Myth has it that bankruptcy does not beat income tax debt – for the IRS, the FTB, or just about any taxation authority. This isn’t entirely real; in the event that debt relates to income tax that is more than 36 months old, you can generally get rid of it in a bankruptcy. But there are enough exceptions, that it pays to know both how to discharge tax in bankruptcy, and what to do when it isn’t dischargeable.
Year one client came in for a bankruptcy with a $40,000 tax debt on the 2004 tax. I looked at his transcript, and he hadn’t filed a tax return. Rather, the IRS filed a return he owed $40,000, and started trying to collect for him, determined.
Because he hadn’t filed a return before the IRS’s return (known in the business as a Substitute for Return), he would never be able to discharge this tax through a bankruptcy.
His option: submitting an Offer in Compromise. This is certainly a program that is special allows a taxpayer to give the tax authority everything he can, in return for a lower liability. It’s one of the times that are few the IRS or just about any tax authority will enter into a contract with a taxpayer.
The offer in compromise program is a simple idea for the IRS. The taxpayer proposes a payment to get rid of all his taxes and the IRS either accepts or rejects the offer. How much should the taxpayer give? Generally, a dollar more than the IRS could get by going after the taxpayer full-force for the next two to five years. This means that the IRS gets any equity in any asset, plus the net earnings (after costs) that the taxpayer makes within the next two to five years.
It is very similar to a bankruptcy, except with a creditor that is single. The taxpayer reports just what he owns and exactly what he earns; the IRS measures this against its variety of allowable costs, and either tells the taxpayer just how he needs to replace the offer or that the offer is accepted.
Generally, the IRS is the easiest entity to reach an agreement with. Because the FTB has a 20-year collection statute on delinquent taxes, it offers no motivation to reach an agreement with anybody who is still working. Exactly the same is true of the Board of Equalization while the Employment Development Department. However these entities are prepared to reach agreements where in actuality the taxpayers are not working.