John J. Stockdale, Jr.
May, 2014

Navigating the Common Problem of Unfiled Tax Returns in Individual Chapter 7s

Several matters recently assigned to Schafer and Weiner, PLLC through the Access to Bankruptcy Court[1] program emphasized the importance to a successful individual chapter 7 bankruptcy case of having timely filed tax returns.  The Bankruptcy Code requires that an individual debtor provide the chapter 7 trustee with his or her most recently filed tax returns.[2]  If the tax returns are not provided, the debtor risks dismissal of his or her case.[3]

However, an individual may not have filed all his or her tax returns.  Where the individual does not have an obligation to file tax returns because, for example, he or she did not earn any income during the applicable tax year, the debtor need only provide an affidavit or declaration setting forth the reason that tax returns were not filed.[4]  Once the declaration or affidavit is filed, this hurdle is overcome. However, a different result arises where either (1) the debtor is entitled to a tax refund for the unfiled tax years or (2) the debtor owes the taxing authority for unpaid taxes during the unfiled tax year.  In these cases, the individual must file its unfiled tax returns and deliver them to the chapter 7 trustee by a date that is 7 days before the first meeting of the creditors.[5]

Where the debtor is entitled to a refund for the unfiled tax years, this requirement forces the debtor to unlock and recover any tax refund(s).  The potential tax refunds must be identified on the debtor’s schedules[6] and if possible, exempted from the bankruptcy estate.[7]  Unless the potential refund is exempted, it will remain part of the bankruptcy estate and may be administered for the benefit of the unsecured creditors by the chapter 7 trustee.[8]

Where the debtor owes money to the taxing authority, the failure to file tax returns has drastic consequences. Generally, unpaid income taxes can be discharged in an individual bankruptcy case where the taxes arose from a return filed or last due later than three years after the petition date.[9]  However, tax debt cannot be discharged when it is attributable to tax years where the debtor has not filed the required tax return.[10]

Schafer and Weiner recently faced both ends of this spectrum in two pro bono cases. 

In the first case, the debtor did not file tax returns in the years leading up to the bankruptcy filing.  However, the debtor was not required to file tax returns for those tax years because he did not earn any income during those tax years.  As a result, we prepared and provided the debtor’s declaration attesting to those facts (together with his last filed tax return) to the chapter 7 trustee, paving the way for the individual to successfully obtain his chapter 7 discharge.

By contrast, the second matter had a substantially different result.  In this situation, the debtors had not filed their tax returns for more than a decade and had substantial estimated tax liabilities for certain of those tax years. Because the tax debt represented an important part of the debtors’ liabilities, and could not be discharged in the bankruptcy case because the tax returns had not been filed, we determined that a chapter 7 bankruptcy could not address their underlying problems and would also have a high risk of being dismissed because of the chronic lack of any tax returns being filed.

We look forward to assisting individual debtors successfully navigate the bankruptcy process from beginning to end and obtain the greatest amount of debt relief, including, where possible, relief from prepetition tax debt.

[1] Access to Bankruptcy Court is a program providing pro bono counsel to individuals at 150% below the poverty level.

[2] 11 U.S.C. § 521(e)(2)(A)(i); FRBP 4002(b)(3).  However, local practice requires that the debtor provide the last two years tax returns to the chaper 7 trustee.

[3] 11 U.S.C. § 521(e)(2)(B); LR 1017-2 (E.D.M.).

[4] FRBP 4002(b)(3); FRBP 1008.

[5] 11 U.S.C. § 521(e)(2)(A)(i).

[6] 11 U.S.C. § 541

[7]See, e.g., 11 U.S.C. § 522(d)(5).

[8]  11 U.S.C. §704(a)(1).

[9]  11 U.S.C. §523(a)(1)(A); 11 U.S.C. §507(a)(8)(A).

[10] 11 U.S.C. § 523(a)(1)(B)(i) provides that a discharge under 11 U.S.C. § 727 does not discharge an individual debtor from any debt for a tax with respect to which a return, if required, was not filed.