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Dischargeability of Tax Debt in Bankruptcy

Dischargeability of Tax Debt in Bankruptcy


In a 1789 letter to the French scientist Jean-Baptiste Leroy, Benjamin Franklin observed that “in this world nothing can be said to be certain, except death and taxes.”  Perhaps along those lines, most people assume that taxes cannot be discharged in bankruptcy.  While it is true that most taxes cannot be discharged, some can.  Personal income taxes can in fact be discharged if they meet the following three tests:

1.  The tax must be more than three years old.  Keep in mind, however, that the three years does not start until the last day when the tax return is due, regardless of when you actually file it.  Under most circumstances, the return is due on the April 15 after the tax year in question.  However, if you request an extension of time to file a return, the three years does not start running until the last day permitted under the extension.  Here are some examples:

·            You filed your 2009 taxes on time (i.e., before April 15, 2010).  Those taxes become dischargeable as of April 16, 2013.

·          You requested an automatic six-month extension until October 15, 2010 to file your 2009 taxes, but you actually filed the return on May 1, 2010.  Since the return was last due on October 15, 2010, the taxes do not become dischargeable until October 16, 2013.

2.  The tax return must be filed more than two years prior to the bankruptcy filing.  This sounds self-explanatory, but there is one important point to remember here:  The taxpayer must be the one filing the return, and not the IRS.  Under some circumstances, if you do not file a return, the IRS can file a “substitute for return” (SFR) on your behalf, and assess you tax on that basis.  The law is quite clear that the filing of an SFR by the IRS does not qualify as the taxpayer filing the return for purposes of this two-year rule.

What is less clear is what happens if the taxpayer files a return or amended return after the IRS filed an SFR.  The IRS takes the position that if an SFR is filed, any tax for that year is never dischargeable in bankruptcy.  Although some courts have ruled to the contrary, the issue is unresolved in the Oregon Bankruptcy Court.

3.  The tax must have been assessed more than 240 days prior to the bankruptcy filing.  This rule comes into play primarily if there has been an audit of the taxpayer’s return, and additional tax has been assessed on that basis, or following the filing of an amended return.  For example, if you filed your 2009 tax return on time, but you were audited in December 2012 and assessed additional tax on January 15, 2013, the tax is not dischargeable until 240 days after that date.  Note that the 240-day period may be extended by any time during which an offer in compromise was pending and by any time period in which a prior bankruptcy case was pending.

Even if these three tests are met, taxes with respect to a fraudulent return or where the taxpayer willfully attempted in any manner to evade or defeat the tax cannot be discharged.  What constitutes a “willful attempt” to “evade or defeat” taxes is not entirely clear.  While it can be considered with other conduct, non-payment of taxes in and of itself is not an attempt to evade or defeat.  Cases discussing this issue have mentioned concealment and/or transfers of assets, payment on large unnecessary discretionary expenses, destruction of books and records, and other efforts to thwart collection as conduct sufficient to deny a discharge of tax debt.

This post pertains only to the discharge of personal income tax.  Payroll taxes, and other taxes required to be collected from employees can never be discharged in bankruptcy.  Further information regarding discharge of tax debt in bankruptcy can be found in the IRS’ Bankruptcy Tax Guide.

In order to determine whether or not a tax can be discharged in bankruptcy, we will have you sign an authorization for us to order an “account transcript” from the IRS.  This transcript will tell us the date when a tax return was filed (or if an SFR was filed by the IRS), whether or not any extensions were requested, whether or not any offers in compromise were pending, whether or not any prior bankruptcy filings were involved, and the dates of tax assessment.

This post is intended to be purely information in nature, and cannot be considered legal advice.  If you have questions related to the dischargeability of tax debt, please call our office at (503) 545-1061 (Oregon cases) or (360) 836-4238 (Washington cases) to schedule a free initial consultation.

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