Recalculate Fed Tax Return and Discharge?

[sje123]

My friend who is about to declare bankruptcy (or rather go see a lawyer about it) discovered something very distressing on her income tax returns. Her late husband deducted the property taxes that weren't paid 2 years in a row. Apparently he had planned to use the tax return to pay the taxes that he already deducted and had done so in previous years. But she had no idea until she looked through her tax statements. She received about 8k back every year.

Does she re-file the tax returns and then try to discharge what she may owe the govt in bankruptcy? It's taken us a while to talk her into looking into bankruptcy and she was a wreck BEFORE this discovery. Now she's really a mess and I have NO CLUE what to tell her. Any thoughts?

[WhoCares1000]

She will not be able to discharge the extra taxes in BK. However, I think this would be one of the hardest things for the IRS to catch because the local tax departments do not report tax payments to the IRS (since most people do escrow accounts, most people get 1098s that note that). The only problem would be if the US Attorney cross-referenced the noted tax debt with the tax returns but even then, that would simply trigger an audit for the most part.

As for the taxes, they cannot be that much where she could not work out a deal with the IRS and State Revenue Department (did not catch what state the OP was in so I am generalizing). Lets assume that the property taxes were $2000/year). That would mean a total of $4000 of income that is now taxable. Lets assume 25% bracket for federal and 7% bracket for state. That would mean that the total tax between state and federal is $1280 + penalties and interest so the max would be about $2000 ($1500 of that would be federal). Now the IRS (and most states) do accept payment plans. If she offered $100/month to the federals and $50/month to the state, she could probably pay this off in about 2 years easily.

So my advice would be to have a CPA look over the returns for the past 3 years just to see if there are any other issues to be dealt with. Once those are known, file an amended return. Once that is done, go through the BK process, then do a payment plan with the IRS and State Revenue department (who will not be able to start the collection process until after the BK). From that, everything should be fine.

The IRS has a reputation (that they try to maintain) for being quite a bit nastier then they really are. If you go to them first, you will find that all they are is a big collection agency that is really more inept than most debt collectors.

[jq26]

Agree with everything posted. This type of income tax liability is non-dischargeable. One added option- before agreeing to a payment plan with the IRS, she may be able to file form 8857 and claim innocent spouse relief / equitable relief.

It isn't something I'm all that familiar with, but it basically boils down to a stance by the IRS that they don't want to punish an innocent spouse for the mistakes of the other spouse in certain situations. So they may grant all or a portion of the request for relief.

http://www.irs.gov/pub/irs-pdf/f8857.pdf

http://www.irs.gov/pub/irs-pdf/i8857.pdf

[WhoCares1000]

I would agree with the innocent spouse thing except I do not think she will get the IRS to agree to that with the other party being dead. I think they want someone to go after and since they cannot go after the dead party, they are going to want her on the hook. I really doubt she is going to get innocent spouse relief in this case.

She could try for equitable relief though and see if she can get a 50% reduction however. The guidelines for that are looser and in this case, the IRS is at least getting some money so if she offers to be 50% responsible, they might accept it.That would probably lower the tax bill to about $1000 between state and federal.

[jq26]

Agreed but worth a shot. Besides, Part III, line 8 gives the option to check that the spouse is deceased and asks that you attach a death certificate. It may be that they thought of a situation like this.

[sje123]

Thank you for all your replies. Wouldn't the trustee notice it? Her mortgage went up thousands of dollars due to the mortgager paying the back taxes yet the taxes are deducted on the tax returns.

[jq26]

Now I'm confused. From your previous post, I was under the impression the potential tax deficiency was due to the fact that real estate taxes were not actually paid, thus not deductible. So the deficiency was an INCOME TAX issue with the IRS.

But the real estate taxes were paid, just by the lender, not by the husband directly. And now the mortgage payment is increased to account for the previous tax shortage. That's a different story. The bill was paid. In the loan documents, there is typically a clause stating that the lender can pay the taxes on the home and then bill you (they can do this with homeowner's insurance as well if you let your policy lapse). They do this to protect their security interest. So now the mortgage is what it is. The good news is that there is no IRS issue. If the taxes were paid by SOMEONE, then I suggest leaving the tax return issue alone. This is not that much different than an escrow account that has simply gone negative, where an escrow analysis then requireda massive step up in future payments to cure arrearage and get the account back to its required surplus. It happens all the time- and borrowers deduct the entire amount of taxes paid despite the bank "loaning" the real estate tax money to them by paying it in advance.

