The Internal Revenue Service (“IRS”) is the 100 pound gorilla in the room when it comes to filing for bankruptcy, because with limited exceptions income tax debts are not dischargeable in bankruptcy. The purpose of this post is to review the limited exceptions that enable individuals to discharge federal and state income taxes in Chapter 7, Chapter 11, and Chapter 13 bankruptcy cases.
The 3-Year, 2-Year, and 240-Day Rules
The U.S. Bankruptcy Code sets out specific time periods that determine if a debtor can discharge personal income taxes, often called the 3-year, 2-year, and 240-day rules (or the 3-2-240 rules). Under these rules, an individual debtor can discharge taxes that came due 3 years before the bankruptcy filing date, as long as it has been at least 2 years since the debtor filed the tax forms and 240 days since the taxes were assessed. The debtor must satisfy the requirements of all three rules to discharge personal income taxes.
The 3-Year Rule:
This rule states that for a debtor to discharge back income taxes, the taxes must become due at least three years before the debtor’s bankruptcy filing date. 11 U.S.C. §507(a)(8)(A)(i). Typically, federal and most state income taxes become due on or around April 15 of each year. In most cases, it is simply a matter of adding three years to this due date to determine the earliest date a debtor can file for bankruptcy and still discharge personal taxes.
Example: Bob’s 2007 federal income taxes are due on April 15, 2008. If Bob owes taxes for that year and wants to discharge them, the earliest Bob can file for bankruptcy is April 15, 20121(April 15, 2008, plus 3 years).
The 2-Year Rule:
Under the 2-year rule, an individual debtor’s income tax returns must have been filed at least two years before filing a bankruptcy petition. 11 U.S.C. §523(a)(1)(b)(ii). This requirement allows a debtor to discharge taxes even if the tax return was filed late, as long as the return was filed at least two years before the debtor’s bankruptcy filing date.
Example: Jim’s 2008 income taxes were due on April 15, 2009. However, Jim didn’t file his tax return until June 10, 2011. If Jim wants to discharge his 2009 taxes, he cannot file for bankruptcy until June 10, 2013 (two years from the date he filed his taxes AND more than three years from the date the taxes were due).
What if you don’t file a tax return in a given year, is the debt still dischargeable in bankruptcy under these rules? No. If you did not file an income tax return in a given tax year, any taxes assessed by the IRS for that year are not dischargeable. If the tax debt is significant, you might be wise to file the tax return and wait out the appropriate period to file bankruptcy.
The 240-Day Rule:
Taxes must be assessed at least 240 days before a debtor files for bankruptcy under this rule. 11 U.S.C. §507 (a)(8)(A)(ii). As a practical matter, the date of assessment is typically on or near the date the taxpayer files his/her individual tax return (assuming the IRS and the taxpayer agree on the amount of taxes owed). However, if the taxpayer files a correction, or a change results from an IRS audit, the assessment date may be substantially later.
Example: JoAnne files her 2008 taxes on time on April 15, 2009. The IRS audits JoAnne’s taxes and finds that JoAnne made a mistake. She actually owes $1,0000 dollars more than reflected on her original tax form. The IRS assesses the new amount on March 1, 2011. To discharge these taxes, JoAnne will have to wait until October 27, 2011 to file for bankruptcy (240 days from the IRS’s new assessment).
Obtaining an IRS Transcript
Frequently, individuals in financial distress are unable to confirm whether they filed tax returns on time, did so under an extension, or made any periodic payments. To avoid missteps the prudent debtor will order an IRS “account transcript” for the tax years in question. The account transcript typically includes the assessment date. You can order an account transcript from the IRS over the phone or online at http://www.irs.gov/Individuals/Get-Transcript.
Other actions can add additional time to some or all of the 3-2-240 time requirements, including (a) making an offer in compromise, (b) having previously filed for bankruptcy, or (3) obtaining a taxpayer assistance order. However, simply entering into a payment arrangement with the IRS does not toll the statute of limitations.
LoFaro & Reiser represents individuals in Chapter 7, Chapter 11 and Chapter 13 bankruptcy filings in the United States Bankruptcy Court for the District of New Jersey based in Newark, Camden, and Trenton. Need assistance determining whether you can discharge personal income taxes in bankruptcy? Contact our office for a free bankruptcy consultation.
IRS CIRCULAR 230 DISCLOSURE: To ensure compliance with the requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this post is not to be used or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code; or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.