Monday, August 8, 2011

IRS Tax Debt and Bankruptcy: Can I discharge my tax debt in bankruptcy?

Question: Can I discharge my tax debt in bankruptcy?

No topic is rife with more falsehoods and misinformation than the dischargeability (the ability of a bankruptcy to wipe out) of tax debts.  In other words, Can I file bankruptcy to eliminate my IRS tax debt? Therefore, I will handle this topic carefully and over the course of several blog posts.

The Basic Rules

To begin with, here are the basic rules.  You can discharge debts for federal income taxes in bankruptcy only if all of the following conditions are true:

  1. The taxes are income taxes. Taxes other than income, such as payroll taxes or fraud penalties, can never be eliminated in bankruptcy.
  2. The tax return must have been originally due at least three years (including all extension periods) before you filed for bankruptcy. 
EXAMPLE: If you file for bankruptcy on May 1, 2011, you can discharge taxes that were due before May 1, 2008.  This would include income taxes for 2007 and earlier – but not taxes due for 2008 since those did not become due until April 15, 2009.

  1. You must have filed a tax return for the debt you wish to discharge at least two years before filing for bankruptcy.  Please note that if you don’t file the return, the tax is not dischargeable. 
EXAMPLE: if you file for bankruptcy on May 1, 2011, you can discharge taxes that you filed before May 1, 2009.  So if you filed a tax return for 2003 on June 2009, the tax due on this return will not be dischargeable even though the return is for an old tax year. 

  1. You did not commit fraud or willful evasion. If you filed a fraudulent tax return or otherwise willfully attempted to evade paying taxes, such as using a false Social Security number on your tax return, bankruptcy can't help.  Fraud and willful evasion usually involve some criminal finding by the IRS.  This isn’t an issue for most taxpayers but if it is, you have bigger problems. 
  2. You pass the "240-day rule." The income tax debt must have been assessed by the IRS at least 240 days before you file your bankruptcy petition.  A tax is considered “assessed” when the tax due become final in the IRS books.  If you filed a tax return, the assessment date will be shortly after the file date.  If the IRS has audited you, the assessment date is when the audited amount is entered into the IRS records.  This rule mostly becomes an issue in an audit situation. 

A Word About Time

I will not talk about anything Stephen Hawking would find enjoyable (mostly because I just ain’t that smart).  However, there are many events that will change the time frames set forth above.  The following list is NOT an exhaustive list of those events but points out the most common ones:

Collection Due Process Appeal:  A timely filed CDP hearing (where you contest the collection action) stops the time from running across he board while the appeal is pending plus 90 days (Bankruptcy Code §507(a)(8)(G)).  The clocks starts again after the appeal process has been closed.

Offer in Compromise:  Offers in Compromise filed within 240-day of the assessment of a tax extends this window during the time the OIC is pending plus 30 days.  Be particularly careful in filing for an OIC after an audit.  Once filed, OICs can remain open for as long as 1 to 1 ½ years – so this prevents you from filing for bankruptcy relief (for otherwise dischargeable tax debt) for up to 20 months. 

Previous bankruptcy:  Be careful when trying to discharge debt that was previously non-dischargeable in a previous bankruptcy, or for taxes in which the tax return was filed during a previous bankruptcy (IRS may have delayed assessing the tax until after the bankruptcy was closed). Also, case law has held that the time for calculating dischargeability (described above) will stop ticking during the time that the previous bankruptcy was pending.  Both the timing or substantive issues might prevent that tax from being discharged. 

For the sake of safety, simply call the IRS before you file for bankruptcy relief and ask them to give you the (i) FILING DATE, (ii) ASSESSMENT DATE, and (iii) whether a TAX LIEN was filed for each tax year that you owe.  The IRS representative will not be able to tell you if a tax is dischargeable in bankruptcy but you will have the basic information necessary to figure it out.


Although the rules seem a bit complex, let’s try to boil them down...

  • Tax return was due 3 years ago
  • You filed the return more than 2 years ago
  • No audit, appeals, or OICs
  • No fraud
THEN the tax will go away in a bankruptcy.  If any of the above is not true, you should consult with your bankruptcy attorney.

Do you have questions about this topic? Email or call me for a free consultation and we can discuss your situation. (760) 990-1632.

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