes are dischargeable:
1. Tax penalties for non-filing, late payment, late deposit, fraud penalties and late estimated payments if the taxes to which they relate are dischargeable.
2. Income taxes which are:
a. Over three years old;
b. Have been filed at least two years prior to the petition; and/or
c. Have been assessed as an audit deficiency for at least 240 days.
3. Estate and gift taxes which are over three years old.
** A taxpayer must not have filed a fraudulent return or otherwise tried to willfully evade payment of the tax.
Once a discharge has been entered by the Bankruptcy Court, submit a written request to Special Procedures Branch that the IRS abate the tax. The Service will abate the liability by preparing a Form 3870. The author has found that the IRS is very inefficient in preparing post-bankruptcy abatements. Many clients have had levies made on their wages or bank accounts after a bankruptcy. You must aggressively pursue abatement. If all else fails, the client may request that the Bankruptcy Court hold the IRS in contempt of court. Until the IRS begins protecting the rights of bankrupts, the IRS may take illegal levy action notwithstanding the bankruptcy. If you have taken reasonable steps to notify the IRS of the bankruptcy and discharge, you will have a potential cause of action for reckless violation of the Code [IRC § 7433].
However, the Bankruptcy Court has the authority upon review of a debtor’s Chapter 7 bankruptcy to deny discharge and dismiss the matter if it believes the debtor can partially or fully repay some debts. In other words, the Court might try to force a conversion to a Chapter 13 bankruptcy upon a person who originally petitioned for a Chapter 7 bankruptcy. Such a decision is based upon an income and expense statement which all debtors have been required to file since the 1984 amendments to the Bankruptcy Code.
MORGAN KING - SUMMARY OF TAX DISCHARGE RULES
Morgan King – Ed. Note: This case is a textbook example of the attorney getting the rules for discharge all mixed up.
ARE TAXES DISCHARGEABLE IN BANKRUPTCY
Stapley v. Cal. Through Its Franchise Tax Bd. (In re Stapley) (Bankr. N.D. 2019)
This case addressed a number of issues, but the following will focus on only the issue of the dischargeability of tax penalties.
Bankruptcy Code § 523(a)(7}(B) provides that tax penalties are: dischargeable if ” … imposed with respect to a transaction or event that occurred before three years before the date of the filing of the petition.” The problem is what does “… transaction or event” really mean? And, what is deemed the date the transaction or event occurred”? To add to this confusion – what are the differences between the Federal as opposed to the state statutes governing the time or event?
In Stapley the court struggled with California law (Franchise Tax Board), as the penalties were assessed on tax events provided under state statutes, in connection with state income taxes. The first part of the opinion dealt with IRS issues, but subsequently addressed California’s issues. The state assessment of tax liabilities happened following an IRS audit (the “piggy back” assessment).
Penalties: ” … claim is based on Bankruptcy Code §523(a)(1) and §523(a)(7) and asks the court to find that plaintiffs do not owe the penalties the FTB claims they owe because the penalties were discharged in plaintiffs’ 2009 Chapter 7 case.”
” … the FTB’s motion for summary judgment spends considerable time discussing why the tax debt is not dischargeable and was not discharged in plaintiffs’ Chapter 7 case.”
” … The parties disagree on the relevant “transaction or event” date.
“The FTB contends it is the date it mailed the Notices of Proposed Assessment on October 8, 2010, which was not “before three years before” the August 2009 petition date.”
“Plaintiffs contend that the relevant “transaction or event” date is the “existence of a deficiency attributable to an abusive tax avoidance transaction” because that is the language used in Cal. Rev. & Tax. Code §19777. Plaintiffs contend these deficiencies occurred in 2002 to 2005 when their returns were due – well before three years before the 2009 petition date.
” … relevant transaction date used by Ninth Circuit was the date the deficiency was assessed in 1977.”
Hence, the “event” for penalties to be dischargeable appears to be connected to when the penalties were “assessed.”
IRS publication:
Litigating Position Regarding the Dischargeability in Bankruptcy of Tax Liabilities Reported on Late-Filed Returns and Returns Filed After Assessment.
In re Thaxton (Bankr. S.D. W. Va., 2017) Held, Debtor’s postpetition interest on IRS taxes not discharged Court seems to recognize that postpetition interest on nondischargeable taxes would be discharged, but only if the plan so provided, and the IRS had been given adequate notice of that plan provision.
The debtor filed a chapter 13 case with a plan that provided for full payment of unsecured priority trust-fund taxes. The principal of the liability was paid in full in the debtor’s chapter 13. Following the final discharge, the IRS sent the debtor a notice of their intention to levy for the post-petition interest that had accrued, but not paid, in the Plan.
The court held that, unlike a secured claim, the plan could not provide for payment of postpetition interest on a non-dischargeable tax. The Bankruptcy Code § 1322(a)(10) provides that the plan may provide for payment of postpetition interest on unsecured nondischargeable taxes (e.g., trust-fund taxes) but only if the plan is a 100% plan.
“Section 502(b)(2), however, does not mean that interest ceases to accrue or that a debtor is exonerated therefrom. Rather, post-petition interest accrues outside the Chapter 13 plan and the debtor remains personally liable therefor post discharge.”
The Thaxton court appears to acknowledge that, in some cases, postpetition interest on nondischargeable taxes would be discharged, but only if the plan so provided, and the IRS had been given adequate notice of that plan provision. In this case, this did not happen. “They made no mention of their intent to pay only the principal of the claim. They also did not tender a clear, open and explicit statement that interest accrued post-petition would be discharged.”
See also, In re Hanna, 872 F.2d 829, 831 (8th Cir. 1989); Johnson v. Internal Revenue Serv. 146 F.3d 252, 260 (5th Cir. 1998). Our Court of Appeals is in accord. See In re Kielisch, 258 F.3d 315, 321-22 (4th Cir. 2001).
In re Olshan (01/28/04 – No. 02-56792) (U.S. 9th Circuit Court of Appeals) Bankruptcy court erred in rejecting the IRS’ claims for unreported non-business income and overstated business deductions after finding that the IRS’ method of computing debtor’s unreported business income was flawed. Undisputed evidence in the record will enable the bankruptcy court to determine debtor’s liability for taxes, penalties, and interest.
US Internal Revenue Serv. v. Snyder, No. 02-15618 (9th Cir. September 15, 2003) An IRS claim for delinquent taxes secured outside of bankruptcy by a lien on a debtor’s interest in an ERISA-qualified pension plan is not secured under 11 U.S.C. section 506(a), because a debtor’s interest in an ERISA-qualified plan is excluded from the bankruptcy estate pursuant to 11 U.S.C. section 541(c)(2).
In re Frontone ___ B.R. ___ (C.D.Ill. 2003) Held, an overpayment to the taxpayer of a tax refund is a debt owed to the IRS, but is not treated the same as the underlying tax, and therefore is dischargeable in Chapter 7.
In May 2001 the IRS sent debtors a notice saying they had overpaid their tax and refunded them $5,140. Subsequently, the IRS assessed additional taxes owed, and demanded the refund be paid back. In September 2002 the debtors filed Chapter 7 and filed an objection to the IRS claim. The court held that § 507(c) gives an erroneous tax refund the same “priority” as the underlying tax, but not the same nondischargeable status.
“The legislative intent behind the change made in 1984 to the language of Section 507(c) is easy to ascertain. Congress obviously concluded – correctly – that it is inequitable to treat taxpayers who fail or decline to pay their income taxes the same as taxpayers who pay their income taxes but who incur obligations to a governmental unit as a result of that governmental unit’s erroneously refunding taxes paid.”
TAX REFUNDS
Dunmore v. U.S., (9th Cir. 2004) Only bankruptcy estate had standing to pursue tax refund that debtor failed to schedule. Dunmore, as a debtor seeking bankruptcy relief, had a duty to carefully schedule his assets, including his refund claims, on his bankruptcy petition. Cusano v. Klein, 264 F.3d 936, 945-46 (9th Cir. 2001). Dunmore, however, breached this duty when he chose not to schedule his claims against the IRS on his Chapter 7 petition. By operation of statute, assets that Dunmore failed to schedule remained the bankruptcy estate’s property, even after the court discharged his debt. 11 U.S.C. § 554(c), (d). Thus, the unscheduled tax refund claims remained the estate’s property post-bankruptcy. Accordingly, we conclude that the bankruptcy estate was the real party plaintiff in interest at the time Dunmore filed his action.
Where are my tax refunds? Online tool, taxpayers can start checking on the status of their return within 24 hours after the IRS receives an e-filed return or four weeks after the taxpayer mailed a paper return. The tool has a tracker that displays progress through three phases: (1) Return Received; (2) Refund Approved; and (3) Refund Sent.
