Will Filing For Bankruptcy Cause an IRS Audit?
I have been working diligently with my attorney to file for Chapter 7 or Chapter 13 bankruptcy. Some of my friends have said that filing for bankruptcy may cause the IRS to put up the red flag for an audit. I am not really curious about why the IRS would audit me for filing for bankruptcy. But I do want to prepare myself for any eventualities. Can you shed any light on this situation? Will the IRS audit me if I file for bankruptcy?
As of right now, there's no stated policy that we know of that would indicate that the Internal Revenue Service specifically targets those who file for bankruptcy. Millions of people have filed for bankruptcy in the past ten years. It would be almost impossible for the IRS to audit every single one of those people. Part of the reason owes itself to practical considerations. The IRS doesn't have the financial resources or the numbers to automatically audit everyone who files for bankruptcy. To some extent, it may not need to. Bankruptcy proceedings sift through your assets, liabilities, and debts in an effort to move you through bankruptcy and put you on your feet again. This can affect the IRS, and isn't too dissimilar from an audit.
Legally speaking, the IRS is certainly not prohibited from auditing a person who has filed for bankruptcy protection. A bankruptcy filing can "stay," or halt, many different government actions against a bankruptcy debtor, such as a court judgment or a lien. This doesn't include IRS audits though. The Bankruptcy Code, specifically a provision found at 11 U.S.C. § 362 (b)(9), exempts IRS audits, notices of tax deficiencies, and demands for tax returns from the list of actions that can be stayed during bankruptcy.
Of course, that doesn't mean that you won't be one of the lucky few to be selected for this noble and patriotic process simply by filing your tax return. But, as we said before, we are unaware that filing for bankruptcy will make an audit any more or less likely.
There are, however, certain groups that may be at a higher risk for audit than others. For example, people who are paid in cash or receive a large share of their pay in the form of tips may be at a higher risk of audit simply because these groups sometimes fail to declare all of their income. Business owners are another group that may be more likely to be audited because of errors they may make in bookkeeping.
While bankruptcy will not necessarily stop you from being audited, it can at least partially protect you from the results of an audit. Bankruptcy protects a debtor from his or her creditors, including the IRS and other government agencies and institutions. While you may still be audited after filing for bankruptcy protection, any taxes owed, interests, or penalties owed to the IRS may be reduced or eliminated entirely. So, while filing for bankruptcy protection won't incur an IRS audit on its own, it may be able to reduce your overall tax liability once any audit has been completed.