California residents filing for bankruptcy will need to take special notice of any IRS adjustments to their tax liability. In an appellate bankruptcy discharge filing, the Ninth Circuit upheld an opinion that taxpayers must file a report of change to the California Franchise Tax Board if they are notified of a federal change in tax liability. If not, their tax debt might not be discharged.
Chapter 7 filers take notice
The filing most affected by this ruling is Chapter 7 bankruptcy. If a Chapter 7 bankruptcy filer receives a federal notice that their income tax return has been adjusted, and they do not notify the California Franchise Tax Board of the change, they risk their additional debt not being discharged by the bankruptcy court.
Understanding the rule
For example, a taxpayer, who is in the middle of Chapter 7, files federal and state tax returns for a particular tax year. After the filing, the IRS discovers there was additional income that was not included on the original return. The IRS notifies the taxpayer they owe more money for that tax year. This also results in additional money owed to the state. The taxpayer fails to notify the California Franchise Tax Board of the increased tax liability. The failure to notify renders the new tax bill as unable to be discharged because the taxpayer failed to file appropriate paperwork to notify the state.
How to avoid this issue
Certainly, if you are filing for Chapter 7 bankruptcy, it is important to be sure tax returns are correctly and timely filed. Omitting income on a return can create serious issues with the bankruptcy proceeding.