SALES TAXES or TRANSACTION PRIVILEGE TAXES
ADOR vs Action Marine, Az Ct Apps 1 CA-TX 06-0006 – in an Arizona Supreme Court decision that holds that the “responsible persons” for a business entity may be PERSONALLY liable for the transaction privilege taxes (you probably call these sales taxes) collected by an entity if the entity doesn’t pay them over to the ADOR, even if the entity files for bankruptcy relief. Historically, most people would have thought that the “responsible person” for the taxes was just the entity itself and not the individuals involved in the entity and that the individuals could not be held liable. Indeed, that was the very holding in bankruptcy decision “Inselman” that is cited by the Arizona Supreme Court.
In re Inselman, 334 B.R. 267 (Bankruptcy Court, District of Arizona 2005)- The Court here concludes that Arizona statutes do not impose “responsible person” liability for the transaction privilege tax liability incurred by a company that is a separate legal entity. The Court therefore concludes that A.R.S. § 42-5028 imposes liability only upon the merchant/taxpayer who engages in the transactions that give rise to the tax, and not upon the officers, employees or agents of such a separate business entity. Consequently the Debtor’s objection to the AZDOR proof of claim pertaining to TPT taxes incurred by the Company is sustained, and that claim is disallowed.
In Re: Michael Calabrese, JR., No. 11-3793 United States Third Circuit, 07/20/2012
In a former restaurant owner’s bankruptcy proceedings, the Bankruptcy Court’s holding that the sales taxes at issue are trust fund taxes under 11 U.S.C. section 507(a)(8)(C) rather than excise taxes under section 507(a)(8)(E) is affirmed, as sales taxes collected by a retailer never become the property of the retailer because it retains those funds in trust for the state, and therefore, petitioner’s sales-tax obligation is subject to section 507(a)(8)(C) and is not dischargeable.
Miller v. US, No. 02-17073 (9th Cir. April 13, 2004) The interplay of Bankruptcy Code sections 1141(d)(2), 523(a)(1)(A), and 507(a)(8) renders an IRS claim for unpaid withholding taxes nondischargeable by a confirmed Chapter 11 bankruptcy plan, whether or not that claim was secured.
Goldberg v. Ellett (07/16/01 – No. 00-15128) (9th Cir. Ct App) Bankruptcy court may enjoin a state tax official from collecting state taxes purportedly discharged in a bankruptcy proceeding in which state declined to participate.
Deroche v. Arizona Indus. Comm’n (11/29/01 – No. 99-16058) (9th Cir. Ct App) When determining the dischargeability in bankruptcy of an excise tax owed on a “transaction,” in which an employer reimbursed the state’s Special Fund for failure to carry insurance, the date of the “transaction” is the date on which the worker was injured; thus, since transaction occurred over three years prior to filing bankruptcy, the excise tax debt was dischargeable.
EXCISE TAXES - PRIORITY OR NOT?
In re Sandia Tobacco Manufacturers (Bankr. D. New Mexico Oct. 10 2018) (from KING TAX HOTWIRE <morgan@morganking.com></morgan@morganking.com>
This case addresses several issues in connection with “excise taxes.” The Bankruptcy Code provides that excise taxes are dischargeable if the taxable event (the sale or other event) happened more than 3 years before the BK is filed (11 U.S.C. § 507(a)(8)(E).
One would think the discharge issues for excise taxes would be fairly simple. But this case demonstrates there may be a myriad of questions:
Issues addressed:
The case involves a variation on the theme of state-imposed excise taxes, in that the taxes were imposed by a not-typically “taxing” entity – the U.S. Department of Agriculture, pursuant to the Equitable Tobacco Reform Act of 2004 (FETRA).
In a nutshell, the Department paid eligible tobacco farmers “transition payments” for 10 years, to account for a drop in prices. Then, Congress authorized the Ag. Dept. to assess tobacco manufacturers payments back to the Agency (for reasons that are obscure to the author).
Ultimately the question became, are the payments that were assessed excise taxes, regulatory fees, customs duties, or other fees or penalties? If excise taxes, they were subject to 11 U.S.C. § 507(a)(8)(E) and possible discharge in bankruptcy.
If subject to § 507(a)(8)(E), did the transactions occur more than three years before the bankruptcy filing?
Were they “taxes”?
The court found the assessments to be taxes based on the elements of a tax; 1) Involuntary, 2) Imposed by a legislative body, 3) imposed for a public purpose (i.e., not as a fee for a particular service), 4) Under the police or taxing power of the state. This is referred to as the Chateauugay/Lorber test.*
Noting that Congress authorized the assessments, not for a specific service, but ” … was to stabilize the tobacco industry,” the opinion explores these questions and holds the assessments to be taxes.
Were they “excise” taxes?
Next, the court, referencing § 507(a)(8)(E)(ii), held that they were “excise” taxes, more or less by eliminating other kinds of taxes as not applicable to the taxes at issue:
“As the FETRA assessments against the Debtor did not provide revenue from imports but instead provided revenue based on Debtor’s business manufacturing tobacco products in the United States, the Court concludes that the FETRA assessments, as applied to the Debtor, are properly characterized as excise taxes.”
When did the taxable event occur?
Next, when did the assessment events occur? If over 3 years before the bankruptcy filing, they are dischargeable. The court discusses the facts surrounding these taxes and an argument about when, exactly, the relevant event happened.
The bickering was over, should the triggering event occur on a quarterly, or an annual basis? ” … the Court concludes that the ‘transaction upon which the FETRA excise tax is imposed is the removal of product from inventory … and therefore the relevant transaction date is the date the product is removed from inventory, not the date the USDA sends an invoice for the assessment, nor the date the invoice is due.”
Conclusion:
Based on the extensive analysis (the opinion runs 19 pages) the court found some of the taxes dischargeable, and some nondischargeable (i.e., priority) based on whether the taxable events were more, or less, than 3 years before the bankruptcy was filed.
PARTNERSHIP TAXES
US v. Galletti, No. 01-55953/4 (9th Cir. August 08, 2002) The IRS cannot collect a partnership’s tax deficiency directly from the partners, without first making individualized assessments or obtaining judgments against the partners, holding them liable for the partnership’s tax debts; bankruptcy claims were time-barred.
TOLLING and BANKRUPTCY
An offer in compromise “OIC” tolls the 240 day period of §507(a)(8)(A)(ii) for the time the OIC overlaps the 240 day assessment period plus 30 days §507(a)(8)(A)(ii)(l). See if your client signed a IRS form 656 for voluntary tolling as well.
An offer in compromise only tolls the 240 day rule. The 240 day rule relates to bankruptcy filings within 240 days of an assessment. So an offer made more than 240 days after an assessment does not toll anything. (Note – I don’t believe an installment payment is the same as an OIC. This is up to you to confirm.)
Look at all rules and liens, to see if it is general unsecured, priority, secured. But the 240 day rule would be satisfied and would not be impacted by an OIC if the assessment is more than 240 days before the OIC.
The literal reading of the Code does NOT conclusively list all tolling situations, at least according to the IRS. The Supreme Court held in Young v US that equitable tolling can apply, and thus that (before it was provided in the Code) a prior BK can toll the periods in 507. Under BAPCPA, a prior BK tolls the 3 year and 240 day periods (plus 90 days), but the Service maintains that a prior BK tolls the 2 year rule as well.
It does not appear that anyone has yet determined that an installment agreement tolls dischargeability. But the state tax authorities could make that argument. However “requesting” an installment does toll the CSED from when requested until the decision is made. But the actual agreement itself does not toll.
The Collection Statute Expiration Date (CSED) is the last day the IRS has to collect a tax liability, which is 10 years from the date of assessment, in most cases. This collection period begins on the day after the assessment of the tax liability.
Note: Make sure to pull the transcripts.
The 3-year period that ordinarily commences on the most recent date the tax return for the year in question is due, pursuant to 11 U.S.C. § 507(a)(8)(A)(i). The basic rule is, if the tax collection entity (state or federal) is prohibited from tax collection due to the existence of the automatic stay in a bankruptcy case that arose during, or overlapped, the running of the 3-year time, the time is tolled (or “suspended”) for the time in which the previous case’s automatic stay overlaps the 3-year period, plus an additional 90 days.
That rule is relatively simple to apply. You begin with the due date, extend it out 3 years, then add the time a prior bankruptcy case stay overlapped, then add on an additional 90 days.
Nachimson v. United States ex rel. Internal Revenue Serv. (In re Nachimson) (Bankr. W.D. Okla., 2019) In this case, Debtor filed a motion to extend the automatic stay, but never uploaded an order granting the motion, notwithstanding there being no objection to the requested relief.
“Because Debtor is a repeat bankruptcy filer, having filed four separate bankruptcy cases in 2014, 2015, and 2016, the automatic stay interrupted collection actions by the United States with respect to Debtor’s tax liabilities. Based on the tolling provision of the hanging paragraph, the United States argues the look-back period is extended an additional 401 days – the 311 days that the Debtor’s bankruptcy proceedings were pending, plus the additional 90 days provided by the statute.
