Here are the other three hurdles your tax debt has to jump over to be forever written off in bankruptcy.
In the last blog we said that a Chapter 13 payment plan can often be a good way to handle your income tax debts. But our main point is that sometimes a Chapter 7 “straight bankruptcy” can discharge (write-off) all or most of your income tax debt, making Chapter 13 unnecessary. For a tax to be discharged it needs to meet four conditions.
Caution about these Four Conditions for Discharging Income Taxes
Meeting these conditions may be more involved than this blog may make it seem. Bankruptcy law and tax law are two very complex areas, and you can be sure when they intersect there are many nuances that this blog cannot capture. And the law is constantly shifting, with new court interpretations all the time. These court interpretations can even be contradictory in different parts of the country. For example, currently there is a major dispute among the federal courts about the second of these four conditions, as we touch on below. So this is an area where you absolutely need to have a highly experienced bankruptcy attorney representing you.
Condition #1: The 3-Year Rule
THREE YEARS must have passed since the applicable tax return was DUE. (Section 507(a)(8)(A)(i) of the Bankruptcy Code.)
We covered this in the last blog, so check that out for more details. This condition is the clearest one, the easiest to determine whether your tax debt meets it. You need to just very carefully determine exactly what day the tax return for the tax in question was last due to be filed with the IRS or applicable state tax authority, INCLUDING any filing extension. If your Chapter 7 case is filed at the bankruptcy court more than three years after that date, you’ve met this condition.
Condition #2: The 2-Year Rule
TWO YEARS must have passed since the applicable tax return was ACTUALLY FILED with the tax authority. (Section 523(a)(1)(B).)
This condition is usually a bit harder to figure out because you often don’t know the precise tax return filing date. Instead of relying on memory or even on your own documentation, it is worth getting this information from the records of the IRS/state tax authority to make sure this is calculated accurately.
Picking up with the example used in the last blog, if the 2009 tax return with a $10,000 tax liability was not filed with the IRS until July 1, 2011, then this condition would not be met and the Chapter 7 case could not be filed to discharge this tax until two years later, after July 1, 2013.
CAUTION: there is a recent line of cases, starting with a case in Mississippi called In re McCoy, stating that this condition is not met when two years have passed since the tax return filing date, IF that tax return was not filed in time. In contrast, most courts have allowed late-filed returns as long as 2 years has passed from then until the bankruptcy filing date. This is a huge difference, and an example why it’s crucial that you have an experienced attorney advising you about local developments in the law.
Condition #3: The 240-Day Rule
240 DAYS must have passed since assessment of the tax. (Section 507(a)(8)(A)(ii).)
This condition seldom comes into play. “Assessment” is the tax authority’s formal determination of your tax liability, usually through its review and acceptance of your tax return. You or your attorney gets the date of assessment from the IRS/state.
But doesn’t the two-years-since-actual-filing condition above make this 240-day condition meaningless? Since taxes are usually assessed just a few weeks after the tax return is filed, wouldn’t this 240-days-after-assessment period be long over before two-years-since-filing period would pass?
Yes, usually, but not always. The assessment can sometimes be delayed. The amount of tax can be in dispute because of a tax audit or tax court litigation. So by the time the appropriate tax amount is finally assessed, the above three-year or two-year time periods may have passed. So that’s when this third condition kicks in, adding a 240-day period after assessment before the tax can be discharged.
So in our example, if the 2009 income tax was in dispute and the $10,000 tax liability was not resolved and assessed until March 31, 2013, then even if the first and second conditions were met earlier, this tax could not be discharged until after 240 days later, or after about November 26, 2013.
Condition #4: Tax Fraud and Evasion
Filed a fraudulent tax return or intentionally attempted to evade the tax. (Section 523(a)(1)(C).)
This is the vaguest of the four conditions. Even if you’ve met the above three time-based ones, if you were dishonest on the applicable tax return—by not reporting a portion of your income or by claiming inflated or inappropriate deductions–or if you purposely evaded paying a tax in any way, it will not be discharged in a Chapter 7 case.
To emphasize what we said above, although this is a moderately detailed discussion about these four conditions, it is by no means complete. You need your own attorney to review your unique situation thoroughly, and apply the law as it is now being interpreted by your local court. Plus, beyond there four conditions there are other considerations—such as the existence of a tax lien, or a prior bankruptcy case—that can affect whether a tax is going to be discharged, and whether it should be addressed through Chapter 7 or 13.