It is possible to obtain a discharge for certain income tax debt in bankruptcy, if the debtor meets certain requirements. For example, income tax debt might be dischargeable under Chapter 7 or Chapter 13 of the Bankruptcy Code, depending on the age of the tax debt and other criteria.
Income tax debt is the only type of tax debt that might be dischargeable. Other types of tax debt, such as property taxes or payroll taxes, are not dischargeable in bankruptcy. Also, if the Internal Revenue Service (IRS) has already filed a lien on property in order to satisfy a tax debt, the lien cannot be removed by a bankruptcy court. After the bankruptcy, the IRS may be prevented from taking any other steps to collect the debt, but the IRS lien would have to be paid off if the property is sold.
Chapter 7 bankruptcy provides a debtor with the full discharge of allowable debts. Basically in a Chapter 7 bankruptcy, the bankruptcy court takes control of all of the debtor’s assets and liquidates them as necessary to pay off as much of the debt as possible. The debtor is no longer responsible for the unpaid balances that remain after the bankruptcy discharge, even if there are not enough assets after liquidation to pay off all of the debts.
In a Chapter 13 bankruptcy, the court approves a plan to repay the debts to the greatest extent possible. The goal is to pay them off in full, but if some balances cannot be paid in full because the assets in the bankruptcy estate are inadequate, they can then be discharged.
Generally tax debt is priority debt in all chapters of bankruptcy. They are the first debts to be paid when assets are liquidated in Chapter 7. In a Chapter 13 bankruptcy, any tax debt incurred during the last three years cannot be discharged. It must be included and paid in full in Chapter 13 repayment plan. However, income tax debt can be discharged to a certain, very limited extent.
How Are the Tax Debts Discharged?
For tax debt to be discharged in bankruptcy, the specific tax debt must meet all five of five criteria. Priority tax debt cannot be discharged in a Chapter 13 bankruptcy. Nonpriority income tax debt is dischargeable in Chapter 7 and Chapter 13 bankruptcies.
It is nonpriority debt, if it meets all five of the criteria as follows:
- The due date for filing the tax return in question was at least three years ago: The tax debt must relate to a tax return that had to be submitted to the IRS at least three years before the taxpayer files for bankruptcy. The due date includes any extensions the debtor took; so, for example, a debtor would not be able to include a tax debt in a bankruptcy filing until at least October 2020 if they requested and received an extension for their 2016 return, which made it due in October 2017.
- The tax return was filed at least two years ago: The tax debt must be related to a tax return that was filed at least two years before the debtor files for bankruptcy. The time is measured from the date on which the taxpayer actually files the return. In most cases, this covers the same period of time as the due date rule unless the due date was missed and the return was filed late. Tax debts that arise from tax returns that have not been filed are not dischargeable. The IRS assesses tax on unfiled returns. These tax debts cannot be discharged unless the taxpayer files a tax return for the year in question.
- The tax assessment is no less than 240 days old: The IRS has to have assessed the tax at least 240 days before the debtor files for bankruptcy. The IRS assessment can come from a balance due reported by the debtor, by, e.g., filing a tax return, or from an IRS final determination in an audit, or other IRS determination of tax owed. In other words, the debtor reported what they owed, or the IRS communicated that a certain amount was owed.
- The tax return cannot have been fraudulent: So, for example, the debtor cannot try to claim their pet hamster as a dependent, then file for bankruptcy when the IRS disallows the deduction.
- The taxpayer is not guilty of tax evasion: The crime of tax evasion is defined as using illegal means to avoid paying taxes. It usually involves hiding or misrepresenting income, inflating deductions, hiding or not reporting cash transactions, or hiding money in offshore accounts. If the debtor in bankruptcy has committed tax evasion, any income tax debt cannot be discharged.
Apply these criteria to each year’s tax debt to determine if that year’s unpaid balance is dischargeable in bankruptcy. Some tax debts might be eligible, while others might be nondischargeable.
Keep in mind that some jurisdictions in the U.S. have additional requirements for tax debt to be dischargeable. For example, in bankruptcy courts within the jurisdiction of the U.S. Ninth District Court of Appeals, a debtor must have filed their tax return in a timely fashion. If the return was filed late, any remaining tax debt cannot be discharged.
In addition, a bankruptcy petitioner must prove that they have filed tax returns for the four years prior to filing their bankruptcy petition before a bankruptcy discharge can be granted. These four returns must have been filed by the date of the first creditors’ meeting in a bankruptcy case. Furthermore, debtors must provide a copy of their most recent tax return to the bankruptcy court and to creditors if they request copies.
Is There Any Way Tax Debts Cannot Be Discharged?
Yes, there are circumstances in which income tax debt will be considered nondischargeable and that is if it does not meet the five criteria above. All tax debt that does not meet one or more of the five criteria is ineligible for discharge.
Do I Need an Attorney?
Discharging tax debt in bankruptcy can be a challenging enterprise. It is probably your best bet to consult an experienced bankruptcy attorney if you have accumulated significant tax debt that you want to discharge in your bankruptcy.
As you can see from the criteria for discharging tax debt above, it can get complicated. You are most likely to get the best possible outcome regarding your tax debt in bankruptcy if you have an experienced bankruptcy lawyer representing your interests. An experienced bankruptcy lawyer can also help you avoid mistakes that could turn out to be expensive. Discharging tax debt requires careful thinking and knowing the law. You want to have a qualified attorney handle this issue.