“When a debtor files multiple, successive bankruptcy cases, the ordinary operation of the automatic stay is altered by Section 362(c)(3)(A). Under Section 362(c)(3)(A), if a debtor had a case pending within the preceding one year period that was dismissed, then the automatic stay “with respect to any action taken with respect to a debt or property securing such debt . . . shall terminate with respect to the debtor on the 30th day after the filing of the later case[.]” 11 U.S.C. § 507(a)(8), § 362(c)(3)(A).
Findings: After addressing these issues, the court held that ” … the three-year look-back period, October 25, 2015, to October 25, 2018, was tolled for 311 days on account of Debtor’s prior bankruptcy filings, plus the additional 90 days provided by the statute,7 for a total of 401 days.”
The court granted the IRS motion for summary judgment. “Based on the Extended Three-Year Look-Back Period, Debtor’s 2013 and 2014 Tax Liabilities are Not Dischargeable.”
In re: Brenda Marie Jones, No. 10-60000 In a bankruptcy dispute involving the discharge of taxes owed by debtor in a new chapter 7 case to the California Franchise Board, judgment of the bankruptcy court is affirmed where debtor’s prior Chapter 13 bankruptcy case had no effect on the look back period such that the period was not suspended and the tax debt discharged.
TAX LIEN
ARS 42-1151. Tax Lien
A. If any tax, interest, penalty or other amount owed by the taxpayer to the department that the department is required to collect is not paid by a taxpayer when due, such unpaid amounts constitute a lien upon all property and rights to property, whether real or personal, belonging to the taxpayer or acquired by the taxpayer from the date the amounts are assessed or the date the return prescribing the liability is filed until the liability for the assessed amounts is satisfied.
TAX LIEN FLOW CHART. It is my understanding that an IRS lien is generally valid valid for 10 years after assessment, not after recording of the tax lien. Most likely the lien is good for 10 years, then the lien expires unless the IRS sues in court and obtains a judicial judgment lien which is renewable.
Also, even if the IRS has a lien on property such a vehicles or a house, it seems to rare for the IRS move to enforce the lien by selling the property vehicle or house. But, that assumes the taxpayer does not have assets which could be seized to pay the lien. Always work with an experienced tax attorney to settle tax debts.
The debtor’s personal liability for taxes is discharged in Chapter 7, then the recorded IRS lien survives the Chapter 7 as a lien against only the property owned by the debtor at the time the bankruptcy was filed and not against property acquired by the debtor after the time the bankruptcy was filed (but check this out with an experienced tax/bankruptcy attorney).
IRS TAX LIEN: The tax lien trumps the exemptions. The IRS will not release a lien with multiple years unless all years are discharged or paid. If there is property still subject to the Lien, ask that the IRS to release as on the basis that the property is small. Otherwise, a payment arrangement can be set up.
INTEREST: – under 26 USC 511, Chapter 13 debtors are required to pay the IRS the quarterly rate it sets, but only simple interest (as opposed to the normal IRS rate of compound interest) for the quarter in which the plan is confirmed. The interest rates are set under the authority of 26 USC 6621.
N. Slope Borough v. Barstow (10/21/02 – No. 01-35892/35901)(9th Cir) Under Bankruptcy Code section 724(b), priority unsecured creditors have a right to obtain only that portion of the proceeds equaling the amount of the tax liens. Any remaining proceeds go first to junior lien claimants, then to the holders of the tax liens insofar as their claims were not already satisfied and, finally, to the estate.
Barstow v. US Internal Revenue Serv. (10/21/02 – No. 01-35819) (9th Cir) The term “tax lien” in Bankruptcy Code section 724(b) means a statutory tax lien, and the term does not embrace a judicial lien securing an underlying tax obligation.
Stein v. Cadle Co. (05/10/01 – No. 99-56751) Under the Federal Priority Statute, 31 USC 3713 gives the federal government priority over other judgment creditors notwithstanding the Federal Tax Lien Act.
PAYMENTS TO IRS and FRAUDULENT CONVEYANCE/TRANSFER
Does the 2 year Fraudulent Conveyance/Transfer Apply to payments made to the IRS? Zazzali v. U.S. (In re DBSI Inc.), 16-35597 and 16-35598 (9th Cir. Aug. 31, 2017) Issue: can the government (IRS), arguing sovereign immunity, prevent the fraudulent avoidance of the tax payments? Conclusion: No.
Operated as a Ponzi scheme, the debtor was a so-called subchapter S corporation that paid the IRS about $17 million on account of taxes owing by its shareholders. Under a confirmed chapter 11 plan, the trustee for a creditors’ trust sued the IRS to recover the payments. We must decide whether a bankruptcy trustee can, through an adversary proceeding, avoid a debtor’s federal tax payment, or whether the Internal Revenue Service’s (“IRS” or “government”) sovereign immunity prevents such relief. To resolve this question, we must consider the interplay between two Bankruptcy Code statutes: 11 U.S.C. §§ 106(a)(1) (“Section 106(a)(1)”) and 544(b)(1) (“Section 544(b)(1)”). In Section 106(a)(1), Congress unambiguously abrogated sovereign immunity “with respect to” Section 544(b)(1). Under Section 544(b)(1), a trustee may avoid fraudulent transfers when the trustee can demonstrate that an actual unsecured creditor could avoid the same transfer under “applicable law” outside of bankruptcy. This is known as the “actual creditor” or “triggering creditor” requirement as it requires the existence of an actual creditor in whose shoes a trustee can stand.
The bankruptcy Trustee invoked Idaho’s Uniform Fraudulent Transfer Act (“UFTA”), Idaho Code Ann. §§ 55–901 1 et seq., as the “applicable law” to bring a Section 544(b)(1) adversary action to avoid $17 million in tax payments that the debtor, DBSI, Inc., fraudulently transferred to the IRS. An unsecured creditor who seeks to avoid such tax payments under Idaho law outside of bankruptcy would be precluded from doing so because of the government’s sovereign immunity. The question, then, is whether, in the bankruptcy context, Congress’s abrogation of sovereign immunity with respect to Section 544(b)(1) extends to the underlying state cause of action, or whether a trustee must also establish that Congress has waived sovereign immunity with respect to Idaho’s UFTA.
Both the bankruptcy court and the district court ruled that Section 106(a)(1)’s abrogation of sovereign immunity “with respect to” Section 544(b)(1) extends to the derivative “applicable law”—here, Idaho’s UFTA. In other words, an additional waiver of sovereign immunity was not necessary. As a result, the government could not rely on sovereign immunity to prevent the avoidance of the tax payments at issue. We agree, and affirm.
IRS and CONTEMPT OF AUTOMATIC STAY or DISCHARGE VIOLATION
The following is from Morgan King:
DEBTOR FAILED TO EXHAUST ADMINISTRATIVE REMEDIES
In re Thal & Slattery (Bankr. S.D. Fla., 2018)
From the opinion:
“These cases present the latest entry in an ongoing debate – if a former debtor seeks damages or attorney fees and costs from the Internal Revenue Service (the ”
IRS”) for violations of the discharge injunction, is the former debtor first required to exhaust administrative remedies before seeking recourse from the bankruptcy court? Having carefully considered the applicable statutes and case law, I have determined that the majority view is correct –
” . . . in order for a former debtor to seek recovery of damages, fees, or costs from the IRS in connection with a discharge injunction violation, the former debtor must first comply with the requirements of 26 U.S.C. §§7430 and 74332.”
In this case the IRS attempted to collect discharged taxes following the final chapter 13 discharge. The debtor filed a motion seeking contempt, refund of the money seized, punitive damages, and attorneys’ fees and costs.
The court held that the debtor must first exhaust IRS administrative remedies before seeking attorney’s fees and costs, punitive damages, and general damages.
The court cited 26 U.S.C. § 7433(b), § 7433(d)(1), § 7433(e),
IRS HELD FOR VIOLATION OF FINAL DISCHARGE
Internal Revenue Service v. Murphy, No. 17-1601 (1st Cir. 2018)
An employee of the Internal Revenue Service (IRS) “willfully violates” an order from the bankruptcy court discharging the debts of a debtor-taxpayer, as that term is used in 26 U.S.C. 7433(e), when the employee knows of the discharge order and takes an intentional action that violates the order. William Murphy filed a Chapter 7 petition in the bankruptcy court seeking primarily to discharge his tax obligations.
The bankruptcy court granted Murphy a discharge. Murphy later successfully filed an adversarial proceeding seeking a declaration that his relevant tax obligations had been discharged. Murphy then filed a complaint against the IRS alleging that one of its employees willfully violated the bankruptcy court’s discharge order by issuing levies against the insurance companies with which he did business in an attempt to collect on his discharged tax obligations. The bankruptcy court granted summary judgment for Murphy.
The parties eventually entered into a settlement agreement whereby the IRS accepted the summary judgment ruling. After final judgment was entered against the IRS, the IRS appealed. The First Circuit affirmed, holding that the IRS’s reasonable and good faith belief that the discharge injunction did not apply to its collection efforts was not relevant to determining whether it “willfully violate[d]” the discharge order.
