Taxes and Bankruptcy
There is a common misconception that income taxes cannot be discharged in bankruptcy. Although this is generally true, there are exceptions allowing for the discharge of back taxes, penalties, and interest in bankruptcy. The rules can sometimes be a bit complex and have a few caveats as discussed below.
The Three-Year Rule
The three-year rule comes from Bankruptcy Code section 507(a)(8)(A)(i), which states that for taxes to be dischargeable, the bankruptcy must be filed at least three years after your tax return was due, including extensions. Generally, this date falls on April 15th of each year, or the next business day if the 15th falls on a weekend or holiday.
Example: Emily owes $50,000 in federal income taxes from 2012. Her tax return was due on April 15, 2013. If Emily wants to discharge her taxes 2012 in bankruptcy, she must wait to file until after April 15, 2016.
If an extension is filed, the due date is generally Oct. 15, with the same rule for weekends.
Example: Emily owes an additional $30,000 in federal income taxes for 2011. Since she filed for an extension that year, the due date of her tax return was Oct. 15, 2012. If Emily wants to discharge her 2011 taxes in bankruptcy, she must wait to file until after Oct. 15, 2015.
The Two-Year Rule
The two-year rule comes from Bankruptcy Code section 523(a)(1)(B)(ii), which states that for taxes to be dischargeable, the bankruptcy must be filed at least two years after your tax return was actually filed.
Example: Emily also owes $20,000 in federal income taxes for 2010. She did not file this tax return until June 20, 2012, over a year after the initial due date. If Emily wants to discharge her 2010 taxes in bankruptcy, she must wait to file until after June 20, 2014.
Note: If the IRS files a tax return on your behalf, it is not considered filed for purposes of this rule, and it is not dischargeable. You must still file a tax return for that year.
The 240-Day Rule
The 240-day rule comes from Bankruptcy Code section 507(a)(8)(A)(ii), which states that for taxes to be dischargeable, the bankruptcy must be filed at least 240 days after the tax is assessed. Generally, taxes are assessed immediately after you file your tax return. This rule applies in an audit scenario, where additional taxes can be assessed after your original return is filed.
Example: Emily did not owe any income tax on her original 2009 tax return, which she filed on time. The IRS subsequently audited her for that year, resulting in $15,000 of income tax that was assessed on Sept. 7, 2012. If Emily wants to discharge her 2009 taxes in bankruptcy, she must wait to file until after May 5, 2013 — 240 days after the tax was assessed, and more than three years after the original due date of the return.
Remember that all three of these rules must be met before your taxes can be discharged in bankruptcy.
As previously mentioned, there are a few important caveats to these general rules:
- Filing an offer in compromise will extend the 240-day rule for the length of time the offer is being considered plus an additional 30 days. This is important to remember if you are considering filing an offer in compromise after an audit, because a rejected offer may have unintended consequences for a bankruptcy filing.
- Filing a timely Collection Due Process appeal with the IRS will extend both the three-year rule and the 240-day rule for the length of time the appeal is pending, plus an additional 90 days. If you are considering bankruptcy, you may want to reconsider filing for a Collection Due Process appeal. One strategy to prevent this result is to file for the appeal late, which is defined as within one year after the date of the Final Notice of Intent to Levy under IRS administrative procedures. This will prevent the tolling of the statute for bankruptcy purposes, while still allowing for the appeal to take place.
- Trust fund employment taxes are not dischargeable in bankruptcy.
- Taxes that are a result of tax fraud are not dischargeable in bankruptcy.
- Discharging taxes in bankruptcy does not remove a tax lien. Although the underlying tax liability is discharged, the tax lien will remain, and will have to be dealt with separately.
- Penalties and interest that are connected to dischargeable taxes are also dischargeable.
- The filing of a prior bankruptcy tolls or extends the statute of limitations in certain circumstances.
Let Us Guide You Through the Process
Although the dischargeability of income taxes in bankruptcy can be a bit complex, it is manageable with the assistance of an experienced attorney. To schedule a free consultation with the NewPoint Law Group, LLP, call 800-358-0305 or contact us online today.