There is a misconception that tax debt cannot be discharged in bankruptcy. As you will see below, there are certain circumstances when a taxpayer can be relieved of a tax debt. I don’t recommend bankruptcy lightly. Bankruptcy should be used when all other avenues have been exhausted.
Certain back taxes can be discharged in bankruptcy
You can discharge some back federal, state, and local income taxes in Chapter 7, Chapter 13, and Chapter 11 bankruptcy. In addition, the penalties and interest attached to these taxes are dischargeable. Determining which back taxes are dischargeable can be a complex process.
For individuals, the most common type of bankruptcy is a Chapter 13. Before you consider filing a Chapter 13 here are some things you should know:
- You must file all required tax returns for tax periods ending within four years of your bankruptcy filing.
- During your bankruptcy you must continue to file, or get an extension of time to file, all required returns.
- During your bankruptcy case you should pay all current taxes as they come due.
- Failure to file returns and/or pay current taxes during your bankruptcy may result in your case being dismissed.
Know the bankruptcy rules
The Bankruptcy Code sets out specific time periods that determine if you can discharge your taxes, commonly called the 3-year, 2-year, and 240-day rules (the “3-2-240 rules”). Under these rules, you can discharge income taxes that came due three years before you file for bankruptcy, as long as it has been at least two years since you filed the tax forms and 240 days since the taxes were assessed. There are some exceptions, and these rules do not apply to all types of taxes such as payroll trust fund taxes. To discharge back income taxes, be aware that you must meet the requirements of all three rules.
- The 3-Year Rule. This rule states that to discharge your back income taxes, they must become due at least three years before you file for bankruptcy. Bankruptcy Code §507(a)(8)(A)(i). Typically, your federal and most state income taxes become due on or around April 15th of each year. In most cases, it is simply a matter of adding three years to this due date to determine the earliest date you can file for bankruptcy and still discharge your taxes. However, if you get an extension of time to file, the three-year period runs from the date that the taxes are due under the extension.
- The 2-Year Rule. Under the 2-year rule, your income tax returns must have been filed at least two years before you file your bankruptcy petition. This requirement allows you to discharge your taxes even if you file your tax forms late, as long as you file the forms at least two years before filing for bankruptcy. §523(a)(1)(b)(ii).
- The 240-Day Rule. Taxes must have been assessed by the taxing agency at least 240 days before you file for bankruptcy under this rule or not assessed at all.
Discharging personal income tax debt
Income taxes that you incur personally as a result operating a business are dischargeable in bankruptcy under the 3-2-240 rules. However, different rules apply to other business-related taxes.
Payroll trust fund taxes are not dischargeable in bankruptcy
Trust fund taxes include payroll taxes that the employer withholds from an employee’s pay. If you fail to withhold required taxes or withhold the taxes from an employee’s check but fail to pay the withheld funds to the taxing authority, the taxes are not dischargeable.
Discharging deliquent payroll tax
The employer’s part of the payroll tax (the tax paid directly by the employer for Social Security and Medicare) is dischargeable in bankruptcy under rules similar to the 3-2-240 rules. The debtor must file for bankruptcy a minimum of three years from the date that the IRS 941 form was due and two years from the date the debtor filed the tax forms.
How we can help with tax planning
Sheltra Tax & Accounting planning service includes advising our clients concerning not only tax liabilities that may currently be discharged but also those that may soon meet the requirements for discharge. If outstanding tax liabilities do not currently meet the requirements for discharge but soon will, the client may want to consider postponing the filing date of the petition. Time can be gained by negotiating an installment agreement with the IRS. An installment agreement may give the client sufficient relief while allowing time to pass as needed for income taxes to become eligible for discharge.
It’s easy for good, hard-working Americans to fall behind. Providing IRS Tax help was a natural evolution for us at Sheltra Tax & Accounting, LLC. Our compassionate team wants to help taxpayers. We have come across many people who have tried to handle their IRS situation themselves but didn’t receive the relief they were seeking. The professionals on our staff know the “ins and outs” of the tax system and can negotiate a personalized solution.
We handle IRS representation services which include:
- preparation of unfiled income tax returns,
- penalty reduction,
- offers in compromise,
- payment plans,
- financial hardship plans,
- wage garnishment/bank levy releases,
- audits and IRS appeals.
We’ll listen to the taxpayer’s IRS difficulties in our office in complete confidence at NO CHARGE. We’ll answer questions, explain options and suggest solutions and provide an estimate of our fees to permanently resolve IRS difficulties. Give us a call.