CHAPTER 7 LIABILITY FOR NON-DISCHARGED TAXES
1. Collection Allowed After The Discharge Of Other Debts
Unfortunately, in a Chapter 7 bankruptcy, the tax agencies may resume collection activity from you on non-discharged taxes as soon as you receive your discharge of other debts, which is normally 4-6 months after you file chapter 7 bankruptcy. The tax agencies may collect from you even though the Chapter 7 trustee has or will have enough money in your bankruptcy case to pay some or all of the non-discharged taxes. The tax agencies do not need to wait to get paid by the trustee and often refuse to wait.
2. No Priority Subrogation If The Taxpayer Pays Taxes That the Trustee Would Have Paid
If the tax agencies collect from you on non-discharged taxes after you file bankruptcy and before the chapter 7 trustee makes payments to creditors, you do not take over (subrogation/assignment) the tax agencies’ priority claims in the bankruptcy. 11 USC 507(d). In other words, you do not step into the shoes of the tax agency. You do not get a priority distribution by the bankruptcy trustee for priority taxes you paid. At best you might have a non-priority claim for reimbursement, which is unlikely to be paid much, if anything. However, one court has ruled that the debtor does not get any subrogation at all because 11 USC 509(c) provides for subrogation for a person who “is liable with the debtor” on a claim and pays the claim. A debtor cannot be liable with himself. In re Allen, Bkrtcy. D. Mass. December 11, 2006, No. 04-1266-JNF. That is why it is usually to your benefit to try to liquidate your non-exempt property (and in some cases your exempt property) before filing bankruptcy and pay as much of the non-dischargeable taxes yourself before filing bankruptcy. Always consult with a bankruptcy attorney first.
3. Interest and Penalties
To make matters worse, interest continue to accrue on non-discharged taxes after a Chapter 7 bankruptcy is filed. Normally penalties are not discharged if the taxes are not discharged. However, penalties are discharged even though the taxes are not discharged if the event which gave rise to the penalty, such as failure to file a return and failure to pay taxes, occurred more than three years before the bankruptcy was filed. 11 USC §523(a)(7)(B). If the Chapter 7 trustee has money to distribute, the Chapter 7 trustee will only pay the principal and interest owed on priority unsecured taxes the day the bankruptcy was filed. So even if the trustee pays on priority unsecured taxes, he will not pay any penalties, regardless of whether the penalties accrued before or after you file bankruptcy, and he will not pay any interest that accrues after you file bankruptcy. (There may be a rare exception if the trustee has sufficient money to pay all creditors in full with interest.) You remain liable for any unpaid amounts, whether interest, penalties or principal. In addition, the Chapter 7 trustee first pays the trustee’s fees and administrative expenses, which leaves less to pay the taxes. Again, it is usually to your benefit to try to liquidate your non-exempt property (and in some cases your exempt property because many exemptions are not effective against tax agencies) before filing chapter 7 and pay as much of the non-dischargeable taxes yourself before filing bankruptcy. It is usually not in your best interest to assume the trustee will pay your non-discharged taxes.
PAYING TAXES AS PRIORITY IN CHAPTER 13 - INCLUDES RULES
Filing old tax returns less than 2 years prior to filing BK:
Category 2, Unsecured Not Priority, Not Discharged And Not Paid In Full Through The Plan
Taxes are not discharged and are not paid as priority taxes through the plan if BOTH of these apply:
1. The tax return, with any extensions, was due more than three years before filing bankruptcy,
and
2. The taxes were not assessed before the bankruptcy was filed but were assessable under applicable law after the bankruptcy was filed, and ONE OR MORE of the following apply to this paragraph 2:
(1) The return was not filed, or
(2) The return was filed less than 2 years before the bankruptcy was filed, or
(3) You attempted to evade taxes, or
(4) You filed a fraudulent return.
Such taxes probably will be paid only a few cents on the dollar in the Chapter 13 plan, the same as credit cards, but will not be discharged. This means you will continue to owe any unpaid amount after the completion of the Chapter 13 plan.
Note: if you get taxes assessed prior to filing then they should be treated as priority. BUT IT IS VERY IMPORTANT TO GET ADVICE FROM A QUALIFIED BANKRUPTCY AND TAX ATTORNEY.
NOTES: see 507(a)(8)(A)(i). Only taxes that are less than 3 years old are priority debt.
Alternatively, 507(a)(8)(A)(ii) also gives priority to any taxes assessed within 240 days before the filing. If he just filed the returns, wouldn’t there be something on his transcripts that shows some kind of IRS assessment within the last 240 days? Look at tax account transcripts.
CHAPTER 13 - TOLLING and 3 YEAR RULE
Kolve v. Internal Revenue Service Dept, Sept. 22 2011 (Bkrtcy.W.D.Wisconsin) The Court held that the Debtors’ prior chapter 13 did not toll IRS collection of the taxes – hence the 3-year rule was satisfied and the taxes were discharged. The debtors in this case filed a prior chapter 13 prior to the date several previous tax liabilities actually came due. That case was later dismissed prior to plan completion.
The plan contained the boilerplate provision found at 11 U.S.C. § 1327(b) vesting all property into the hands of the debtors. Subsequently, more than 3 years following the filing due date of the previous tax liabilities, the debtors filed a new chapter 13. The IRS argued that the prior chapter 13 had tolled the running of the 3-year period, thus rendering the liabilities non-dischargeable in the new case.
The case raised several questions.
1. If a tax is not due at the time the bankruptcy is filed and the automatic stay arises, can it be said that the filing of the bankruptcy tolled the 3-year period, given that the stay did not prohibit collection (since there were no taxes due for which collection could be “prohibited”)?
2. Did the prior chapter 13 toll the 3-year period at all, since the confirmation of the plan re-vested the assets (or a substantial portion of them) into the hands of the debtors (thus rendering them not protected against post-petition tax collection).
In other words, where the IRS was prohibited from collecting only a portion of the debtors’ assets (the post-petition income dedicated to the plan), did the case toll the running of the 3-year period? The court said, no.
The court made several rulings, including, that it is not the bankruptcy per se that can be said to prohibit collection, but rather the automatic stay; that it cannot be said that the IRS was prohibited from collecting a tax that had not yet come due; and that since the Plan did not prohibit all tax collection, it cannot be said that the time period was tolled for discharge purposes.
Excerpted from the opinion:
” … after confirmation the debtor receives control of at least some of the assets which had formerly been property of the estate. What does this mean for the equitable tolling (or suspension) of the look back period in this case? After the debtors’ extension requests expired, the 2005 and 2006 income taxes were due October 15, 2006, and October 15, 2007, respectively.
“The debtors’ chapter 13 plan was confirmed in February of 2006. The plan does not appear to have contained any provision which would prohibit the collection of these tax claims. The confirmation returned control over all pre-confirmation property of the estate to the debtors, and at least some post-confirmation property as well.
“This re-vesting meant that the automatic stay — which had previously acted to prevent post-petition creditors from pursuing property of the estate — was no longer “in effect” as to those assets. The stay never prohibited the IRS from pursuing a collection action against the debtors, and at the time these tax claims came due, the “stay of proceedings” was in effect (at most) as to only a portion of the debtors’ post-confirmation assets.
“Which circles back to the crucial question. Was the IRS actually prohibited from collecting these tax claims at any point after the October 2006 due date of the 2005 taxes or the October 2007 due date of the 2006 taxes?
“This Court agrees with [prior case] Jones that the answer to this question is no. The tolling provision of § 507(a)(8) only applies to situations in which the taxing authority was actually affected by the automatic stay in the prior case.
“The phrase “stay of proceedings” in the statute relates to “an otherwise applicable time period” as to collection of tax claims. The congressional purpose in enacting the statute was to codify the decision in Young, which was premised upon the idea that tolling was justified because the IRS had been “disabled from protecting its claim” during the pendency of the prior case. … As the IRS did not in fact suffer under any such disability, and could instead have acted to collect the post-confirmation taxes at any time after they came due from those assets which had re-vested in the debtor upon confirmation under § 1327, there is no basis for tolling, whether pursuant to the statute or in equity.”
Loving v. United States (In re Loving) (Bankr.S.D.Ala., 2011) (8/29/11) Debtor files case before 3-year rule satisfied. On April 8, 2011 a consumer bankruptcy attorney filed a bankruptcy case to discharge income taxes for tax year 2007. Unfortunately, the 3-year rule would not be satisfied until 7 days later (April 15 2011). The IRS objected to discharge, citing the 3-year rule that the due date for filing the return must be over 3 years prior to filing the bankruptcy. 11 U.S.C. § 507(a)(8)(A)(i).
The Court observed: “In [her] response, Plaintiff asserted that she filed her tax return on February 19, 2008, a date that is more than three years prior to her bankruptcy filing. Also, she alleged that her 2007 taxes were assessed more than three years prior to her bankruptcy filing.”
