There is a common misconception that income taxes are never dischargeable in bankruptcy. In fact, you can discharge some back federal, state, and local income taxes in Chapter 7, Chapter 13, and Chapter 11 bankruptcy. Moreover, the penalties and interest attached to these taxes are dischargeable as well. Determining which back taxes are dischargeable can be a complex process. Nonetheless, it is possible to discharge significant income tax debt in bankruptcy, if your tax debt fits within certain rules.
THE 3 YEARS, 2 YEARS, AND 240 DAY RULES
The Bankruptcy Code sets out specific time periods that determine if you can discharge your taxes, commonly called the 3-year, 2-year, and 240-day rules (the “3-2-240 rules”). Under these rules, you can discharge income taxes that came due three years before you file for bankruptcy, as long as it has been at least two years since you filed the tax forms and 240 days since the taxes were assessed. There are some exceptions, and these rules do not apply to other types of taxes, such as property taxes.
To discharge back income taxes, be aware that you must meet the requirements of all three rules.
1. The 3-Year Rule. This rule states that to discharge your back income taxes, they must become due at least three years before you file for bankruptcy. Bankruptcy Code §507(a)(8)(A)(i). Typically, your federal and most state income taxes become due on or around April 15th of each year. In most cases, it is simply a matter of adding three years to this due date to determine the earliest date you can file for bankruptcy and still discharge your taxes.
Example: Joe’s 2008 federal income taxes are due on April 15, 2009. If Joe owes taxes for that year and wants to discharge them, the earliest he can file for bankruptcy is April 15, 2012 (April 15, 2009, plus three years).
However, if you get an extension of time to file, the three-year period runs from the date that the taxes are due under the extension.
Example: Joe files for and receives an extension of time in which to file his 2008 taxes to October 15, 2009. The tax due date is now October 15, 2009, rather than the original due date of April 15th, 2009. If Joe wishes to discharge those taxes, he must wait to file for bankruptcy until October 15, 2012.
2. The 2-Year Rule. Under the 2-year rule, your income tax returns must have been filed at least two years before you file your bankruptcy petition. This requirement allows you to discharge your taxes even if you file your tax forms late, as long as you file the forms at least two years before filing for bankruptcy. §523(a)(1)(b)(ii).
Example: Jill’s 2008 income taxes are due on April 15, 2009. She does not get an extension, and she does not get around to filing her tax forms until June 1, 2010. If Jill wants to discharge her 2008 taxes, she cannot file for bankruptcy until June 1, 2012 (two years from the date she filed her tax return and more than three years from the date her taxes were due).
Quick Note: Despite the clear wording of the two-year rule, there are limitations and potential limitations on the ability of a debtor to discharge taxes arising from late-filed forms. See “Important Note on Late-Filed Returns” below for details.
3. The 240-Day Rule. Taxes must have been assessed by the taxing agency at least 240 days before you file for bankruptcy under this rule or not assessed at all. As a practical matter, the original date of assessment is typically on or near the date you file your income tax form (assuming the IRS or other taxing agency agree on the amount of taxes owed).
Example: Joe files his 2008 tax return on April 15, 2010. The IRS assessed the taxes the same day. Joe met the requirements of the 3-2-240 rules on April 15, 2013. (This example is a bit simplified. You should always check the actual assessment date and not assume it is the same as the filing date.)
Amended or corrected returns and audits. If you file a corrected return, or if a change results from an IRS audit, the assessment date may be substantially later. §507 (a)(8)(A)(ii). For that reason, if you are in a dispute with the IRS regarding how much you owe and plan to file for bankruptcy, you should tell your bankruptcy lawyer about the dispute.
Example: Joe files his original return on April 15, 2010. The taxes, along with some penalties and interest, are assessed on December 31, 2010. Joe then files a corrected return on June 1, 2011, showing that he owes additional taxes. Based on this amended return, the IRS assessed new taxes, penalties, and interest on January 1, 2013. Joe must now wait to file for bankruptcy until August 28, 2013 (January 1, 2013, plus 240 days) to discharge the entire tax debt. If Joe files for bankruptcy before this new 240 day period is complete, the taxes assessed in 2010 would still be dischargeable, but the new taxes, penalties, and interest would not be dischargeable.
Example: Jill files her 2008 tax return on time on April 15, 2009, and assesses her taxes shortly after that. However, the IRS audits Jill’s taxes and finds that Jill made a mistake. Unbeknownst to Jill, she owes a few hundred dollars more than the amount shown on her original tax form. The IRS assesses the additional taxes along with some penalties and interest on March 1, 2012. If Jill wants to discharge the newly assessed taxes, penalties, and interest), she will have to wait until October 27, 2012, to file for bankruptcy (240 days from the IRS’s new assessment).
Tolling. Some actions can add additional time to some or all of the 3-2-240 time requirements, including (a) making an offer in compromise, (b) having filed for bankruptcy previously, or (3) obtaining a taxpayer assistance order. §507(a)(8)(A)(i). The time periods under the 3-2-240 rules are tolled (suspended) while any of these events are pending. However, entering into a payment arrangement with the IRS or another taxing agency does not toll the time periods under the 3-2-240 rules.
Quick Note: If you are in a payment arrangement with the IRS, you should stop payments upon filing for bankruptcy, unless instructed by your attorney otherwise. The IRS cannot take any collection action against you while you are protected by the automatic stay of the bankruptcy. If the payment is deducted automatically, be sure to take the necessary steps to stop it.
ORDERING TAX TRANSCRIPTS
Unfortunately, finding the due date, filing date and assessment date is not as simple as looking at your last form. To determine if your taxes are dischargeable, you should obtain an “account transcript” (sometimes called a “literal transcript”) from the IRS for each year for which you owe taxes. The account transcript will show the due date, filing date, and assessment date, which are crucial in determining whether the taxes fit within the 3-2-240 rules.
How to OrderTax Transcripts: To order a tax return transcript, see http://www.irs.gov/Individuals/Order-a-Transcript. You can order the transcript online, by phone at 1-800-908-9946, or by using IRS Form 4506T. The request will take up to two weeks to process. Note that an “account transcript” is not the same as a “tax return transcript.” A “tax return transcript” will not have all the information you need.
This is a reposting of an article by Philadelphia Attorney, Dan Mueller. There is no relation between Mr. Mueller and Mark Fernandes,PA. nor are we lawyers and do not offer legal advice.