This week I begin a short series on the discharge of income tax debt in bankruptcy. This discussion is going to mainly focus on how tax debt is handled in the Chapter 7 setting. With small distinctions, dischargeable tax debt is treated the same in either a Chapter 7 or Chapter 13. This series is gong to consist of four parts. This first post will discuss the discharge of tax debt generally. Part two will discuss tax liens and how they are treated in bankruptcy. Part three will discuss certain types of tax debt not discharged in bankruptcy such as the trust fund recovery penalty. Finally, the series will conclude with a discussion about what type of proceeding is necessary to actually accomplish the discharge of tax debt.
As a general rule, the discharge of income tax debt under the Bankruptcy Code is governed by 11 U.S.C. §§ 523(a)(1) and 507(a)(8). These sections describe the circumstances under which a tax debt is exempt from discharge. To put this in easier terms, the following factors have to be satisfied before an income tax debt will be discharged in bankruptcy:
1) The tax year you are seeking to discharge has to be three years prior to your date of fling;
2) You had to have filed a return at least two years before your petition is filed;
3) Any tax assessed by the taxing authority had to be assessed at least 240 days before your petition is filed; and
4) The return you do file cannot be fraudulent and cannot seek to evade the tax
As you can see the rules are fairly simple. As to the first item, if you are filing your bankruptcy case in 2013 tax years 2010 – 2012 are exempt from discharge. In other words, the first year you will be able to seek a discharge for is 2009 and older. Again, the second prong is fairly simple, you had to file the return at least two years before you file bankruptcy. In other words, you can not file your 2009 taxes and five days later file for bankruptcy and seek to discharge your 2009 tax debt. In addition, you must file the return; a substitute return filed for you by the taxing authority will not satisfy this requirement.
The third prong is a little more difficult to understand. In many cases the taxing authority may, at a date after you file your return, assess a tax on you. The third prong simply requires that any such assessment be at least 240 days before you file. This can often develop as a result of new information obtained by the taxing authority.
Finally, the fourth prong is also fairly self explanatory. The return you do file cannot be fraudulent and you cannot, through the filing of the return, attempt to evade paying taxes. This would most likely come up if you significantly under report your income for that tax year.
A final consideration, which I will discuss next week, is how the presence of a tax lien impacts the discharge of income tax debt.