Many debtors filing bankruptcy think they cannot discharge income taxes in bankruptcy. However, that is not true. Income taxes can be discharged in bankruptcy. Of course, it is hardly that simple to discharge your tax debt. Discharging taxes depend on a variety of factors, and many debtors are not eligible to discharge their tax debt.
To understand how complicated it can be to determine if your tax debt is dischargeable, consider that debts come in three forms- secured (i.e. your mortgage), unsecured (i.e. your credit card bill), priority (i.e child support and alimony). Now consider that taxes can be classified as all three- even sometimes within the same debtors case.
A secured tax debt is one that the IRS has filed a lien against the debtor. That lien attaches to all of the debtors property, making it secured. A priority tax debt is one that the debtor will not be able to discharge in bankruptcy, but there is no lien. An unsecured tax debt is one the debtor should be able to discharge.
So what determines if an income tax debt is eligible for discharge? There are six rules for discharging income tax, and they apply equally to State and Federal income taxes. The tax is dischargeable if all of the following conditions exist:
- The most recent due date for filing the return is more than three years old. (Note: the three-year period is computed from the most recent date the tax return is due for the tax year. An extension to file the return delays the start time, so dont just assume you know the due date. Your 2006 return was due no earlier than April 15, 2007. If an extension was filed, it could have been due as late as October 17, 2007 (depending on weekend dates)).
- A tax return has been filed or given by the taxpayer for the tax year in question at least more than two years preceding the filing date of the bankruptcy.
- If a tax claim has been assessed, then it has been at least more than 240 days between the last date of assessment and the filing of the bankruptcy.
- The tax is assessable, meaning the debtor is not a non-filer.
- The tax return was not fraudulent
- There was no willful tax evasion by the debtor
Therefore, a debtor should keep those conditions in mind before filing bankruptcy. For instance, the debtor might be able to discharge his/her taxes if he/she waits another 35 days to file the petition. It is thus recommended that if a debtor thinks his/her taxes might be dischargeable, that a tax account transcript is ordered from the IRS to verify filing dates, due dates and assessment dates.
It should further be noted that this blog is a very basic description of the rules associated with discharging income taxes and there are bound to be many complex questions that arise in a debtors case. Some questions that might need to be addressed by the debtor include, but are not limited to:
- Does an offer in compromise toll any of the time periods?
- What property is covered by an IRS lien?
- Will IRS self release a tax lien?
- How does the IRS setoff tax refunds when the debtor is in bankruptcy and has dischargeable taxes?