The Impact of Unfiled Tax Returns on Bankruptcy

When filing bankruptcy, you will be obligated to provide a breadth of financial information along with your petition. The specific form to be filed is called a Statement of Financial Affairs for Individuals Filing for Bankruptcy. Generally, the information on this form is easy to fill out if you have access to your tax returns. Otherwise, you will have to recreate your income from pay stubs, bank accounts, and other documents. Unfiled taxes should be filed prior to filing a bankruptcy petition for several reasons but, failing to do so could cause you more problems than you think.

What Happens With Unfiled Tax Returns

The bankruptcy petition should be accompanied by your tax returns. Chapter 7 filings require you to have filed the last two years of tax returns while a Chapter 13 requires the filing of at least the last four years. However, in some instances, a debtor files for bankruptcy protection without understanding the implications of an unfiled return. Should you fail to file your returns first, the Internal Revenue Service may file a return on your behalf.

Additionally, if you have prior filed returns and owe the IRS money, you may be able to have some of the debt discharged in bankruptcy. Should you have unfiled returns and be owed a refund, you may lose the right to collect a refund if one is outstanding. If you have unpaid taxes and your returns are unfiled, you could lose the right to have some of them discharged as part of a Chapter 7 and the unfiled tax returns will also mean you will be unable to restructure outstanding tax debt as part of a Chapter 13. In some cases, the court will reject your petition for bankruptcy should you have unfiled tax returns or you could be denied a discharge of your petition.

When the IRS Files Your Return

Should the Internal Revenue Service file your return on your behalf, you may be shocked at what happens. The substitute federal return (SFR) is based on information received by the IRS from your employer. This means they will take into consideration any 1099's and W2 forms issued for monies earned.

It is important for you to understand  the IRS does not do any type of "deep dive" into your specific circumstances so you will only get a single exemption for yourself, they will not add any deductions which you may have been entitled to, and you will not be given credit for any tax credits you may be entitled to. Additionally, the IRS will add significant penalties for late payment and other penalties which will mean you are being issued an inflated tax bill.

Replacing the SFR

Should the IRS file substitute returns on your behalf, you can correct your tax filings by taking the necessary steps to file accurate returns on your own. This should be completed before filing your bankruptcy petition. Your bankruptcy attorney may recommend you seek assistance from a tax specialist before they complete your bankruptcy filing.

Tax Debt and Chapter 7 Bankruptcy

When you still owe the Internal Revenue Service money and you are filing bankruptcy, if you have filed late returns you may not be eligible to ask for part of the debt to be discharged. This is because the taxes must be owed for three years prior to filing. If the returns are filed just prior to filing bankruptcy, they do not qualify for discharge. When you are filing Chapter 13, you will be eligible to have any IRS debt included as part of your repayment plan as long as your returns are filed prior to your bankruptcy petition. You should discuss the impact of additional penalties and other fees charged by the IRS with your bankruptcy attorney when you meet to discuss your bankruptcy options.

Working With a Bankruptcy Attorney

Debtors who are considering filing for bankruptcy protection should make sure they inform their bankruptcy attorney about all of their financial obligations including unfiled state or federal tax returns. This is important because these returns will have an impact on your petition and may create additional problems if they are unaware of your tax filing problems. Since unpaid taxes are part of your overall debt, and uncollected refunds are a component of your assets, they could also have an impact on the decision to file Chapter 7 or Chapter 13 bankruptcy.

Tax Liens and IRS Wage Garnishment

Tax liens will not go away when you file Chapter 7, however, unless you were notified prior to filing Chapter 7 that you may be subject to a lien, the IRS is not able to file a new lien during the process. Another important thing to be aware of is if you have existing wage garnishments and file for bankruptcy protection, the automatic stay stops these collection activities. This could give you some time to negotiate a settlement for some debts, including taxes owed to the IRS. Talk to a bankruptcy attorney if you have existing wage garnishments so they can make sure they stop once your petition is accepted by the court.

The decision to file for protection under the U. S. Bankruptcy Code is not an easy one. However, you should keep in mind thousands of people every year seek this form of protection. We have worked with clients who have suffered a financial setback due to illness, divorce, or work slowdowns or layoffs. Filing Chapter 7 will give you a clean slate from many of the debts you are facing because they will be discharged. Chapter 13 allows you to make payments over a period of up to five years allowing you time to get your finances in order and get a fresh start on rebuilding your future.

Sources: Statement of Financial Affairs