In granting the IRS motion for summary judgment in the case, the court noted that the rule regarding when a tax is assessed had no bearing on the key issue here; to be dischargeable the tax must have been assessed more than 240 days prior to bankruptcy, which occurred in this case. 11 U.S.C. § 507(a)(8)(A)(ii). The court also observed that the date the bankruptcy was filed was within 3 years from the most recent due date for filing the return.
CHAPTER 13 and POST-PETITION INTEREST ON DELINQUENT TAXES
PRIORITY DEBTS: A chapter 13 plan must provide for payment in full of all priority claims that arose before the filing of your bankruptcy, such as taxes, child support or alimony. Even once the chapter 13 is completed it is probable that you will still owe interest for priority and non-dischargeable taxes, which is not be paid through the plan. Only a 100% payment plan may provide for payment of interest, meaning that the plan pays all of your debts. Basically, once the bankruptcy is completed you will still owe interest on the taxes that were paid in your plan.
Personal liability for accrued post-petition interest on non-dischargeable taxes the chapter 13 plan. ¶ 3.13(a)(3), ¶ 3.13(a)(6).
The case of In re Widick, No. 10-40187 (Bankr. D. Neb 2019) provides a reminder that bankruptcy does not discharge all debts even when the debtor pays all of the tax for the year through the bankruptcy plan. Mr. and Mrs. Widick completed a chapter 13 plan. To obtain the plan and to complete the plan, they paid all of the income taxes for two years and all of the trust fund recovery penalties for two quarters. The debtors did not understand that paying all of the taxes does not keep the IRS from coming back after the bankruptcy case to collect the interest. They brought this action to hold the IRS in contempt for violating the discharge injunction due to its efforts to collect from them after the bankruptcy court granted the discharge in this case. With relative ease, the bankruptcy court delivered to them the sad news that the IRS could continue to collect from them after the discharge and the authority for the IRS actions went back for three decades in the controlling circuit case of Hanna v. United States (In re Hanna), 872 F.3d 829 (8th Cir. 1989)
In re Thaxton (Bankr. S.D. W. Va., 2017) May 30 2017 Held, Debtor’s postpetition interest on IRS taxes not discharged. The debtor filed a chapter 13 case with a plan that provided for full payment of unsecured priority trust-fund taxes. The principal of the liability was paid in full in the debtor’s chapter 13.
Following the final discharge, the IRS sent the debtor a notice of their intention to levy for the post-petition interest that had accrued, but not paid, in the Plan.
The court held that, unlike a secured claim, the plan could not provide for payment of postpetition interest on a non-dischargeable tax. The Bankruptcy Code § 1322(a)(10) provides that the plan may provide for payment of postpetition interest on unsecured nondischargeable taxes (e.g., trust-fund taxes) but only if the plan is a 100% plan.
“Section 502(b)(2), however, does not mean that interest ceases to accrue or that a debtor is exonerated therefrom. Rather, post-petition interest accrues outside the Chapter 13 plan and the debtor remains personally liable therefor post discharge.”
The circumstances here indicate the obligation owed by the Thaxtons is in the nature of post-petition, or “unmatured” interest inasmuch as it accrued on their obligation to the Service during the pendency of the plan. Title 11 U.S.C. § 502 provides pertinently as follows:
(a) A claim or interest, proof of which is filed under [§] 501 of this title, is deemed allowed . . . (b) Except as provided in subsections (e)(2), (f), (g), (h) and (i) of this section, if such objection to a claim is made, the court, after notice and hearing, shall determine the amount of such claim in lawful currency of the United States as of the date of the filing of the petition, and shall allow such claim in such amount, except to the extent that — . . . . (2) Such claim is for unmatured interest[.]
The Thaxton court appears to acknowledge that, in some cases, postpetition interest on nondischargeable taxes would be discharged, but only if the plan so provided, and the IRS had been given adequate notice of
that plan. (Source: Morgan King)
CHAPTER 13 - UNSECURED PRIORITY, PAID THROUGH THE PLAN
In a Chapter 13 you may be able to get a tax lien released by paying the IRS, through the plan, the value of the property that the lien is against. This may be far less than the amount of the lien. There are three categories oi unsecured individual income tax in Chapter 13.
1. Category 1, Unsecured Priority, Paid Through The Plan
In a Chapter 13 you cannot discharge unsecured priority taxes. The plan must propose to pay priority taxes through a plan.. The principal and interest owing on priority taxes as of the day of filing the bankruptcy petition are normally paid in full through the plan. The plan does not pay post-petition interest, pre-petition penalties or post-petition penalties and, unlike chapter 7, the debtor is discharged from any liability on these upon completion of the plan. Pursuant to 11 use §1322(a) (2), 507 (a) (8), and §523 (a)(1)(B) & (C), priority taxes are taxes which meet ONE OR MORE of these 3 requirements:
(1) You filed the return more than 2 years before the bankruptcy was filed,
and
(2) You did not attempt to evade taxes,
and
(3) You did not file a fraudulent return.
From materials prepared by Dan Furlong, Arizona attorney 2013
CHAPTER 13: UNSECURED, NON-PRIORITY, NOT DISCHARGED, NOT PAID IN PLAN
Taxes are not discharged and are not paid as priority taxes through the plan if BOTH of these apply:
1. The tax return, with any extensions, was due more than three years before filing bankruptcy,
and
2. The taxes were not assessed before the bankruptcy was filed but were assessable under applicable law after the bankruptcy was filed, and ONE OR MORE of the following apply to this paragraph 2:
(1) The return was not filed, or
(2) The return was filed less than 2 years before the bankruptcy was filed, or
(3) The taxpayor attempted to evade taxes, or
(4) The taxpayor filed a fraudulent return.
Such taxes probably will be paid only a few cents on the dollar in the Chapter 13 plan, the same as credit cards, but will not be discharged. This means you will continue to owe any unpaid amount after the completion of the Chapter 13 plan.
From Dan Furlong’s materials from the Bankruptcy 201 program
TRUST FUND TAXES & CHAPTER 13
The “Trust Fund Penalty” is not dischargeable in chapter 13 cases because case law has held that it is “a tax required to be collected or withheld and for which the debtor is liable in whatever capacity” under 507(a)(8)(C). It is non-dischargeable in chapter 13 pursuant to 1328(a)(2), which makes a specific reference to 507(a)(8)(C).
LAW REQUIRING TURNOVER OF TAX REFUNDS
Section 521(e)(2)(A)(i) requires a debtor to turn over a tax return to the trustee “for the most recent tax year ending immediately before the commencement of the case.”
CAN TAX AGENCY SEIZE REFUNDS AS A SETOFF FOR PRIOR TAXES?
A tax agency may seize a refund for a tax year that ended before you filed bankruptcy and apply it to a tax owing for a tax year that ended before you filed bankruptcy. This is an exception to the automatic stay. 11 USC §362 (b) (26). Example: You file bankruptcy on January 15, 2008 before you file your tax return for tax year 2007. You owe taxes for tax year 2001 which will be discharged in your bankruptcy because they meet discharge requirements. If you are entitled to a refund for the 2007 tax year, then the tax agency may, without requesting permission from the Bankruptcy Court, seize the refund as a setoff and apply it to the 2001 taxes.
LATE FILED or UNFILED TAX RETURNS or SUBSTITUTE FOR RETURN
In re Martin, 543 B.R. 479 (BAP 9th Cir. 2015) BAP rejected the government’s argument that taxes can never be discharged if the debtor files a return after assessment by the IRS.
Smith v. I.R.S. (In re Smith), 828 F.3d 1094 (9th Cir. July 13, 2016) Bankruptcy The panel affirmed the district court’s order reversing the bankruptcy court and entering summary judgment in favor of the IRS in a debtor’s adversary proceeding seeking a determination that his federal income tax liabilities were dischargeable in bankruptcy.
NOTES: A Substitute for Return is not a return for purposes of the two year rule. The most that the Debtor can discharge is the difference between the amount on the filed amended return and the amount owed for the Substitute Return. Plus the amended return is would need to meet the two year rule.
HYPO: Potential client has many years of old taxes (2003-2009) in which the returns were all filed in 2016. 2-year rule met, obviously 3-year rule met, 240-day rule met, no fraud, taxes all assessed in 2016 a couple months after returns were filed.
ONE POSSIBLE 9TH CIRCUIT BAP ANSWER: the Ninth Circuit follows the Beard rule rather than the McCoy rule, so it is possible to have late filed returns discharged. However, there are two other issues with late filed returns. With returns as old as your Clients, there may have been substitute for returns filed. You NEED to get transcripts of each year to make a determination on this issue. Here is a blurb on that topic: U.S. v. Martin (In re Martin) 542 B.R. 479 (BAP 9th Cir. 2015). In Martin, the BAP also presaged the decision by the Ninth Circuit itself in July 2016 rejecting the one-day-late rule by adhering to decisions by the Fourth, Sixth, Seventh, Eighth and Eleventh Circuits employing the four-part test resulting from a 1984 Tax Court decision known as Beard. The Ninth Circuit’s decision rejected the one-day-late rule is Smith v. I.R.S. (In re Smith), 828 F.3d 1094 (9th Cir. July 13, 2016).