I'd leave the tax issue alone. It isn't dischargeable anyway. The question now is if the borrower can afford this larger mortgage payment. Best to seek local bk counsel on this one.

[sje123]

The issue is that in previous years the husband deducted the property taxes and when the refund came in, he paid them. This is how it was working, unbeknownst to her who thought that the taxes were escrowed.

In the last two years she just followed the deductions but when the refund came, she didn't pay them because she did not realize they were not escrowed. Then the bank paid them (even though she took a deduction for paying them which she didn't).

So her mortgage payment went up thousands of dollars which led her to consider bankruptcy (there is no way she can make the basic payment let alone the new one).

Is there still NOT an IRS issue?

[myhouse]

Is there still NOT an IRS issue?

There is not. The bank paid them on her behalf, so the deduction is legal. Now, of course, they want reimbursement. But that is between her and the bank, and the IRS is not involved in that.

[sje123]

Thank you so much. She is in such a panic about EVERYTHING and this will help!

[myhouse]

Thank you so much. She is in such a panic about EVERYTHING and this will help!

Not sure what happened to the rest of my post.

I'm curious as to how her payment went up by "thousands" of dollars. I can't imagine that two years' taxes would raise the payment by more than a few hundred dollars per month. Hopefully the lender isn't pulling a fast one on her.

[jq26]

I agree with the last couple of posts. No IRS issue, but why did it go up "thousands of dollars"? Even if the RE taxes were $5000/yr and they hadn't been paid for two years, you're looking at an $850/month increase.

Is there equity in the home? If so, maybe the lender can restructure the note and bury the taxes they paid on the homeowner's behalf into the principal and just extend the amortization period. It really makes no sense to bury someone who can pay the regular mortgage payment and has home equity that would secure the added debt anyway.

[sje123]

Taxes are around 10k a year. They are behind 2 years and they're escrowing the next year so it's 30k. There is no equity in the house (minus about 150k when another friend talked to an appraiser).

[WhoCares1000]

Where are you from, New Hampshire. Gosh, the only places around here that see a $10,000 tax is either $1Million+ homes or farm land.

[sje123]

Westchester county NY. I can't say for certain but I think the original mortgage was something like 600k. I know that an appraiser friend of another friend trying to help out this woman said the house would not sell for 500k now. And there is no equity.

[WhoCares1000]

Ahhh, one of the highest property tax counties in one of the highest taxed states in the nation. Yeah, I would believe a $10,000 tax bill.

I do not think there are IRS implications however because the bank was nice enough to pay them (probably to protect themselves because a property tax liens are higher than their mortgage liens). The only issue you may have is if the IRS decides that you should not have taken the deduction in the years you did but in the year the bank paid the taxes.

If that is the case, then you simply move the deduction to the year the taxes were paid and then the most you have to pay is the penalties and interest. Those would come to less than $2000, even in your case, which can be wiped out with a payment agreement.

I am surprised however that your husband, who obviously made a decent amount of money for you to own a house in Westchester County, left you destitute. Not good planning on his part.

[jq26]

I think the bigger (maybe the only) problem is that the mortgage payment is now HUGE and unaffordable. Why doesn't she just dump the home and be done with it? Or is that already in the cards? It seems inevitable.

If that is the plan, then seek a bk attorney. For $1500, she'll get someone who knows local practice and can tell her just what liability, if any, lives on after discharge. I don't particularly see any tax liability, but there could be more to it.

[sje123]

Ah

I am surprised however that your husband, who obviously made a decent amount of money for you to own a house in Westchester County, left you destitute. Not good planning on his part.

This isn't me. It's a friend of mine who is young and has a 10 year old son. When they bought the house they both had good jobs and were relatively (early 40s) young. They bought at the height of the real estate craziness with plans to refinance.

Of course his illness came along and not only did he leave work and go on SSDI (which is about 1500 a month) but she had to leave a job where she made great money but traveled almost all the time (the dad worked close to home and was the son's prime caretaker).

The illness and pay decrease wiped out most of their savings (income decrease and paying for home health care) and she's done just about everything she can think of to make more money while still being home in the evenings for her son (who is pretty devastated by the loss of his father). She's sold a lot of their belongings, all of her jewelry and has taken part-time jobs here and there. She's also done child care for others on the weekend. Bankruptcy was the last thing on her mind. She thought she could keep cobbling the mortgage payment together until the market went up. The money is gone and the market is flat.

So a group of her friends have been trying to get her to see it's a good option for her.