Tax bankruptcy discharge
Some tax debt is not dischargeable through bankruptcy. Tax bankruptcy discharge can happen through Chapter 7 and Chapter 13 bankruptcy if they meet specific criteria. The criteria include five rules: 1) the due date for filing a tax return is at least three years ago; 2) the tax return was filed at least two years ago; 3) the tax assessment (if any, other than the filing of the return) is at least 240 days old; 4) there is no fraud or willful evasion; and 5) the taxes are income taxes (as contrasted with, say, payroll taxes or sales taxes). Naturally, the tax bankruptcy discharge is first of all contingent on the taxpayer being eligible for a discharge, period. But that’s a whole ‘another page.
1. The Three Year Rule
The tax return (and therefore payment) for a particular tax year must have been due without penalty at least three years before filing for a tax bankruptcy discharge.
If you filed an extension, the three years are determined by the extension. For example, Adam Smith’s return would have been due on April 15 – or the next business day thereafter – but he applied for an extension out to October 15. If the tax year was 2010, his return would and payment without penalty would have been due October 15, 2011. Unless October 15 fell on a weekend, which I didn’t bother to verify, but you get the idea. Measuring from October 15, 2011, the earliest date his taxes are dischargeable is October 15, 2014 – three years later. But all this assumes Mr. Smith filed his return.
2. The Two Year Rule
The tax return must have been filed at least two years before filing for a tax bankruptcy discharge. In our hypothetical above, let’s assume Mr. Smith procrastinated in filing his 2010 return. October 15, 2011, comes and goes and, well, no tax return. Maybe he owed more than he could pay and figured if he put his head in the sand it would go away. It didn’t. He comes to his senses in time to get his return filed on October 14, 2012. Dodged a bullet, did Mr. Smith. Come October 15, 2014, he’ll still be able to discharge his taxes if he files bankruptcy on October 15, 2014. His taxes were due without penalty for more than three years (measuring from October 15, 2011-October 15, 2014), his return was filed more than two years prior to his bankruptcy filing.
Let’s see how our favorite capitalist did on the rest of his criteria.
3. The 240 Day Rule
Taxes must have been assessed by the IRS at least 240 days before filing. Poor Adam. His CPA fouled up or somehow or other the IRS found fault with his 2010 return filed on October 14, 2012. On February 14, 2014, the IRS files a NOTICE OF ASSESSMENT (or some similarly named form) informing him that his return had errors and that the IRS has assessed an additional…let’s just say $2500, not that the amount much matters. It’s all about the timing. Now our Mr. Smith must wait 240 days beyond the assessment date before he files for his tax bankruptcy, even though he already has satisfied the two-year and three-year rules. He breaks out his calendar and counts out the days until October when he can safely file his bankruptcy.
4. Fraud or Willful Evasion Rule The tax return must not be fraudulent, and there can be no willful attempt to evade taxes. These are often described separately (4. Fraud; 5. Willful Evasion), creating six instead of five rules. What’s fun about doing it that way is you end up with the so-called “six-gun rule”, i.e., miss one bullet in the chamber and your discharge of taxes in bankruptcy is D.O.A. It probably goes without saying but I’ll say it anyway: tax fraud and tax evasion are two sure ways to risk not only potential civil and criminal penalties but will forever bar the discharge of taxes in bankruptcy.
5. Other Income Taxes: Taxes other than income taxes, such as Trust Fund Recovery Penalties, payroll taxes, and other types of taxes cannot be discharged. The good news, though, is that even these taxes have a statute of limitations – of sorts. TEN YEARS the IRS has to collect these. Few of us can hold out for that long with tax liens and levies hanging over our heads.