Q. Can I eliminate my personal taxes through bankruptcy?

A. As long as the returns did not involve "fraud," Federal and state income taxes can be discharged in a Chapter 7 bankruptcy, provided the returns were filed and the taxes assessed more than three years before the bankruptcy petition is filed. There are additional rules for discharging taxes assessed subsequent to filing, as a result of an audit. Taxes due based on returns prepared by the Internal Revenue Service as "substitutes for returns," cannot be discharged. Employment or payroll taxes, including the trust fund recovery penalty, cannot be discharged. You should consult with an attorney whose practice is concentrated in bankruptcy, as well as with a tax professional, if necessary.

Q. What is an Offer in Compromise?

A. An Offer in Compromise is an agreement between the taxpayer and the Internal Revenue Service that resolves the taxpayer's liability for less than full payment. The most frequent basis for acceptance of an Offer is that doubt exists that the taxpayer could ever pay the full amount owed. This determination is based on a Collection Information Statement (Form 433-A), showing the taxpayer's current financial situation, including the value of assets and current income and expenses for purposes of projecting future income over a specified period, which depends on the statute of limitations. Before filing an Offer (Form 656), the taxpayer must have filed all required returns. Returns also must be filed timely, on a fully paid basis, while the Internal Revenue Service considers the Offer and for five (5) years after the Offer is accepted. If a bankruptcy proceeding is pending, the Offer cannot be considered by the Internal Revenue Service until the bankruptcy is terminated. To find out if you qualify, you should consult with a tax professional.

Q. What is a trust fund recovery penalty?

A. When employment or payroll taxes are not paid by the business, the Internal Revenue Service can assess liability against the "responsible officers" of the business for the unpaid trust fund portion of the tax, i.e., the amounts withheld from employees for income tax, social security and Medicare. The penalty cannot be discharged in bankruptcy. If the Internal Revenue Service proposes a trust fund recovery penalty (or the Illinois Department of Revenue issues a Notice of Penalty Liability for sales tax or withheld state income taxes), you should consult a tax professional, as there are ways to minimize or avoid the liability.

Q. I was divorced last year and now the Internal Revenue Service is after me for taxes owed on returns I previously filed with my ex-husband. How do I qualify for "innocent spouse" relief?

A. If you filed a joint return with your ex-spouse, there is an understatement of tax on the return(s) due to erroneous items (items omitted from or incorrectly reported on the joint return), you can show that when you signed the return(s) you did not know or had no reason to know that the understatement of tax existed (or the extent to which the understatement existed) and taking into account all the facts and circumstances, it would be unfair to hold you liable for the understatement of tax, you may be allowed innocent spouse relief. We recommend that you consult with a tax professional before you file Form 8857, Request for Innocent Spouse Relief.

If you have additional questions or require further information, please contact us.