By: Gail L. Hills, Esquire
Clients often consult with me because they owe a significant amount of tax debt. Some have filed their tax return, but do not have the money to pay what they owe. However, some make the mistake of not filing their return at all if they cannot pay. I say this is a mistake because, despite the common myth, you can actually discharge some of your back federal, state, and local income taxes in Chapters 7, 13, and 11. But you have to file your income tax returns first because not only are those back taxes dischargeable in bankruptcy, penalties and interest are dischargeable too. The Bankruptcy code provides a set of rules that determine which back taxes are dischargeable in bankruptcy. Although determining which ones are dischargeable can be complicated, it can be done if your tax debt is covered by these three rules.
The 3-2-240 Rules: This refers to the specific times periods set out by the Bankruptcy code. They are also known as the 3-year, 2-year, and 240 day rules. You can discharge taxes that came due three years before filing for bankruptcy, so long as it has been at least two years since you filed the tax return, and 240 days since the taxes were assessed. Each of these rules must be met to qualify to have your back income taxes discharged.
The 3-Year Rule
To eliminate tax debt, the tax return must have been originally due at least three years before you filed for bankruptcy. This means that if your taxes are due April 15, 2015, you must wait until April 15, 2018 to file bankruptcy if you want to discharge those back taxes. However, if you receive an extension of time to file your taxes in 2015, the date used to calculate when you can discharge your back income taxes is the day the extension expires.
The 2-Year Rule
The Two-Year Rule requires you to file your tax return at least two years before filing for bankruptcy. Even if you file your tax return late, the date you actually file is the determining factor under this rule. Using the example above, if you receive an extension to file your 2014 tax return, but do not file your return until May 20, 2015, you would have to wait until May 20, 2017 to file for bankruptcy.
It is important to note that if you do not file your tax return for any given year, those taxes assessed by the IRS are not dischargeable in bankruptcy regardless of how much time has passed. Likewise, if the IRS files a return on your behalf, that tax debt is not dischargeable. That is why it is extremely important to file your taxes even if you cannot afford to pay them.
The 240-Day Rule
This rule requires that your taxes were either assessed at least 240 days before you file for bankruptcy or have not been assessed at all. So long as you and the IRS agree on the amount of taxes owed, this date is typically on or near the date you filed your return. Yet, if you later file an amended return or are audited by the IRS and it results in a change, the assessment date will be later. So if you file your return on April 15, 2014, your taxes are assessed the same day. You would meet the requirements of the 3-2-240 rules on April 15, 2017. But if you file an amended return on January 15, 2017, you would have to wait an additional 240 days from January 15, 2017 (September 9, 2017) to file for bankruptcy.
There are other factors that can affect the 3-2-240 rules timing, such as making an offer in compromise, previous bankruptcy, or obtaining a taxpayer assistance order. Entering a payment agreement does not impact the 3-2-240 rules. However, willful evasion of taxes or deliberate tax fraud disqualify those tax debts from dischargeability regardless of whether they meet the 3-2-240 rules.
The 3-2-240 rules also apply to state and local income taxes. But they do not apply to other taxes such as real estate taxes.
Despite the complexity of discharging income tax debt, I have the tools that allow me to make that determination for you. Make an appointment today to see if you qualify to have your tax debt discharged through bankruptcy.