When you enlist the help of a lawyer in filing for chapter 7 bankruptcy, one of the first questions they're going to ask you is whether or not you owe any back income taxes. How you answer this question could play a big role in the future of your bankruptcy case. Owing income taxes and owing on a substitute for return are two very different things, and if you understand the difference and answer your lawyer accordingly, he or she will be better prepared to help you.
Owing Income Taxes
If you tell your bankruptcy lawyer that you owe income taxes to the IRS, his or her belief is that you filed tax returns for the years that you owe, and you and the IRS are in agreement about the dollar amount of the money you should have paid them for those tax years. Claiming that you owe taxes insinuates that you went through the entire tax filing process but couldn't come up with the money to pay the amount shown on the final line of your tax return.
Failing To File
When you tell your attorney that you failed to file, you're effectively saying that you were not a willing participant in the filing of your tax return. You may have gotten a notice from the IRS informing you that your taxes have been filed on your behalf, but this is not viewed by bankruptcy courts as filing taxes. When the IRS files your taxes for you, it's called a substitute for return, and a substitute for return and an income tax return are not one in the same.
Why Does It Matter?
Under chapter 7 bankruptcy, income taxes that are at least 3 years old, were filed a minimum of 2 years prior to filing for bankruptcy, and were assessed by the IRS at least 240 days before filing bankruptcy can be discharged. If you don't make any contact with the IRS and they file a substitute for return on your behalf, you don't meet the second criteria because you never actually filed your taxes.
You Didn't File -- Is There Any Hope?
If you owe taxes on a substitute for return, there are a couple of circumstances in which your amount owed to the IRS can be lowered or eliminated.
You Agreed To Your Substitute Returns
The IRS will file your substitute for return in 2 phases. First, they'll gather any income information they have on you and use it to fill out the appropriate tax forms. Next, they'll attempt to contact you before actually entering the information into their system. If they successfully make contact with you and you agree that your amount owed is correct and that you are willing to sign your substitute for return and have the information entered into the system, this is known as an agreed substitute for return. As long as you have agreed to your substitute for return and it meets the other criteria for dischargeable income taxes, it will be written off during the bankruptcy process.
You File All Delinquent Tax Returns Right Away
If you haven't filed your taxes and you haven't agreed to and signed a substitute for return, then you will not be able to discharge your income taxes when filing chapter 7 bankruptcy. You can, however, lower the amount you owe by filing all delinquent tax returns right away.
The IRS issues 2 types of fines when you avoid your taxes -- one for not filing, and one for not paying your amount due. In most cases, these fines can be reduced by 75 percent if you willingly take the steps to make good with the IRS. You'll still owe the full amount of money due, but you'll only be responsible for paying for 25 percent of the fines issued for not filing or not paying.
Furthermore, filing now can help reduce your amount due by providing the IRS with a more accurate account of your individual situation. When the IRS files a substitute for return, they allow you the standard deduction and nothing more. They won't count any extra exemptions or deductions that you might have. If you had a few dependents at the time your taxes should have been filed and/or you spent money on things that could have been written off on your taxes, simply providing the IRS with more accurate information about yourself could substantially drop your amount due.
If you tell your lawyer you owe taxes to the IRS, understand that you're implying that you actually filed taxes. If you haven't filed taxes for the years in question but received a notice that a return has been filed on your behalf, state this clearly to your attorney. By having a firm understanding of your involvement (or lack thereof) with the IRS, your lawyer can provide more accurate guidance on how you can eliminate some of your tax burden. You can contact a tax attorney at a firm like Wiesner & Frackowiak, LC.