Why you should file your tax returns (even if you can’t pay the tax)

Nobody receives their w-2s and 1099s and thinks “someday, years from now, I’m going to file bankruptcy and discharge the tax I will owe on this return.”  But failing to file a tax return could prevent you from being able to wipe out income taxes if you do eventually end up in bankruptcy.

It’s true, it is not an easy thing to discharge income taxes in bankruptcy.  There are many factors which influence whether a tax can be extinguished.  For example, it has to be a tax that was due at least three years ago (technically speaking, a tax for a year for which the return was due at last three years prior to the date the bankruptcy petition is filed).

And the return has to have been filed at least two year before the bankruptcy case is filed.  The return could even be filed late as long those two years have passed.  And there’s your first reason to file the tax return as soon as possible — to get that two-year clock running.  Yep, you may never need to file bankruptcy, but you’ll be so glad those returns were filed at least two years ago if you ever do.  But that’s not the most important reason to file your tax returns on time.

There’s a bigger, more insidious reason.  If you don’t file your tax return when it’s due and the IRS sees income on your w-2s and 1099s, the IRS can estimate the amount of tax they think you owe by preparing as Substitute For Return.  Once the IRS estimates the tax they think you owe on their Substitute For Return, they will let you know by sending you a bill.  And, yes, you can then file a real tax return to show the IRS you think you owe less than they estimated.

But, for bankruptcy purposes the IRS’s Substitute For Return does not qualify as a return for that two year rule.  Worse yet, bankruptcy courts have been deciding in recent cases, that any return filed by the taxpayer after the IRS has prepared a Substitute For Return does not qualify as a return for bankruptcy purposes.  That means that once the IRS prepares a Substitute For Return for a specific tax year, you are never going to be able to discharge that tax.  Ever.

So, yeah, you may never file bankruptcy, but you should file those tax returns . . . . just in case you do.