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More On Taxes and Bankruptcy


More on Taxes and Bankruptcy

Most people think that filing bankruptcy can't get rid of taxes. This is not true. Both Chapter 7 and Chapter 13 of the Bankruptcy Code provide for the elimination of substantial amounts of personal "income" tax liability.

There are, however, certain requirements...but when these requirements are met....taxes can be eliminated as easily as unsecured credit card debt.

Income Tax Discharge Guidelines

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) enacted by Congress and signed by the President in 2005 essentially merged the tax discharge rules applicable to Chapter 7 and Chapter 13 bankruptcies. These rules are complex, and their specific application to a taxpayer depends on the individual facts and circumstances of each particular case. In simple terms, most “old” taxes can be discharged, while “new” tax liabilities are treated as “priority taxes” and are nondischargeable.

The ability to discharge a tax in bankruptcy, and the selection of the proper bankruptcy chapter, is primarily determined by four dates: (1) the last date on which the taxpayer’s return was due for the year of the delinquent tax; (2) the date the taxpayer actually filed the applicable return; (3) the date the tax in question was assessed by the IRS; and (4) the proximity of the foregoing dates to the taxpayer’s bankruptcy case filing date.   These time requirements are found in Bankruptcy Code (the “Bankruptcy Code”) Sections  507(a)(8)(A)(i), 523(a)(1)(B) and 507(a)(8)(A)(ii), respectively.  Generally, the Bankruptcy Code allows an individual to discharge an income tax if all of the following requirements are met:

  • The tax return was filed more than two years before the bankruptcy filing;
  • The tax return was due more than three years before  the bankruptcy filing;
  • The tax liability was assessed more than 240 days before the bankruptcy filing;
  • The taxpayer did not file a fraudulent tax return or engage in tax fraud; and 
  • A tax return was actually filed for the delinquent tax liability.

In plain language the bankruptcy discharge of a personal income tax liability is primarily governed by the lapse of different time periods from the tax return due date, the actual return filing date and the tax assessment date, to the date of a taxpayer’s bankruptcy filing date.  These periods can be thought of as separate statutes of limitation periods that once expired will convert a tax from a non-dischargeable “priority tax” to a dischargeable “non-priority tax” that may be dischargeable in a bankruptcy case. An income tax will be dischargeable (subject to certain bad conduct rules) if all of the foregoing time periods have expired: (1)  the taxpayer’s return was due (including all extensions) more than 3 years before the bankruptcy filing (the 3 -Year Look Back Rule); (2) the return was actually filed more than two years before the bankruptcy filing (the 2-Year  Filing Rule); and (3) the tax was actually assessed more than 240 days before the bankruptcy filing (the 240-Day Assessment Rule). 

Unfortunately, calculation of the beginning and end of the 2-Year Rule, 3-Year Rule and 240-Day Rule is not simple, and often requires experience in reviewing and interpreting Internal Revenue Service tax transcripts. Additionally, the running of these time periods can be extended, or tolled, by many different events. For example, a prior bankruptcy stops the clock, or tolls, the running of the Two-Year Filing and Three-Year Look Back time periods; an offer in compromise will toll the running of the 240-Day period; and a Collection Due Process Appeal of a proposed assessment will toll the commencement, and hence, the running of the 240-Day period. The various time and limitation periods for tax collection and bankruptcy discharge, and the possible occurrence of events that may toll the running of these “limitations” periods,  are among the most important considerations in planning for and implementing strategies to solve a client’s delinquent tax obligations.  

The availability and benefits of a bankruptcy discharge of income tax liabilities may also be impacted by the existence of a filed Notice of Federal Tax Lien encumbering the taxpayer’s property. A filed federal tax lien attaches to all of the taxpayer’s real and personal property and must be taken into account in any bankruptcy filing or other delinquent tax solution considered by the taxpayer or the taxpayer’s legal counsel. The interplay of delinquent federal tax liabilities, a filed tax lien and bankruptcy, has always been one of the most complex areas of law, and is  now even further complicated by  provisions contained in The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.  If you have had a federal tax lien filed against you, it is imperative that you seek knowledgeable legal counsel.

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What if the IRS has filed a tax lien?

A "tax lien" is where the IRS files a Notice of Lien in a local County Clerk's office. The filing of a tax lien does not make a dischargeable tax into a non-dischargeable tax.....but the filing of a tax lien can...as a practical matter... substantially diminish the benefit. The reason is this. When a tax is dischargeable....by this we mean that it can be gotten rid of as a "personal" obligation of the taxpayer. What a tax lien does is put a lien on the things the taxpayer owns. More specifically, a tax lien is a lien against "all personal and real property" of the taxpayer, no matter where the property is located; so long as the lien was properly filed. A lien works like this. It encumbers the property on which it affects, much like a mortgage encumbers your house.

For purposes of bankruptcy, if you want to keep the property encumbered by a tax lien, you have to pay the IRS....at least up to the value of the property encumbered. For instance, say you own a home that is worth $100,000, on which you have a mortgage with a payoff of $90,000. And say you owe the IRS $30,000 in taxes for taxes old enough to be discharged. If the IRS files a lien for $30,000 in the county where this real property is located, the lien would....in effect...eat up the $10,000 in the value of your home above what is owed on your mortgage. For purposes of Chapter 13, if you want to keep your home, you would have to figure in to your Chapter 13 plan payments sufficient to pay the full $10,000 to the IRS, plus interest. Assuming the lien does not encumber any other property, the other $20,000 would be discharged in the Chapter 13 case. The good news is that...although the $10,000 needs to be paid to the IRS....in Chapter 13, the IRS can be forced to take payments over the life of the plan, which can be up to 5 years, making the payment of this debt more affordable, while preserving your right to keep your home.

For purposes of Chapter 7....using the same example....and since liens generally "pass through bankruptcy" unaffected, the tax would be discharged, but the tax lien would remain a lien on your home after your bankruptcy case is done.

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How Do You Find Out All The Information About My Taxes?

We make a special written request to the IRS for information. Getting information from the "horse's mouth" is the only way we can properly represent you. Debtors who failed to keep copies of their returns can obtain copies or transcripts from the IRS. Though not an actual photocopy of the return, a tax return transcript shows most line items from the return, as filed. There is no charge for a transcript, but user fees apply for copies of the actual return.

To request a free transcript you will need to complete Form 4506T. Mail or fax a completed Form 4506T to the IRS. Transcripts are available for the current and three prior calendar years. Transcripts can also be ordered by calling 1-800-829-1040. 

Alternatively, taxpayers can use Form 4506 to request a copy of a tax return. This form can be downloaded from the Forms and Publications section of this Web site or obtained by calling 1-800-TAX-FORM (829-3676). Mail the completed form to the address in the instructions and include a check or money order for $43.00.

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What about "income" taxes assessed by a State government?

With very few exceptions, the same rules that apply to the IRS, also apply to the State.


The discussion of taxes above has been greatly simplified to promote understanding, and results will vary greatly depending upon your particular assets, debts, income, expenses, and the timing of your filing.

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