
James F. McDonough
Of Counsel
732-568-8360 jmcdonough@sh-law.comFirm Insights
Author: James F. McDonough
Date: November 20, 2015

Of Counsel
732-568-8360 jmcdonough@sh-law.comI was asked if there is any drawback to not filing tax returns on time or to paying taxes late or not at all. Aside from the obvious, there are other ramifications that may not manifest for some time.
We encounter in our practice business owners who have fallen behind in paying income taxes. One of the options that must be considered is bankruptcy. Unfortunately, this alternative may not be available with respect to certain tax debts that are not dischargeable in bankruptcy. In the most general of terms, bankruptcy claims are either secured or unsecured, with the unsecured claims further divided into priority claims and general unsecured claims. Taxes are deemed to be pre-petition claims if the taxable year for the taxes ends before the taxpayer files the bankruptcy petition.
This statement would appear to cover the business owner’s income tax returns until we ask if the income tax returns were filed timely.
Non-dischargeable claims in bankruptcies involving individuals, include tax debts with respect to which (1) a required return was not filed or was filed late and within two years before the bankruptcy petition was filed, or (2) the debtor made a fraudulent return or willfully attempted to evade tax.
The logic of the law is sound. An individual should not receive a discharge in bankruptcy for tax obligations if he or she does not file a return or files a fraudulent return. The late return is the more interesting provision. If taxpayers were allowed to file late and then discharge those taxes in bankruptcy, the IRS would never have the opportunity to initiate collection action. Moreover, if taxpayers could withhold returns for several years before filing those returns and filing bankruptcy, there would be significant revenue loss to the public and little incentive for anyone to file on time.
There is another reason why filing timely is important. We represent executors of estates where a decedent, either divorced or never married, has passed away and left his property to children or siblings. In these instances, there is no one who can access information from online sources for the decedent’s self-prepared return or who has any inkling on how the non-filing parent kept records for income tax purposes. Although we are able to request copies of income tax returns and transcripts from the IRS, recent budget cuts (practitioner hotline) and data breaches has slowed the process significantly or stalled it altogether.
Another issue is whether the statute of limitations has run on income tax returns from prior years. In one matter, we do not know if or when returns were filed and this makes it difficult to assess if there is any risk from these filings. In the other matter, we are certain returns have not been filed. This would not a significant problem were it not for rental property (Schedule E) income and expense that is difficult to identify. In each instance, a timely filed return for the tax year before death would have provided a roadmap.
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