The Smart Way To Cut The IRS Out

calendar year at a glanceLike so much in life, it’s all about timing

I revisited an older post here about delaying the filing of a bankruptcy til the New Year when the debtor expects to owe taxes in April.

A Chapter 13 filed in January can include and pay the taxes associated with the tax year ending in December.  As the taxing folk see it, the tax is owed just as soon as the tax year ends, regardless of whether the return is yet filed or even due.

So, file now and forfeit the ability to pay the current year’s taxes through the plan without interest.  (You can file a claim for the year of the filing, but I’m getting big pushback from the IRS when I do it.)

But let’s look at the converse of those facts:  your client owes back taxes and expects this year to get a nice refund.

Or would get a nice refund if it wasn’t for those old taxes that entitle the IRS to set off the old taxes against the refund.

How does bankruptcy change the equation

The principle of set off allows one party to reduce what that person owes another by the amount the other owes him.  In our practice, that means the IRS can reduce the amount it owes you for this year’s refund by the amount you owe them for an earlier year.

Section 553 of the Bankruptcy Code preserves the right of offset:

… this title does not affect any right of a creditor to offset a mutual debt owing by such creditor to the debtor that arose before the commencement of the case under this title against a claim of such creditor against the debtor that arose before the commencement of the case…

Note that the debts have to be mutual.

Mutuality requires that the debts be held by the same parties, in the same capacity, and that the off-setting debts both be prepetition or post petition.  Meyer. Med. Physicians, 385 F.3d 1039.

Destroy the mutuality in the taxpayer/tax collector equation, and set off is not available.

File bankruptcy mid year

Suppose your client expects a refund for 2017 tax year, were it not for some old, dischargeable taxes.

In a case filed before the end of this tax year, the right to a refund becomes a post petition debt.  The tax or the refund isn’t owed til the tax year closes.

Bingo:  there is no mutuality.  The client owes a prepetition tax debt;  come January, the IRS owes the client a post petition refund.

So, we have just demonstrated once again that the answer to the question about when to file is “it depends.”

That’s what makes this practice so challenging.

Image courtesy of Flickr and Knterox


  1. Can IRS setoff a dischargeable tax debt? Taxes owed for 2011: timely filed, assessed. Bankruptcy filed 4/17/14. IRS takes half of $7k refund for 2011 tax debt.