IRS Back Taxes and Bankruptcy – Yes, They Might Be Dischargeable!
Most people believe that any IRS tax debt can never be discharged in a bankruptcy – but like many terrifying myths that surround bankruptcy – this isn’t always true either. Back in 1966, there was an addition to the Bankruptcy Code that allowed some wiggle room around the ability to discharge back income taxes in a bankruptcy, and there have been some changes in the laws since. Don’t get ahead of yourself though, because – as with everything that involves the IRS – it’s complicated.
In a Chapter 7 Bankruptcy, however, there are some Federal, State, and local income taxes that can be discharged. Not only that, if you’ve accrued penalties and interest charges in association with these back taxes, then those are discharged along with the dischargeable taxes. taxes.
There are – of course – a number of conditions that determine what kind of back taxes are dischargeable and which aren’t. These generally have to do with time. The primary rules around discharging back taxes in a Chapter 7 bankruptcy center around specific time periods, and for any taxes to be eligible for discharge in a bankruptcy, the tax return needs to pass all of these rules:
- The 3 Year Rule – have 3 years passed since the tax return was due?
- The 2 Year Rule – have 2 years passed since the tax return was filed?
- The 240 Day Rule – have 240 days passed since the taxes were assessed?
These requirements are generally known as the “3-2-240 Rules,” and they are as follows:
The “3 Year Rule:”
This states that you must wait at least 3 years from the date that the tax return was due and filed in order for it to be eligible to be discharged. So, if you owe back taxes for the year 2012, and the due date and the date you filed was April 15th of 2013, you must wait to file for bankruptcy until after April 15th of 2016; or – three years after the due date.
The “2-Year Rule:”
Here again, it must be at least 3 years from the date that the tax return was due to be eligible to be discharged. However – if you filed your tax returns late – you will need to wait 2 years from the date you actually filed the taxes. So, if you owe back taxes for the year 2012 and the due date was April 15th of 2013 – but you didn’t actually file those taxes until April 15th of 2016 – then you must wait 2 years from that date before you can file for bankruptcy if you want those taxes to be eligible for discharge – or April 15th of 2018.
The “240 Day Rule:”
Once again, the 3 year waiting period must be observed, but sometimes your taxes aren’t actually recorded – or assessed – until later. Your taxes are considered “assessed” when the IRS has actually processed your return, figured out what you owe, and put the actual balance you owe on it’s books.
It’s important to know that the date the IRS actually assesses your income taxes is not always or necessarily when you file your tax return, and a number of things can affect when the date your taxes were actually assessed (not least of which is the fact that the IRS and all 50 states have different definitions of what “Assessed” means – but that’s the least of your worries if you’re filing for bankruptcy and you owe back taxes).
The 240 Day Rule generally comes up if you have been audited, for example, or had to re-file your tax returns for any reason. When this happens, it becomes very important when your taxes were actually “done” by the IRS, because you need to wait 240 days after that for any taxes owed to be eligible for possible discharge in a bankruptcy. This is where you will need to obtain a copy of the record of the date of your assessment in order to determine when you can file for bankruptcy. The IRS is required to provide this information to you, so if you are in any doubt about this, make sure you get this information sent to you.
Sometimes Income Tax is Never Dischargeable:
Generally, for a Chapter 11 or a Chapter 13 bankruptcy, the tax debt must be either paid in full or paid via an offer in compromise, although there may be circumstances that will allow exceptions, so you should still look into this. However, here are some other examples where taxes are non-dischargeable in a bankruptcy:
- The Self File Returns Rule: you didn’t file your taxes, and the IRS assessed your tax debt because you didn’t file. If the IRS ends up assessing your taxes, that tax debt is never dischargeable, even if you file a corrected return later.
- The Withholding Rule, or Trust Fund Liability: If you are personally responsible to an individual or individuals for money that you held in trust for them for the IRS, such as an employee that you withheld money from their checks for their Federal Income Tax – but you never paid the IRS that money you deducted for them, that tax debt is not dischargeable.
- The Willful Evasion Rule: If there was a willful attempt to evade or defeat your income taxes, that money is not dischargeable.
- The Fraudulent Return Rule: If you knowingly filed a fraudulent return, that money is not dischargeable.
Other Situations to Consider Concerning Bankruptcy and the IRS
These are all basics around discharging income tax debt, and – as you can see – it’s definitely “do-able,” however, there are a lot of permutations that need to be discussed with an attorney to see if you qualify, these include:
- figuring out when you actually filed taxes
- figuring out when the IRS actually assessed taxes
- limitations on discharging back taxes under the “3-2-240” rules
- voluntary release of a post-discharge tax lien
- returns that are filed late
- business taxes
- payroll taxes
- employers portion of payroll tax
- sales tax
Again, all of these – and potentially more – all fall under the category of the one rule that is indispensable, the “Go Talk to a Lawyer” rule. Bankruptcies are sort of like snowflakes – no two are alike, so it’s best to consult an attorney.