Discharging Tax Debt in Bankruptcy

In addition to debts such as a mortgage, line of credit and credit cards, many bankruptcy debtors are also behind on their tax obligations. The question often comes up: Can taxes be discharged in bankruptcy?

The answer to that question can be complicated. For instance, some tax debts can be discharged while other tax debts cannot. If you run a business, for example, and owe sales tax, that sales tax can never be discharged in bankruptcy. On the other hand, ordinary income tax can be, depending on various factors.

If you owe the IRS (or your State) for income tax, you may be able to discharge that debt in bankruptcy. First, you must understand how taxes are treated in your bankruptcy. There are essentially three types of debts for bankruptcy purposes: secured debt (such as your mortgage and car loan,) unsecured debt (such as credit cards and medical bills,) and priority debt (such as taxes.) If you are filing a Chapter 7 these different types usually do not make a big difference (but they still must be scheduled correctly on Schedules D, F and E, respectively.) In a Chapter 13, however, the type of debt can make a big difference. Since you are paying back at least some of your debts in a Chapter 13, the amount of each type of debt can determine how much you would have to pay into your Chapter 13 Plan.

Putting aside scheduling and treatment of debts, the conditions for discharging income tax debts are as follows:
1. The debt has to be for an income tax that was due at least 3 years prior to the filing of your bankruptcy petition. As an example, if you file your bankruptcy on May 1, 2012 then any taxes you owe for 2008 (which were due on April 15, 2009) may be discharged, but taxes for 2009-2012 cannot be discharged; and
2. You must have filed your income tax return at least two years prior to the filing of your bankruptcy petition. Taking the above example, if you filed your tax return on time (on or prior to April 15, 2009) and file your bankruptcy on May 1, 2012, then you have satisfied this 2-year rule. But let’s assume that you did not file your 2008 income tax return on time. Instead, you filed it late — let’s say on November 1, 2011. In that case, you must wait until November 2, 2013 (two years since the filing of the return) to file your bankruptcy if you want that tax debt to be discharged, even though it was due more than 3 years prior.

Things get more complicated if you owe for multiple years, some of which meet the above two requirements and some which do not. These are complex issues which can easily get confusing and not handled properly without the right guidance. The bankruptcy forms may seem simple and straight forward, but they are not. If you are contemplating filing for bankruptcy, call us for a free consultation.