Can Income Taxes be Discharged in Bankruptcy
There is a common misconception that income taxes are never dischargeable in bankruptcy. In fact, you can discharge your back federal, state, and local income taxes in Chapter 7, Chapter 13, and Chapter 11. Penalties and interest are also dischargeable. Determining which back taxes are dischargeable
The 3 Year, 2 Year, and 240 Day Rules.It is possible to discharge significant income tax debt in bankruptcy, if your tax debt fits within the following rules: The 3 Year, 2 Year, and 240 Day Rules. The Bankruptcy code sets out specific time periods that determine if you can discharge your taxes. Under these rules, you can discharge those income taxes for which the tax return was due more than 3 years before the bankruptcy petition is filed, as long as it has been more than 2 years since you filed the income tax returns and more than 240 days, plus any time an offer in compromise was pending plus 90 days, since the income taxes were assessed. These rules are complicated and are often misunderstood. The important thing to understand is that you must meet the requirements of all three rules to discharge your taxes. 1. The 3-Year Rule. This rule states that to discharge delinquent income taxes, the due date for filing the income tax return must be more than three years before you file for bankruptcy. Bankruptcy Code ?507(a)(8)(A)(i). Typically, your federal and most state income taxes become due on or around April 15th of each year but if you filed an extension the due date will be later (on or around October 15 for federal income taxes). In most cases, it is simply a matter of adding three years to this due date to determine the earliest date you can file for bankruptcy and still discharge your taxes. Example: Joe's 2008 federal income taxes are due on April 15, 2009. If Joe owes taxes for that year and wants to discharge them, the earliest he can file for bankruptcy is April 15, 2012 (April 15, 2009, plus 3 years). Example: If Joe in the example above obtains an extension until October 15, 2009, his tax due date is October 15th, not April 15th. Therefore, he must wait until October 15, 2012 to file for bankruptcy, if he wishes to discharge these taxes. 2. The 2-Year Rule. Under the 2-year rule, your income tax returns must have been filed by the taxpayer more than two years before filing your bankruptcy petition. This requirement allows you to discharge your taxes, even if you filed your tax forms late, as long as you file them at least two years before filing for bankruptcy. ?523(a)(1)(b)(ii). However, if the IRS filed a substitute tax return for you then the income taxes may not be dischargeable but the penalties and interest on the penalties would be dischargeable. Example: Jill's income taxes were due on April 15, 2009. Jill did not get an extension. However, she did not get around to filing her tax forms until June 1, 2010. If Jill wants to discharge her 2009 taxes, she cannot file for bankruptcy until June 1, 2012 (two years from the date she filed her taxes AND more than three years from the date the taxes were due). What if you did not file? If you did not file an income tax return in a given tax year, any taxes assessed by the IRS for that year are not dischargeable. ?523(a)(1)(b)(i). In my Austin, Texas bankruptcy practice, I sometimes see clients whose taxes would have been dischargeable, if only they had filed their tax forms. If their tax debt is significant, I may advise them to go ahead and file the tax forms, then wait to file for bankruptcy. Quick Point: If the IRS files a return on your behalf, it is not considered a filed return for the purposes of this rule. You must still file a tax form for that year. 3. The 240-Day Rule. Taxes must be assessed at least 240 days before you file for bankruptcy under this rule. As a practical matter, the date of assessment is typically on or near the date you filed your income tax form (assuming the IRS and you agree on the amount of taxes owed). However, if you file a correction or a change results from an IRS audit, the assessment date may be substantially later. ?507 (a)(8)(A)(ii) Example: Joe filed his 2009 taxes on April 15, 2009. His taxes are assessed by the IRS on the same day. Joe meets the requirements of the 3-2-240 rules on April 15, 2012. However, if Joe files a correction on January 1, 2012, the 240-day clock starts over. Therefore, he cannot file for bankruptcy until August 28, 2012 (January 1, 2012, plus 240 days), if he wants to discharge these taxes. Example: Jill files her 2009 taxes on time on April 15, 2009. The IRS audits Jill's taxes and finds that Jill made a mistake. She actually owes a few hundred dollars more than shown on her original tax form. The IRS assesses the new amount along with some penalties and interest on March 1, 2011. To discharge her 2009 taxes (and the penalties and interest) Jill will have to wait until October 27, 2012 to file for bankruptcy (240 days from the IRS's new assessment). If you are in a dispute with the IRS regarding how much you owe and plan to file for bankruptcy, you should inform your bankruptcy lawyer of the dispute. A tax dispute can impact the assessment date. Other actions can add additional time to some or all of the 3-2-240 time requirements, including (a) making an offer in compromise, (b) having filed for bankruptcy previously, or (3) obtaining a taxpayer assistance order. ?507(a)(8)(A)(i).
Post-Bankruptcy Tax Assessments are Not DischargeableA taxing authority is legally permitted to start or continue a tax audit and assess additional tax after a taxpayer files for bankruptcy, if the time period for assessing additional tax has not expired. A tax that is assessed after the bankruptcy is filed is not discharged. The IRS generally has three years from the date a taxpayer files an income tax return to audit a return and assess additional tax. Therefore, if the taxpayer has satisfied the first condition above then more than three years will have elapsed between the date the income tax return was due, including extensions, and the date that the bankruptcy petition is filed, and the IRS cannot legally assess any additional tax for years that were discharged in the bankruptcy, with three exceptions. The first exception is that, if a tax return omits gross income by more than 25%, then the IRS has 6 years from the return filing date to assess the additional tax. The second exception is that if the taxpayer files a fraudulent return or is guilty of tax evasion, then the IRS can assess the additional tax at any time. The third exception is when the taxpayer signs a written agreement extending the deadline. Therefore, the rule preventing a bankruptcy discharge of taxes assessed after the bankruptcy filing date will only occur in those situations where IRS can prove that the taxpayer filed a return omitting gross income by more than 25%, filed a fraudulent return or is guilty of tax evasion, or signed a written agreement extending the deadline.
Fraudulent Tax Returns are Not DischargeableA tax debt is not dischargeable if the taxpayer files a fraudulent tax return. A tax return is fraudulent if the taxpayer intentionally fails to report income or makes misrepresentations on the tax return. Further, if a taxpayer willfully attempts to defeat or evade payment of a tax then the tax is not dischargeable in bankruptcy. The tax fraud issue may be raised after the bankruptcy case is closed. If a taxpayer has the ability to pay the tax but uses the funds for other purposes or if the taxpayer evidences a pattern of failing to file tax returns, failing to pay taxes, or attempting to hide income and assets then the taxpayer may be guilty of tax evasion and the taxes would not be dischargeable.