The second issue is that the IRS could take the position that the failure to file is “fraud”. I do not know of a written opinion by an Arizona Judge, but here are copies of IRS filings in Arizona cases.
Any amount for ‘substitute for return’ is nondischargeable. If when Debtors filed returns there was more owed, the additional owed would be dischargeable.
TAXES INCURRED BY THE ESTATE
Hall v. United States, No. 10-875 Supreme Court affirmed the Ninth Circuit, decided On May 14, 2012, holding that a federal income tax liability resulting from the post-petition sale of an individual debtor’s farm during the pendency of a Chapter 12 bankruptcy is not “incurred by the estate” within the meaning of 11 U.S.C. § 503(b)(B)(i) and therefore is not dischargeable in the bankruptcy. This case turned on whether the tax was “incurred by the estate.”
OFFER IN COMPROMISE "OIC"
An offer in compromise “OIC” tolls the 240 day period of §507(a)(8)(A)(ii) for the time the OIC overlaps the 240 day assessment period plus 30 days §507(a)(8)(A)(ii)(l). See if your client signed a IRS form 656 for voluntary tolling as well.
An offer in compromise only tolls the 240 day rule. The 240 day rule relates to bankruptcy filings within 240 days of an assessment. So an offer made more than 240 days after an assessment does not toll anything. (Note – I don’t believe an installment payment is the same as an OIC. This is up to you to confirm.)
United States v. Brabant-Scribner (8th Circuit 2018) Offer of compromise is not a reasonable alternative to seizure under 26 C.F.R. sec. 301.6334-1(d)(1), which requires an alternative for collection, not an alternative to collection.
The Eighth Circuit affirmed the district court’s grant of the government’s petition for permission to levy taxpayer’s home and to apply the proceeds toward her debt. The court rejected taxpayer’s claim that the government must respond to her offer to compromise the debt before the court may levy on her principal residence.
The relevant language is ‘a reasonable alternative for collection of the taxpayer’s debt.'” The word ‘for’ is key. An alternative for collection refers to a different source from which to collect the debt…. The IRS might have other assets the IRS can levy on instead of her home.
See United States Codes
“(k) No levy while certain offers pending or installment agreement pending or in effect
(1) Offer-in-compromise pending. No levy may be made under subsection (a) on the property or rights to property of any person with respect to any unpaid tax-
(A) during the period that an offer-in-compromise by such person under section 7122 of such unpaid tax is pending with the Secretary; and
(B) if such offer is rejected by the Secretary, during the 30 days thereafter (and, if an appeal of such rejection is filed within such 30 days, during the period that such appeal is pending).
SPLITTING A TAX YEAR IN CHAPTERS 7 and 11
article by Dan Furlong, Arizona bankruptcy attorney.
The general rule is that the chapter 7 trustee cannot pay taxes that become due for the tax year in which the bankruptcy was filed. For example, if you file chapter 7 bankruptcy on July 1 of a year (one half through the tax year) and the following April it is determined that you owe income taxes for that year, the trustee will not pay any of those taxes, not even one half, unless you split the tax year as explained in the next paragraph. There is language in the bankruptcy code, 11 USC §507(a)(8)(A)(iii), that seems to say the trustee can pay such taxes. However, most courts, including In re Allen, Bkrtcy. D. Mass. December 11, 2006, No. 04-1266-JNF have ruled that the trustee cannot pay such taxes unless the debtor elected to split the tax year.
The IRS code, 26 USC §1398(d)(2)(A), allows a Chapter 7 or Chapter 11 debtor to split a tax year into two short tax years. One short tax year ends the day before the bankruptcy is filed. The other short tax year starts the day the bankruptcy is filed. If such an election is made by the debtor, then the tax liability for the first short tax year may be paid by the trustee as a priority claim.
The election by the debtor to split the tax year must be made on or before the due date for filing the return for the tax year in which the bankruptcy was filed. The election is irrevocable.
However, the election does not apply if the bankruptcy is dismissed. The election may not be made if the debtor has no nonexempt assets. Daniel F. Furlong
SUMMARY: Most federal income taxes in Chapter 7 are dischargeable only if the debtor meets all of the following conditions:
In other words, there are a number of subtle requirements that must be met before you can discharge a tax debt in bankruptcy. The best way to make sure you fulfill the requirements is to speak to a local attorney.
DO YOU ADD 90 DAYS OR 180 DAYS TO CDP TOLLING PERIOD?
1/12/12 – IRS says 90, but won’t put it in writing! As we know, in order to discharge a personal income tax liability in bankruptcy, five rules must be satisfied. One of these rules is, the bankruptcy must have been filed at least more than 3 years from the most recent due date for filing the return (typically, from April 15, or October 15). The 3-year period is extended for certain “tolling” events that may, or may not have occurred in the history of the liability.
For example, if, during the running of the 3-year period, the debtor filed either a previous bankruptcy, or a request for a collection due process hearing (“CDP”), the clock stops on the running of the 3-year period, for a period of time as provided in the Bankruptcy Code. But the language of the Bankruptcy Code appears to be at odds with the rule as actually practiced by the IRS, and therein lies a potential disaster for analysis of dischargeability of taxes.
A strict reading of the Bankruptcy Code, and the Tax Code, on the tolling effect of a CDP clearly results in the conclusion that the tolling period is the period from initial request for a CDP, to the date of final determination of the hearing, plus an additional 180 days.
The problem is that bankruptcy practitioners, and the IRS, assume one need only add 90 days. But if in fact one must add 180 days, it’s inevitable that some attorneys are going to file cases after only 90 days have been added, thus resulting in non-dischargeability, because the 3-year period will not have been satisfied.
TAX COURT DECISIONS
In re Bunyan (01/20/04 – No. 02-56786) (U.S. 9th Circuit Court of Appeals) Pursuant to 11 U.S.C. section 505(a)(2)(A), the bankruptcy court lacked jurisdiction to consider the validity of income tax assessments filed by the IRS in Chapter 13 proceedings. A 1993 circuit court order granting the Commissioner’s motion to dismiss necessarily adjudicated the issue of when the tax court decisions became final.
RETURN TRANSCRIPT vs ACCOUNT TRANSCRIPT
CLICK HERE FOR IRS GUIDE TO TRANSACTION CODES
According to Morgan King’s Law Letter # 35 the problem is a simple misunderstanding about what kind of transcripts apply. Attorneys often simply request the taxpayer’s transcripts, without being more precise about what kind of transcript. So, in most cases, the IRS will provide Transcripts of Return, when what is needed instead are the Account Transcripts. They are totally different.
The Transcript of Return is nothing more than a summary of the information contained on the respective tax return. In contrast, the Account Transcript contains the entire history of that particular year’s tax liabilities from the IRS point of view, such as the amount of taxes and interest owed, whether or not the taxpayer filed a 1040 tax return and if so when it was filed, any extension to file, any substitute for return (SFR), subsequent audits and assessments, whether or not the taxpayer filed a past bankruptcy, offer-in-compromise, or appeal of a proposed assessment in the past, penalties, liens, and other important information for each respective tax year. Any part of that information may determine whether the tax liability is eligible for a bankruptcy discharge.
The IRS is not limited to only 3 years back for account transcripts. The author frequently gets account transcripts going back 8, 10, 12 years. Typically, the information on those transcripts makes it clear that the taxes are, or are not, dischargeable.
ALSO FROM MORGAN KING: A fundamental step in looking at a possible IRS tax-discharge bankruptcy is obtaining the IRS Account Transcript for each year for which taxes are owed. In a good many cases where the taxpayer failed to file his or her return on time (i.e., filed it after the due date in April or October), the transcript will answer three questions that must be satisfied to discharge the taxes; 1) the most recent date the tax return was due to be filed; 2) the date the client actually filed his/her tax return; and 3) the date the tax was assessed.
There are some issues that bear on the due date and the assessment date. But it’s the 2-year rule – the date the client actually filed the return – that presents a greater set of issues that must be addressed.
In a nutshell, the 2-year rule is, the taxpayer must have filed his or her IRS Form 1040 at least more than 2 years before the bankruptcy is filed (plus more time if there is a “tolling event,” plus 90 days).
1) The “Tax Per Return” on the transcript shows zero
A zero is a clue that the taxpayer did not file a tax return; had there been a $$ dollar amount shown with the “Tax Per Return,” the figures almost certainly came from the taxpayer’s filed 1040 tax return; hence, the taxpayer did in fact file a return. But if there is no dollar amount shown with “Tax per return,” it is more likely that the return, if any, was a substitute for return (“SFR”) filed by the IRS, which is always blank (hence, sometimes called a “dummy return”).
