Malpractice Trap for Bankruptcy Lawyers when Representing Clients with Tax Debt

The unfortunate reality is that many attorneys practicing bankruptcy law do not fully understand the laws regarding discharging tax debt.  On several occasions in the past, clients have told me they had a consultation with another lawyer, and the lawyer said something along the lines of, “I won’t give you an opinion on your tax debt,” or “Just file the bankruptcy, and wait to see how the IRS responds.”

Naturally, that is not comforting advice for a prospective client who may be facing large tax obligations.  That is probably the reason the attorney was not able to convert that prospective client into an actual client.  Aside from poor client service, there is a potential malpractice trap for the attorney who fails to analyze dischargeability of tax debt. 

Here is the scenario:

Assume Client has $25,000 of IRS personal income tax debt related to tax years 2008 ($5,000), 2009 ($5,000), and 2010 ($15,000).  Client filed his tax returns on time each year (and there are no other facts in this example that would toll the lapsing of time for dischargeability).  You are preparing a Chapter 7 bankruptcy case for Client.  You fail to analyze dischargeability of Client’s tax debt.  You file the case in February 2014.  Client ends up discharging the tax debt related to 2008 and 2009, but cannot discharge the remaining $15,000 of tax related to 2010 because three years had not lapsed since the tax return was due.  If you delayed filing the case for just two months, until April 16, 2014, Client would discharge an additional $15,000 of tax debt.   

How to avoid the malpractice trap:

  • All bankruptcy attorneys should educate themselves on the tax debt dischargeability laws. 
  • When you have a client with tax debt, take the time (and charge an appropriate extra fee) to analyze the client’s tax obligations, including the date the tax return was filed, assessment dates, and intervening offer-in-compromise, bankruptcy, or other circumstances that toll lapsing of time for dischargeability. 
  • Summarize the data into a report, chart, or timeline so you can reasonably predict whether the tax debt is eligible for discharge, or when it will become eligible for discharge. 
  • Determine the optimal time to file your client’s case.  If some tax debt is not dischargeable today, delay filing the case (to the extent possible) until the tax debt is eligible to be discharged.  Of course, there are many circumstances when it may not be advisable to delay filing.