IRS and State Tax Problem Solving


A. Options:
Certain options are available to individuals or businesses who have IRS or state tax problems. By exercising one or a combination of the following options, most individuals and businesses can resolve their tax problems.

1. Do nothing:
By doing nothing, the IRS or FTB can exercise its administrative remedies and seize assets, levy bank accounts, garnish wages, file liens, etc.

2. Find some money:
By satisfying the tax obligation, the problem is resolved. Occasionally, the availability of money from relatives, friends, or lending institutions is sufficient to satisfy the liability.

3. Payment schedules:
If an individual owes less than $25,000.00 in personal tax liabilities to the IRS, the IRS has established a "quick resolution" program which will allow a 36 month (maximum) installment plan to pay off the liability. If the taxpayer can afford a payment that would satisfy the liability in 36 months, the IRS requires minimal financial information to establish an installment agreement.

4. Offer in compromise:
Many years ago the IRS established the offer in compromise program, which seemed to be basically a failure in the State of California and generally nation-wide. The IRS standards in the Laguna Niguel District were set so high that it was rare for an offer in compromise to be accepted. In early 1992, a directive from the Director of Internal Revenue Service out of Washington, D.C., instructed the local districts to "accept more offers in compromise." This "revised" policy of the IRS to ease up on the standards of acceptance has caused a nationwide frenzy to submit offers in compromise on the recently revised and simplified forms.

(Unfortunately, for those residents of the Laguna Niguel District, the offer in compromise acceptance rate is the lowest in the nation - less than 17% of "processable offers".)

The Franchise Tax Board's offer in compromise program will review the federal offer and consider "piggy-backing" if the IRS has accepted an offer.

5. Statute of Limitations:
The IRS collection statute of limitations on a personal liability, based on a tax return which has been filed and assessed, is 10 years. The State of California has no statute of limitations on collections.

6. Chapter 7 Bankruptcy (see, Section II):
Chapter 7 bankruptcy is available for individual taxpayers as well as businesses. The ability of a Chapter 7 bankruptcy to eliminate taxes in many circumstances is powerful. Chapter 7 bankruptcy may provide the necessary relief from taxes to allow a business or an individual to re-establish themselves without the threat of loss of property or of the business.

7. Chapter 13 Bankruptcy (see, Section III):
Chapter 13 bankruptcy is a reorganization available to individuals and small businesses. It can afford complete protection from the IRS or State by preventing garnishment, levies, liens, and any other enforced collection activity. A court supervised plan is proposed and confirmed by the Court which governs the creditors' rights to payment in an orderly manner.


A. The Bankruptcy Estate:
When a petition for Chapter 7 bankruptcy is filed, a bankruptcy estate is created. All property or rights to property of the debtor become property of the bankruptcy estate.

B. The Duties of the Trustee:
A Chapter 7 trustee is appointed to oversee the bankruptcy process. The trustee's basic function is to protect the interests of unsecured creditors by identifying property belonging to the bankruptcy estate. If there is non-exempt property available for liquidation, the trustee sells it and distributes the net proceeds to unsecured creditors. The trustee also determines whether certain transfers have been made to insiders, relatives, or others which could be classified as either fraudulent or preferential. Those transfers can typically be set aside in order to bring the property back into the bankruptcy estate for distribution.

C. Dischargeability of Civilian Debts:
Civilian debts, such as Visa, Mastercard, unsecured bank loans, etc., are generally dischargeable in a Chapter 7 bankrup

1. Exceptions to Discharge:

The Bankruptcy Code enumerates several exceptions to a discharge in bankruptcy. Among the most notable exceptions are child support arrearages, spousal support arrearages, student loans less than 7 years old, debts conceived in fraud, debts as a result of a breach of a fiduciary responsibility, and certain taxes.

2. Court Action:
Generally a creditor must file a complaint in the bankruptcy court to litigate whether a debt should be excepted from discharge. Non-dischargeable obligations for child support, spousal support, student loans, and tax obligations are controlled by statute and do not need to be litigated to determine their status. Generally, if a debtor wants to demonstrate that such typically non- dischargeable debt is dischargeable, the debtor would need to bring a motion to determine dischargeability during the bankruptcy proceeding.

D. Dischargeability of Personal Income Taxes:

1. Three Orange Rule:
Three criteria must be met for a tax to be dischargeable in a Chapter 7:

a. Tax return due more than 3 years, plus applicable extensions, prior to the filing of the bankruptcy, and;

b. The tax return must have been filed more than two years before the filing of the bankruptcy, and;

c. The tax liability must be assessed more than 240 days prior to the filing of the bankruptcy.

2. Tax Liens:
If a federal or state tax lien is recorded or filed prior to the filing of the petition for bankruptcy, the IRS or state agency technically has a secured claim in the bankruptcy. If the debtor has assets to which the lien can attach, the state and the IRS will generally exercise their lien rights after the bankruptcy has been discharged by seeking payment in an amount equivalent to the net equity value of the assets of the debtor.

If no lien is filed, the IRS or state tax claims remain as unsecured.

E. Abatement:
After the debtors have received a discharge from the bankruptcy court, it is necessary to seek an abatement. The abatement procedure requires the IRS or the state to delete the amount owed on their records and release any liens outstanding on the discharged years.


A. Chapter 13 Concept:
Chapter 13 is designed to provide a plan of reorganization for individuals and small businesses. Upon the filing of a petition for Chapter 13 bankruptcy, the automatic stay is put in place to protect the debtor from any collection activity.

B. What is an Estate?
The Chapter 13 bankruptcy estate is similar to a Chapter 7, it includes all property of the debtor.

C. Duties of the Trustee:
A Chapter 13 trustee is appointed upon filing of the petition. The duties of the trustee include determining whether the proposed Chapter 13 Plan is feasible considering all circumstances surrounding the filing of the petition. Regular monthly payments are collected by the trustee and the trustee distributes the debtor's payments to the creditors, according to the terms of the Chapter 13 Plan.

D. Chapter 13 Plan:

1. Gross Income Minus Expenses:
To establish monthly net disposable income, from the debtor's gross income is subtracted the regular withholdings or self-employment taxes, mandatory insurance, and necessary, reasonable living expenses.

2. Monthly Plan Payment (Monthly Net Disposable Income):
One hundred percent of the monthly net disposable income is applied to the Chapter 13 Plan. Upon confirmation of the Chapter 13 Plan, the Judge requires that the debtor pay the Chapter 13 trustee the plan payment amount for a period of 36 to 60 months.

3. 100% Versus 0% Plan:
If the net disposable income is insufficient to pay 100% of the debtor's obligations over a 3 to 5 year Plan, the court can approve a Plan which pays as little as 0% to unsecured creditors. Secured creditors and priority creditors must be paid in full.

E. Classification of Tax Claims:
For a tax claim to be classified as unsecured non-priority, and therefore subject to reduction by the percentage proposed in the Chapter 13 Plan, three rules must be met:

1. Tax return due more than 3 years, plus applicable extensions, prior to filing the petition;

2. Tax return filed (some exceptions apply);

3. Tax not assessed within 240 days prior to the filing of the Chapter 13.

By: Gary A. Quackenbush

Law Offices of Gary A. Quackenbush
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