Note, the date shown at “Return Due Date or Return Received Date – Whichever is Later,” is the actual date a return was filed for either the client’s 1040, or an IRS SFR. That date is the actual date the return or SFR was filed, not the date shown with Code 150. The phrase “Return filed and tax assessed” that typically appears with code 150 is misleading; it is not the rate the return was filed, and represents an assessment only if a $$ dollar amount appears with the code 150.
2) The transcript shows a code “460”
Code 460 is an extension of the due date to October. The three-year period starts with the most recent due date (not the most recent actual filing date).
3) Code 420 but no 421
A code 420 on the transcript, with no follow-up code 421. The start of an audit is indicated by code 420, and 421 indicates the conclusion of the audit. If there is a 420 and not also a code 421, it suggests that the audit is still going on. The point is that the audit may result in additional tax assessments. If the bankruptcy is filed before the audit is over and before a tax assessment occurs, the additional taxes will not be discharged until the assessment is final, plus 240 days. This could be called a sleeping assessment. Or, better yet, an assessment ambush. Don’t be blind-sided by a sleeping audit assessment.
4) Code 421
This is the end of the audit and may suggest sleeping assessment, this time by any state that has an income tax. States that have personal income taxes typically require that the taxpayer report any additional IRS liabilities from an audit to the respective state tax agency, so that the state can add its “piggyback” assessment. If you see 421, better check the state tax agency for the inevitable piggyback assessment (then wait out the time until that assessment is final, plus 90 days.
5) Code 520
The 520 code marks the filing of one of three things: 1) a prior bankruptcy, 2) an IRS Collection Due Process appeal, or 3) tax litigation. If any of these occur during the pendency of the 3-year, 2-year, and 240-day rules, the respective time period is tolled, or suspended, for the period such event halted tax collection, plus an additional 90 days. 11 U.S.C. ????? If the tax is an IRS assessment, a prior bankruptcy stops collection (such as levy or vehicle grab) for the time during which the BK automatic stay prevents collection, plus 90 days.
6) Code 320
suggests a penalty in connection with criminal investigation. If the investigation means a true criminal offense has occurred, it may suggest that the tax failed either the fraudulent return or tax evasion rule, rendering the tax nondischargeable. But note, the elements that must be proved in connection with federal law (i.e., the IRS) may not be the same in connection with bankruptcy law. Hence, a code 320 is not dispositive and calls for further investigation by the BK attorney.
indicates other penalty codes. This indication may be important because the penalties (excluding trust-fund penalty) are dischargeable if the event triggering the penalty happened more than 3 years before bankruptcy filing. Filing within under 3 years renders the penalty nondischarged in the bankruptcy. Penalties are indicated by other transaction codes such as 170, 180, 280, and 310 (for the identification of various transaction codes click on the IRS Guide link below.
typically refers to the return filed by the debtor, but again is not dispositive. In some cases a code 599 means something other than the taxpayer’s tax return.
Entries on the Account Transcript typically do not have blank space between the lines with the codes. A blank space between two items listed on the transcript with code numbers suggests that an entry has been whited out by the IRS. This, in turn, suggests that what was deleted is a code indicating a criminal proceeding.
NOTE FROM MORGAN KING: Your client may insist that he/she filed the tax return, and yet there is no evidence on the transcript corroborating it. However, just because it does not appear on the respective transcript, that alone is not always dispositive; it has been held that the burden is on the IRS to prove no return was filed; held for the debtor, McGrew v. IRS (Bankr.N.D.IA 2016).
SOCIAL SECURITY & TAX LIENS - GARNISHMENT
ISSUE: Potential client in need of CH7 has admitted tax liability with IRS. Prior to considering bankruptcy she was having discussions about an offer in compromise. Tax liability about $15,000 with determination made and IRS levy letter of up to 15% of social security benefits received recently.
ANSWER: §6331(h) provides that a levy upon Social Security is a continuing levy. Courts have held that a pre-petition levy upon Social Security, when accompanied by a prepetition tax lien filing, survives a bankruptcy discharge, because it’s effectively a lien on all future Social Security payments from day one. See, e.g., Roberts v. United States/IRS (In re Roberts), 219 B.R. 573 (Bankr. D. Ore. 1997) (a preference and lien case). Note – determine if your client has a lien filed as well as the Social Security levy.
If client receives a discharge, the IRS will probably stop its levy on post-petition social security benefits. See Lee v. Schweiker, 739 F. 2d 870 (3rd Cir. 1984), and Matter of Neavear, 674 F. 2d 1201 (7th Cir. 1982), where the Social Security Administration was not allowed to setoff a prepetition debt against post-petition benefits, most likely the IRS will not fare any better (but note Schweiker and Neavear were both setoff cases involving Social Security overpayments – no IRS or Internal Revenue Code involvement). Also see 26 USC §6331 et seq. vs. 42 USC §407 et seq.
INNOCENT SPOUSE ISSUES - NOT BANKRUPTCY RELATED
TAX COURT GRANTS INNOCENT SPOUSE STATUS
Contreras v. Comm’r IRS T.C. Memo 2019-12
The tax court over-ruled the IRS denial of relief to the spouse, and on the basis of the equitable factors under 26 U.S.C. § 6015(f) (which, technically, is not “innocent spouse” per se, which has a separate standing for relief) held the spouse was not liable for the taxes.
If the taxpayer is not entitled to “innocent spouse” relief under 26 U.S.C. § 6015(b) or (c), he or she may qualify for “equitable relief” under § 6015(f).
The Code prescribes several conditions for equitable relief to be applied, one of which is “abuse,” i.e., the requesting spouse was abused the result of which is the applying spouse signed an invalid or erroneous tax return.
“The IRS recognizes that abuse can come in many forms: physical, psychological, sexual, or emotional, and can include efforts to control, isolate, humiliate, and intimidate the requesting spouse,or to undermine the requesting spouse’s ability to reason independently and be able to do what is required under the tax laws.” –
Robin Clark, J.D. Dariene Pulliam, Oct. 31 2014, The Tax Advisor, “Innocent Spouse Relief under Rev. Proc. 2013-34.”
In Conteras, the IRS rejected the taxpayer’s request for innocent spouse or equitable relief status.
But the tax Court held the applying spouse was given relief from liability based on § 6015(f). The Contreras opinion provides a concise summary of the forms that “abuse” (or “duress”) may take:
” During the marriage Mr. Contreras abused petitioner. The police were called to the home many times over several years leading up to the divorce and after. Their daughter witnessed Mr. Contreras’ aggressive abusive behavior towards petitioner. He threw items at petitioner, kicked in a bedroom door,damaged property, threw petitioner’s possessions outside the home, and broke mirrors along with other aggressive physical acts. Mr. Contreras was also verbally abusive. On several occasions the abuse was so severe petitioner took their children and left the home to stay with her grandmother. Mr. Contreras was frequently out of town working on construction sites, and when home he was often intoxicated. On one occasion Mr. Contreras was arrested for intoxication after the police were called to the home. Petitioner stated she was afraid he would “come home and beat her”. On October 14, 2010, petitioner obtained a temporary restraining order against Mr. Contreras for two weeks. Petitioner learned that Mr.Contreras was having an affair with yet another woman.”
The court held that abuse includes ” efforts to control, isolate, humiliate, and intimidate the requesting spouse, or to undermine the requesting spouse’s ability to reason independently and be able to do what is required under the tax laws.”
Reprint from Morgan@MorganKing.com
ADOR
10/2019: In lieu of a ‘transcript’ ADOR said to request a “Breakdown Letter” from Collections. An attorney can also do that for his client if the client signs a POA. That is ADOR form 285.
AGAIN – WARNING TO ALL VISITORS: I AM NOT A TAX ATTORNEY, DO NOT RELY ON ANY TAX ADVICE ON THIS SITE. INSTEAD, OBTAIN ADVICE FROM A COMPETENT TAX ATTORNEY WHO UNDERSTANDS BANKRUPTCY LAW. THIS OFFICE RARELY FILES A CLIENTS’ BANKRUPTCY WITH TAX ISSUES WITHOUT FIRST CONSULTING A VERY GOOD TAX ATTORNEY WITH EXPERTISE IN BANKRUPTCY. IT WOULD BE WISE FOR YOU TO DO THE SAME.
Please Note:
The information contained in this web site, article or link may be outdated, incorrect or not applicable; it is your obligation to confirm the accuracy.
It is very important that you obtain legal advice from an attorney experienced in the laws related to your particular situation. Never rely on information obtained from the Internet, your friends or neighbors; it is very rare that their situation is exactly like yours. Seeking good legal advice before you take action will certainly cost you less than it will cost to fix your unintentional errors.
