Tax Collections After Bankruptcy Discharge-What To Do

It’s scary, or infuriating, when the IRS continues to try to collect taxes discharged in bankruptcy.

What was the point of filing bankruptcy if the government ignores your discharge?

Yet IRS attempts to collect taxes from people with a bankruptcy discharge form the single largest group of cases in my law office today.

Why the IRS persists

Seldom is the IRS correct that taxes are still due.

Sometimes, the IRS is confused. Other times, they appear to be indifferent to the bankruptcy discharge.

Too often, I suspect that their record keeping system is not up to the job.

But, whatever the excuse, you need to get it sorted out. Let’s look at common issues found in IRS collection letters after bankruptcy.

Tax lien lives on

The most common letter from the IRS after a bankruptcy concerns tax liens that survive the bankruptcy.

A Chapter 7 discharge does not affect tax liens. Tax liens pass through a Chapter 7 unaltered.

When a tax is discharged in bankruptcy, any surviving tax lien does not attach to assets acquired after bankruptcy

Whether by design or not, the IRS letter to taxpayers emerging from bankruptcy with a surviving tax lien is poorly written. It doesn’t clearly spell out that the tax the IRS is trying to collect is just the sliver of taxes that attached to assets of value owned when the case was filed.

What to do? Decide if the continued existence of the lien makes any difference in your economic life. If you need to apply for significant credit, you may want to wipe out the lien by paying the value of the “stuff” it attached to when you filed. If the lien attaches only to personal property with little real value, you may choose to simply let the lien die of old age. Taxes are generally collectible only for 10 years from the date they are assessed, with some time added for time in bankruptcy.

IRS failed to credit taxes paid in Chapter 13

Can’t tell you how often this comes up. The IRS is little better than mortgage servicers in keeping track of the money it is paid.

Occasionally, the confusion arises when only one of a married couple filed Chapter 13. Somehow, the IRS didn’t connect the taxes paid through the Chapter 13 plan with the tax liability of the non filing spouse, even when the liability was joint.

Similarly, if the taxes arose in a business, the IRS may not have recognized that taxes paid by an individual or that individual’s Chapter 13 trustee were on account of business taxes.

What to do? If a polite letter pointing out that the tax has been paid doesn’t fix the problem, the collection actions violate the discharge injunction in the bankruptcy case. Brought to the attention of a bankruptcy judge, the IRS may get its knuckles rapped and be ordered to pay your attorneys fees and any damages you suffered.

IRS doesn’t understand the community property discharge

The Bankruptcy Code has been around in its present form for nearly 40 years, but the IRS can’t get its head around the community property discharge found in §524(a)(3).

That statute says that the bankruptcy discharge granted to one spouse protects a couple’s community property acquired after the bankruptcy filing from debts discharged in bankruptcy.

So, taxes discharged in one spouse’s bankruptcy can’t be collected from the community property of the spouse who didn’t file. (The non filing spouse may be exposed to collection if that spouse has separate property and is also liable for the tax).

What to do? Start by educating the IRS. Point out that your spouse has a discharge, you remain married, and your community property is protected from pre bankruptcy tax collection. This one is trickier, since the IRS has legitimate rights to collect from separate property, if there is any.

You miscounted the passage of time

Consider whether the mistake might be yours. The bankruptcy discharge doesn’t list the debts discharged in your case; it simply says that the dischargeable debts are discharged.

The central factor controlling whether the unsecured portion of a tax is discharged is the interval between the assessment of the tax and the filing of the bankruptcy. The calculation can be complicated by prior bankruptcy filings and other events that pause the clock.

What to do? Get an experienced bankruptcy attorney or a tax professional to review whether the tax the IRS wants to collect was really discharged. If it was discharged, go back to court for help from a bankruptcy judge.

IRS simply screwed up

It happens these days more than it used to.

The IRS is understaffed and technologically challenged. They make mistakes.

If the IRS, or any other taxing authority, had notice of the bankruptcy filing, they are legally obligated to honor the discharge, even if it’s hard to do.

What to do? First off, write a letter with the proof that the taxes are discharged. Usually that means sending a copy of the bankruptcy schedules listing the IRS and a copy of the discharge along with the collection letter they just sent. Most bankruptcy judges want you to give the offending creditor a chance to fix the problem before running back to court. You set yourself up for a better result in court when you’ve made a business-like attempt at self help and been brushed off.