Tuesday, July 26, 2011

Freedom for the Innocent: IRS Relaxes Innocent Spouse Relief Qualifications

The IRS, in a dramatic announcement yesterday, finally repealed the regulations prohibiting the consideration of an application for innocent spouse relief made more than two years after the IRS’ initial attempt at collection. The new rule permits taxpayers to apply for innocent spouse relief at any time during the statute of limitation for the collection of a tax liability, which usually lasts 10 years.

Pursuant to Section 6015 of the Internal Revenue Code, a taxpayer may seek relief from joint and several liability associated with filing joint returns in certain circumstances. Under subsection (f), a taxpayer could seek equitable relief from understatements and underpayments when relief is not otherwise available. This section allows the IRS broad power to reduce or eliminate certain penalties when an appropriate case presents itself. However, this relief was dramatically limited by the Treasury Regulations, which placed a two-year window in which a taxpayer may seek such relief.

As part of the announcement, the IRS also stated that previously rejected applications for innocent spouse relief would be reconsidered, as long as the taxpayer re-files the IRS Form 8857 and the collection statute of limitations for the tax years involved has not expired. Taxpayers with cases currently in suspense will automatically fall under the new rule and do not need to reapply. Further, the IRS will not apply the two year limitation in pending litigation, and may suspend collection on certain judgments.

If you believe you may qualify for relief pursuant to the innocent spouse rules, download and file IRS Form 8857 found at http://www.irs.gov/pub/irs-pdf/f8857.pdf.

Tuesday, July 19, 2011

Accrued Taxes During Bankruptcy Not Included in Bankruptcy Estate: Tenth Circuit Joints in Circuit Court Split

Last month we told you about the circuit court split involving the understatement of basis. This month, the Tenth Circuit joined in a split regarding whether taxes incurred during the sale of certain farm assets during a Chapter 12 bankruptcy proceeding are part of the Bankruptcy estate, or are instead incurred by a debtor personally, outside of the protections of the bankruptcy. The court held in U.S. v. Dawes that federal income taxes resulting from the sale of farm assets are not incurred by a Chapter 12 bankruptcy estate.

The facts of the case did not fare well for the taxpayers. Mr. and Mrs. Dawes had a history of not paying their income taxes; specifically, they pled guilty to the crime for taxes due in 1981, 82, and 83. They also failed to pay their taxes for the years 1986, 87, 88 and 1990. This caused the IRS to seek and obtain a judgment for the unpaid tax. The judgment also found that the Daweses had fraudulently conveyed certain assets in an effort to avoid the IRS and other creditors. After the judgment was obtained, the IRS notified the Daweses that it intended to seize certain assets. Before it could, the couple filed Chapter 12.

During the bankruptcy, the Court permitted the Daweses to sell several tracts of farm land to pay off debt, which created certain income tax liabilities. These new tax liabilities were incorporated into their plan for reorganization, which sought to place them in the category of unsecured debt, paid only to the extent funds might be available after priority claims were satisfied.

The Dawses hoped to take advantage of Section 1222, which provides that certain claims otherwise entitled to priority payment (such as claims filed by the IRS), but which are owed to the government as a result of the sale of farm assets, are downgraded to unsecure claims and deemed eligible for discharge. They argued that because the federal income taxes at issue are owed to the IRS as a result of a farm asset sale and were “incurred by the estate,” they may be treated as general unsecured claims.

The issue- whether income taxes flowing from the sale of a farm asset during a Chapter 12 bankruptcy are taxes “incurred by the estate and so subject to downgrade and discharge—is the subject of a circuit court split. The Eighth Circuit says yes; the Ninth says no. The United States Supreme Court granted certiorari on June 13th. Considering the split, the Tenth Circuit found that the taxes incurred due to the sale of the property were the individual liability of the debtor, not of the bankruptcy estate. As such, the Dawses were not allowed to take advantage of Section 1222 and discharge the owed tax.

Do not fail to consider the tax consequences of certain property transfers if you are seeking bankruptcy protection under Chapter 12. The Fourth Circuit has not decided the issue so be sure to discuss this potential problem with your Bankruptcy attorney.