With the downturn in the economy and massive job losses, personal bankruptcy filings have exploded.Some individuals seeking bankruptcy protection may benefit from including federal tax debts in their petition.Unfortunately, not all tax debts are dischargeable in bankruptcy.To be dischargeable, individual income tax liabilities must meet the following “mechanical” rules of 11 USC 523(a)(1) and 507(a)(8):
- More than three years must have elapsed since the tax return generating the liability was due, including extensions.Various acts such as prior bankruptcies, collection due process (CDP) hearings, innocent spouse relief and tax assistance orders can extend the thee-year time frame.
- The tax return must have been filed more than two years earlier than the bankruptcy petition (generally applicable to late-filed returns).Note, however, that Internal Revenue Service (IRS)-prepared “substitute for returns” are not considered filed returns for this purpose and thus a tax liability assessed from them would not be subject to discharge (IRC 6062(b)).Therefore, it is almost always advisable for the individual to file all delinquent returns and, if possible, let the mechanical time frames pass before the bankruptcy petition is filed.
- At least 240 days must have elapsed since the date of an IRS assessment (generally applicable to audit adjustments and amended returns).This time frame is extended by an offer in compromise agreement with the IRS.
Filing fraudulent returns or willful attempts to evade or defeat tax also can prevent such taxes from being discharged.Certain other types of taxes, including withheld payroll taxes, the trust fund penalty under IRC 6672, most state sales taxes and certain excise taxes, are never dischargeable.Such non-dischargeable taxes may also be priority debts.