Your tax debt has to jump over 4 hurdles to be forever written off in bankruptcy. But if it does, that tax is history.
Speaking of history, it was Benjamin Franklin who said, “In this world nothing can be said to be certain, except death and taxes.” But that was before bankruptcy. It can kill taxes.
Two Myths
Whether taxes can be done away with and how tie into two myths about bankruptcy and taxes. Like other myths, these persist because there IS some truth behind them.
First myth: You can’t discharge (legally write off) income taxes in bankruptcy.
It’s true that LOTS of income taxes can’t be discharged. And that’s true under either Chapter 7 “straight bankruptcy” or the Chapter 13 “adjustment of debts” payment plan. For a tax to be discharged it has to meet 4 conditions. If it doesn’t meet any one of them, the tax will not be discharged.
But, if those conditions ARE met, then bankruptcy will discharge that tax just like a credit card or medical debt.
Second myth: to deal with taxes in bankruptcy you need the extra power of the 3-to-5-year Chapter 13 case, because a mere Chapter 7 case doesn’t do you any good.
It’s true that Chapter 13 has some special tools for attacking income tax debts. It’s especially helpful if you owe a lot of tax debt, or owe for multiple tax years. So Chapter 13 in some tax situations can be the far better way to go.
But Chapter 7 “straight bankruptcy” can sometimes discharge all or most of your income tax debt. Then Chapter 13 may be unnecessary and even counterproductive.
Four Conditions
The four conditions apply both to Chapter 7 and Chapter 13. But because Chapter 13 adds some complications, including that you may still need to pay part of the tax debt even if all four conditions are met, we instead focus here on them under Chapter 7. We cover the first of the three conditions in this blog and then the other three in the next one.
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.)
Sounds clear enough. If you owe $10,000 to the IRS for 2009 income taxes, that tax return was due April 15, 2010. So if your Chapter 7 case was filed before April 15, 2013, you would not meet this condition, but if it was filed after that you would meet this condition.
However, the statute says you look to the date the tax return was “last due, including extensions.” So it is absolutely critical to see if during the year at issue you asked for and were granted an extension to file the return. If so, you have to add the length of the extension to the three years. So, in the above example, if you had gotten an extension to file the tax return from April 15, 2010 to October 15, 2010, then this three-year condition would be met only by filing the Chapter 7 case after October 15, 2013.
Also, you have to be extremely careful about the actual tax filing due date, accounting for the IRS’s “extension” to the following Monday when the 15th falls on a weekend, as well as for odd little holidays that come up occasionally. For example, in 2012 when April 15 fell on a Sunday, and then Monday was Emancipation Day, a holiday observed only in the District of Columbia but applicable to the IRS, the tax return due date was April 17. If someone were to file a Chapter 7 case three years later on April 16, 2015 attempting to discharge a 2011 tax debt, they would not meet this condition because they’d be just a bit too early.
Summarizing the situation so far (as to this first condition only):
1) before April 15, 2013, only income taxes for the tax years of 2008 or earlier can be discharged;
2) then, after April 15, 2013, taxes for 2009 may be able to be discharged, depending on whether you got an extension that year.
This is probably the most important and, believe it or not, the clearest of the four conditions. But the tax isn’t dead until it meets the other three conditions, to be covered in the next blog.