Should clients file taxes if they’re bankrupt?

Roughly half of the people I see in our bankruptcy practice owe taxes. There are a lot of ways to become indebted to the government – income taxes, retail sales taxes, excise taxes, corporate taxes and source deductions — just to name a few of the most common debts.

When your clients need to file for bankruptcy, they just want to be done with it. So, filing their taxes and acknowledging that they owe the government even more money is probably the last thing on their minds.

Although many people may think, “Since I’m declaring bankruptcy anyway, I’m not going to waste time filing my taxes.” It’s a mistake with immediate and long-term consequences.

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The immediate problem Bankruptcy law can help your client deal with the taxes payable, but it can’t protect her from the consequences of not filing her return.

Failure to file income taxes is considered an offence under the Income Tax Act, and those who skip out could be fined and jailed. While that doesn’t happen often, anyone who has earned income is required to file a tax return every year.

If your client receives a Requirement to File Notice under section 150(2) of the act, it’s time to stop procrastinating and file. By sending this Notice, CRA triggers the Offences and Punishment section of the Tax Act.

If you client hasn’t filed for a number of years, tell her CRA has the right to simply assess her income and her taxes payable—without her input. Whenever I have seen CRA do this (and it is quite common) they guess high so that the person owes much more tax than they would have if she had filed her return. Once CRA makes one of these assessments, the tax debt is fully enforceable; CRA may freeze bank accounts, garnishee wages or receivables, or register tax liens on peoples’ property.

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In the long term If your client’s answer to addressing her debt (or any other debt, for that matter) is to file for bankruptcy, she’ll need to present proof to her trustee that she has filed her returns for this year and last year. Without proof, all of her debts (taxes and otherwise) will remain payable, instead of being cleared in bankruptcy. Her trustee will encourage her to file all of her outstanding tax returns as a show of good faith to CRA and the bankruptcy court. The law only requires this year and last year’s tax returns to be filed, but filing all of the outstanding returns demonstrates your client’s intent to comply with the Tax Act, which in turn is interpreted as accepting responsibility for past mistakes.

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Most people don’t want to file their tax returns because they can’t pay, and are afraid to find out how much they owe. Explain to your client that the cost of bankruptcy doesn’t change based on the amount she owes, but compliance and co-operation are important to the court.

CRA can ask your client to appear in bankruptcy court to complete her bankruptcy, and the agency is more likely to do so if she doesn’t file all her returns. Regardless, the court will ask your client if she’s filed her returns. If she hasn’t, she won’t be released from bankruptcy.

The majority of people who file for bankruptcy never appear in court. If they follow the rules and co-operate with their trustees, they’re automatically released from bankruptcy after a set period of time.

And when your client is released from bankruptcy, any taxes she owed before she filed for bankruptcy are eliminated. She has a clean slate.

Ted Michalos is founder & trustee of Hoyes, Michalos & Associates.