We recently interviewed Christopher Holmes and Jess M. Smith, III, the senior partners at Tom Scott & Associates, P.C. Below is Part 3 of that interview, which focuses on filing your taxes in relation to when you file for bankruptcy, as well as how a subsidize premium for health insurance purchased through the Healthcare.gov website can affect your taxes.
Q: On another topic, what happens when someone who has filed for bankruptcy has not been filing their taxes on time every time?
JS: A hot issue is tax returns in Chapter 13 filed late.
CH: Pre-2005, if you filed bankruptcy first and you had a bunch of unfiled tax returns, you could turn them in after your bankruptcy and basically all of the taxes were going away except for the ones from the last three years. That gave great incentive for people to get right with the IRS after they’ve file for bankruptcy. Now, they’ve reversed the law to make it much more harsh on debtors. If you don’t file your taxes within two years of the bankruptcy the taxes due are never going away.
Here is a horror story example: A salesman in his late 50s, who lived in Noblesville in Hamilton County, came to us in 2009 with a bunch of letters and documents from his accountant. Based on his recollection and the documents, he thought his taxes from 2000 through 2005 had been filed in 2005. So we were getting ready to file his bankruptcy case in 2009, we made sure he paid his taxes for 2006, 2007, and 2008, which were the three years before his bankruptcy filing. We went through the bankruptcy and he paid those taxes, and then he eventually obtained his bankruptcy discharge.
About two months after his discharge, the IRS started coming after him saying that his returns from 2000 through 2005 weren’t filed until 2008. Because they were filed within two years of the bankruptcy, they were had not been discharged. He swore those returns had been filed and said, “I know my accountant mailed these in.” he gave me power of attorney and I got on the phone with the IRS in Sacramento. Unfortunately for the client, the IRS had scanned the envelopes, with the postmarks, of all of those returns, so they had image files that showed that for some reason the returns had not been mailed in until 2008.
So, he had misrepresented to me the status of those returns when we filed his case in 2009, so as soon as he was out of his bankruptcy when we paid his 2006 through 2008 taxes, we now had to file another bankruptcy to deal with these old taxes, because the IRS was starting to levy his pension.
CH: His old taxes would have been discharged because they were more than three years old, except for the fact that those taxes were filed within two years of the day of the filing of the bankruptcy case, so you don’t get the benefit of that so-called three-year rule, which meant the taxes didn’t go away as they would have back in the good old days before 2005.
JS: Looking back, he had to file his case in 2009, because he had another creditor pursuing him in court, so he didn’t have the luxury of waiting two years and a day to file for bankruptcy. That’s important for people to understand now, if you have not filed your taxes and you want to get resolution on them. Usually, the recommendation is to get them done sooner rather than later to have any hope of discharging them in a bankruptcy.
CH: The moral of the story is to file your taxes every year to avoid that sort of problem.
JS: Another issue that is moving to the forefront of bankruptcy cases – and I don’t know yet how we’re going to resolve it because it is such a new issue – is that people have been signing up for personal health insurance under the recently legislated Affordable Care Act – otherwise known as Obamacare – and then it is turning out that their annual income is too high, so when they file their taxes they no longer qualify for the subsidized premiums they received. they are then getting nailed by the IRS with huge liabilities. I have client coming in tomorrow who owes over $3000 on his 2014 taxes.
CH: So he had a subsidy that was bigger that it should have been because it was based on his current income?
CH: So they projected his income as less than what it proved to be, so he received a bigger subsidy than he would otherwise.
JS: I don’t yet know all of the details, but instead of receiving the refund his accountant projected, the IRS said, “No, you owe us a little over $3000.” What I currently know is that it has something to do with Form 8962 Insurance Premium Tax Credit, referred to as the PTC form. Moving forward, that is probably going to be a common issue that triggers tax liabilities the people don’t anticipate.
CH: Because the subsidy is based on an income means tests.
JS: I don’t know for sure yet, but apparently he sought out a subsidize premium when he applied through the Healthcare.gov website in 2013 for healthcare insurance coverage for 2014. When tax time came in 2015 to recapture, he got nailed. We’ll have to wait and see how this situation gets resolved, but it is an issue that will likely come up more frequently in years to come.
Parts 1 and 2 of This Interview
Part 1: Divorce and Bankruptcy