I frequently have consultations with debtors who owe income taxes and want to know if they are dischargeable in bankruptcy. Income tax is typically owed due to one of two reasons: 1) the debtor is self-employed and was either unaware that they needed to file taxes or unable to afford their scheduled tax payments, or 2) the debtor claimed the maximum amount of exemptions to increase take-home pay in the paycheck and now they can’t pay their tax liability after they file their income taxes.
Whether their income taxes are dischargeable is depends on several factors. There are five rules to determine if tax debts are dischargeable. If the income tax debt meets all five of these rules, then the tax debt is dischargeable in Chapter 7 and Chapter 13 bankruptcy:
1. The due date for filing a tax return is at least 3 years ago
2. The tax return was filed at least two years ago
3. The tax assessment is at least 240 days old
4. The tax return was not fraudulent
5. The taxpayer is not guilty of tax evasion
Return must have been due at least three years ago
The tax debt must be related to an income tax return that was due at least three years before the taxpayer files for bankruptcy. The due date includes any extensions.
Example 1: Debtor filed his 2005 tax returns on February 1, 2006, and owes $1,000. Taxes were officially due April 15th of that year. The $1,000 becomes dischargeable on April 16, 2009, which is over three years from the date that the tax year 2005 taxes came due.
Example 2: Same scenario except that Debtor got an extension to file his 2005 taxes and the new due date was October 15, 2006. The $1,000 that the debtor owes on October 16, 2009.
Return must have been filed at least two years ago
The tax debt must be related to a tax return that was filed at least two years before the debtor files for bankruptcy. The time is measured from the date the taxpayer actually filed the return.
Example: Debtor filed his 2000 tax return on April 10, 2006, and owes $1,000. The bankruptcy must be filed after April 10, 2008, in order for the $1,000.00 to be dischargeable.
Income tax assessment must be at least 240 days old
The Internal Revenue Service or Indiana Department of Revenue must have assessed the tax at least 240 days before the debtor files for bankruptcy.
Income tax return was not fraudulent
The tax return cannot be determined to be fraudulent.
Income taxpayer cannot be guilty of tax evasion
The debtor cannot be guilty of any intentional act of evading the tax laws.
Other Tax Issues:
In order to file Chapter 7 bankruptcy or Chapter 13 bankruptcy you must have filed your income tax returns for the previous 4 years, unless because of lack income you were not required to file tax in any of those years.
If the IRS assessed income tax for you because you failed to file your required tax return then you cannot discharge that tax unless you signed a return for that year.
Occasionally the IRS or the Indiana Department of Revenue will place a tax lien against your property. Tax liens are not dischargeable in bankruptcy.
Penalties on income taxes due may be dischargeable in a Chapter 13 bankruptcy even if the underlying taxes are non-dischargeable, but penalties are not dischargeable in a Chapter 7 bankruptcy unless the underlying taxes are dischargeable. Consult with an experienced bankruptcy attorney to determine what option is best for you.