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Discharging Income Taxes through Chapter 7 Bankruptcy

April 26, 2012

You CAN “discharge” some income taxes, and be relieved of the legal liability for those taxes, in Chapter 7. But any tax debt you are trying to discharge has to meet a number of strict conditions. What are those conditions?

There are four main conditions.

But before describing those four, please clearly understand that this whole area—dealing with tax debts in bankruptcy—is a complex one. We are presenting the information in these blogs to you because the better you’re informed, the more in control of your situation you’ll feel. But part of being well informed is understanding when you definitely need an attorney’s help. Meaning that part of our job is to make very clear when you do. This is definitely one of those areas.

And now, on to those four main conditions for discharging income taxes.

1. Have Three Years Passed Since the Tax Return Was Due?

Every income tax debt has a due date for the filing of its tax return. That makes calculating whether or not you’ve met this condition very straightforward. But remember the important twist here: if you asked for an extension of time—from April 15 to October 15, usually—the three-year period does not begin until the extended due date for filing the tax.

2. Have Two Years Passed Since the Applicable Tax Return Was Actually Filed?

It does not help that a tax is old unless at least two years have not passed since the return was in fact filed. Plus the tax return must have been filed by you, NOT by the IRS or the Oregon Department of Revenue. Such a “substitute for return”—the common procedure in which the tax authority essentially files a tax return on your behalf based on whatever information it has available—that does not count as a filed return to start this two-year period running.

3. Have 240 Days Passed Since Assessment Of the Tax?

Assessment is the tax authority’s formal determination of your tax liability, usually through its review and acceptance of your tax return. In most situations an income tax assessment happens within a few weeks after you file the return. So this 240-day requirement is meaningless then because that period expires long before the above three-year and two-year ones. But sometimes the amount of a tax is in dispute because of a tax audit or litigation in Tax Court, which delays the assessment. By the time the accurate tax amount is assessed, the above three-year or two-year time periods may have passed. That’s where this condition comes into play, only allowing the tax to be discharged if the bankruptcy case is filed more than 240 days after the date of assessment. Also, this 240-day period is put on hold while a taxpayer’s “offer in compromise” is pending. That’s a settlement proposal you make to the tax authority to pay less money or agree to certain payment terms. The idea is that the time should not expire while the government is considering your offer.

4. Have You Filed A Fraudulent Tax Return or Intentionally Tried to Evade the Tax?

Even if all the required time periods have passed, if you were dishonest on your tax return—failed to include some of your income, for example–or tried to avoid paying a tax some other way, that tax cannot be written off in bankruptcy.

These four conditions should give you a good idea whether any or all of your income tax debts can be written off in a bankruptcy. And in some cases applying these four conditions will tell you one way or the other. But in other cases different considerations can come into play. What if the IRS recorded a tax lien against your home and on your personal possessions? How would a prior bankruptcy affect these timing rules? What about your appeal of a tax? What is considered an honest mistake on a tax return instead of an intentional tax evasion?

Bankruptcy can definitely discharge income taxes in the right combination of circumstances, but you need to have an experienced attorney apply all the pertinent rules to your case.