The information in this web site is not intended to constitute legal advice or to create an attorney-client relationship.
by Bob Ciancola, Arizona attorney (reprinted with permission of the author)
The rise in incidents of foreclosure of homeowner mortgages across the nation is but one aspect of this. Repossessions of cars and mobile homes are also common occurrences in the current economic environment. This article explores the income tax consequences to the borrower which may ensue from surrendering property to satisfy a debt. In general there are two tax aspects to consider: (1) recognition of gain or loss on the transaction and (2) recognition of cancellation of indebtedness (COD) income.
Section 1001 of the Internal Revenue Code provides that upon a sale or exchange of property, the amount of gain recognized is the excess of the “amount realized” on the sale over the taxpayer’s adjusted basis in the property, and the amount of loss realized is the excess of the adjusted basis over the amount realized. In tax law, when a transaction occurs it is said to be “realized.” When the transaction affects taxable income by resulting in a taxable gain or deductible loss, it is said to be “recognized.” Whether the gain or loss is recognized depends on the type of property involved.
A person may have several residences but can have only one “principal” residence at a time. In general, in the case of property which has been used as the principal residence of a taxpayer for two of the past five years and has no period of “nonqualified use” gain may be excluded from income up to a maximum of $250,000 for a single taxpayer and $500,000 for a married couple. IRC 121. “Nonqualified use” means any period preceding the time the property was last used as the principal residence of the taxpayer and occurring after January 1, 2009. Any gain allocable to “nonqualified use” will not be eligible for the exclusion. Any gain not excluded is taxable as a capital gain (except for depreciation recapture if the property had been used as rental property and depreciation claimed. Loss on the sale is not deductible and cannot be used to offset capital gains.
Property, whether real or personal, used in a trade or business is accorded special tax treatment. Gains are treated as capital gains (except for depreciation recapture) and losses are treated as ordinary, fully deductible losses. Real estate held for rental is generally not considered used in a trade or business. Gains and losses from such property are capital in nature.
Gains from sale of property held for personal use – as a vacation or second home, a personal car, etc. – is capital gain. Losses are not recognized.
Where property is transferred for underlying indebtedness, the amount realized depends on whether the debt is recourse or nonrecourse to the property owner. If the debt is nonrecourse, the amount realized will include the full amount of the debt. Code section 7701(g) provides that the fair market value of such property shall be treated as being not less than the amount of any nonrecourse indebtedness to which such property is subject. Where the debt is recourse to the property owner, Treas. Regulation § 1.1001-2 provides that the amount realized is the fair market value of the property.
Whether debt is recourse or nonrecourse is generally determined by the terms of the note evidencing the debt. If the note provides that the borrower is not personally liable for repayment and the lender agrees to look only to the collateral, it is nonrecourse. If the borrower is personally liable for repayment it is recourse. In the case of real estate, Arizona has Arizona Anti-Deficiency Flow Chart (2890 downloads) : one dealing with mortgage foreclosures and one dealing with trustee sales under a deed of trust. Under these statutes, the lender is generally barred from suing the borrower on a deficiency where the foreclosed or sold property fails to repay the lender for the full amount of the note. These statutes only apply to property used for residential purposes, of two and one-half acres or less, upon which is a one or two family structure and in the case of the mortgage foreclosure statute, only to acquisition indebtedness. Where the lender is barred from suing under these statutes, the debt would presumably be treated as nonrecourse for tax purposes, despite its terms, but surprisingly there is no direct authority for this in the Internal Revenue Code or regulations. Note that the anti-deficiency statutes do not apply to business property, apartment complexes, or any situation other than a foreclosure or trustee sale. Also they do not apply to mobile homes or other personal property. In addition, if funds are borrowed against a home and used for non-home purposes, the lender under a deed of trust may elect to forego the trustee sale and foreclose judicially, which would make this debt recourse debt.
Where the gain or loss is recognized under the above rules it is calculated by subtracting the property’s tax basis (generally, its cost, including improvements) from the “amount realized.” In the case of foreclosures or similar transactions where the lender takes back the property, in cases where the debt is recourse debt, the amount realized is the lower of (1) the amount of debt on the property less any amount for which the taxpayer remains personally liable, or (2) the fair market value of the property. When property is sold at a foreclosure sale, it is normally auctioned to the highest bidder. When that bidder turns out to be the debt holder, any amount bid at or below the outstanding loan amount will not require an exchange of cash. Therefore, to determine the amount realized, the usual practice is to look at the amount bid. That bid is, however, not necessarily the same as the fair market value. In a 1998 U.S. Tax Court case, the Court found that the bid amount was not indicative of the value of the property where the debt holder was the only bidder at the foreclosure sale and that it was not an arms-length transaction. It noted that the lender might have reasons for submitting a bid in excess of the property’s value, including not wanting to recognize a loss on its books. Because the IRS could not rebut the appraisal submitted by the taxpayer, the Court held that the appraised value, not the amount bid at the auction, was the fair market value and therefore the amount realized.
The Internal Revenue Code specifically provides that gross income subject to tax includes COD income. As a result, when a debt is forgiven by the lender in whole or in part, the forgiveness is generally subject to income tax. In the case of a mortgage foreclosure, or more typically in Arizona, a trustee’s sale under a deed of trust, the amount realized by the lender on the property may be less than the amount of the underlying debt. At this point, there are three aspects to consider: whether a debt has been forgiven, the amount of COD income required to be recognized, and whether the debtor qualifies for an exception to the COD recognition rule.
Where a debt is recourse debt, the amount forgiven by the lender is generally taxable to the borrower, unless an exception applies. If the debt is nonrecourse, no COD income is recognized where the underlying debt is extinguished. In the case of a loan modification, however, if the lender agrees to reduce the amount of the debt, the debt is not extinguished and the taxpayer will recognize COD income even where the debt is nonrecourse.
There are several exceptions to the COD income recognition rule. These are (1) where the loan is forgiven through bankruptcy; (2) where the taxpayer is insolvent; (3) where the loan is “qualified farm indebtedness;” (4) where the debt is “qualified real property business indebtedness”; or (5) where the debt is “qualified principal residence indebtedness.” The last exception was added by the Housing and Economic Recovery Act to cover events occurring before January 1, 2010 and extended three additional years by the Emergency Economic Stabilization Act of 2008. It applies only to a taxpayer’s principal residence and only to debt used in the acquisition of the property. It is limited to $2 million. In the case of a homeowner or other taxpayers, exceptions (1) and (2) may apply; in the case of business property, any of the above may apply. If an exception applies to business property, an offsetting reduction in “tax attributes” – such as net operating loss or tax basis of property – is required. In addition to the above, if the forgiveness of debt is of a tax-deductible item – such as interest on a personal residence – no COD income is recognized. Because these rules are complex, any taxpayer receiving a 1099 reporting COD income should see a qualified tax professional.
Joe, who is unmarried, purchases a house in Maricopa County which he uses as his principal residence. Joe paid $600,000 for the house and financed it with a deed of trust for $540,000 and $60,000 in cash. He later takes out a line of credit secured by a second deed of trust on which he borrows $80,000 to invest in a business. The line of credit, by its terms, is nonrecourse to Joe. Joe stops making payments on both loans in the fifth year and the house is sold in a Trustee’s sale for $400,000. Joe is treated as having sold the house for $620,000, because the debt is all considered nonrecourse. He is treated as having realized a gain of $20,000 ($620,000 debt less $600,000 basis). Joe is neither insolvent nor bankrupt. The gain is not covered by the qualified principal residence indebtedness exclusion because the extra $80,000 Joe borrowed was not used to buy the house, but the gain is still excludable from taxable income because it is less than $250,000 and covered by the principal residence exclusion. There is no COD income because the debt is nonrecourse.
The facts are the same except the property is held for rental and Joe never lives in it. He claimed $10,000 of depreciation on the building. He is treated as having realized a $30,000 capital gain ($620,000 nonrecourse debt less basis of $590,000). Joe is neither insolvent nor bankrupt so the gain is taxable. There is still no COD income.
The facts are the same except the property is a commercial store and the holder of the $80,000 second deed of trust writes off the loan but Joe still owes the $140,000 deficiency on the first loan because the debt is recourse. Joe is treated as having sold the store for $400,000, the lower of the debt on the property less the amount for which he remains personally liable ($620,000 – $140,000 = $480,000) or the fair market value of the property ($400,000). Joe has a capital loss of $190,000 ($590,000 – $400,000). Joe also has $80,000 of COD income, which is ordinary income. Since Joe only leases the store it is not qualified real property business indebtedness.
Sue purchases a home for $800,000, which is financed by a first deed of trust securing an ARMS loan of $720,000. When Sue becomes unable to afford the payments following the adjustment, the lender agrees to reduce the principal balance to $670,000. Sue has $50,000 of COD income, regardless of whether the debt is recourse or nonrecourse.
Bob Ciancola is an attorney in Scottsdale practicing in business transactions, tax law and estate planning. He may be reached at 480 991-0803 or by email at bob@ciancolaw.com.
