Discharging Personal Income Taxes in Bankruptcy

by Richard S. Feinsilver on February 6, 2010

There has been a long standing misconception that all tax liabilities were not dischargeable in personal bankruptcy. While the bankruptcy law has always held that payroll and sales tax liabilities incurred by the owner of a business could not be discharged in bankruptcy, certain personal income tax liabilities can be discharged in either a Chapter 7 or Chapter 13 bankruptcy provided that the tax liability meet three distinct criteria.

First, the tax liability must be at least three tax years old. This criteria is not as straight forward as it sounds. The Internal Revenue Code states that an individual’s tax liability is due and payable by April 15th of the year after the tax came due. The three year period starts from April 15th of the year after the tax became due, not December 31st of the tax year. For example, an individual’s tax liability for the tax year ending December 31, 2008 did not become due and payable until April 15, 2009. A taxpayer’s 2008 tax liability would not be eligible for discharge until April 16, 2012.

Second, it must be at least two years since the tax return was filed and accepted by the taxing authority. This criteria is also a little tricky. Prior to October 17, 2005, an individual could discharge certain personal income tax liabilities in Chapter 13 bankruptcy without meeting this criteria – in fact, an individual was not even required to prove that they even filed a return. This has now all changed. In order for a tax return to be eligible for discharge in bankruptcy, a return must be actually filed with the taxing authority.

Let’s look at the terms “filed” and “accepted” individually. An income tax return is considered to be “filed” by a taxing authority when it is received – again fairly straight forward. A tax return is deemed “filed” when either it is filed electronically and you have an e-filing receipt, or it is physically received by the taxing authority. The term “accepted” has an entirely different meaning. In tax terms, the word “accepted” does not have the same meaning as “received”. The term “accepted” means that the taxing authority has received and reviewed your return. If a taxing authority makes an inquiry, or conducts an audit of a return, the return is not deemed “accepted” until that process in completed and closed by the taxing authority. Sometimes, this process can take months, or even longer.

Last, it must be at least 240 days since the tax has been “assessed” by the taxing authority. The date of “assessment” is the date that the taxing authority has closed their file (in the case of a review, recalculation or audit) and has issued a demand for payment.

If a personal income tax liability meet all three of the above criteria, that liability can be discharged in a personal bankruptcy filing. As a reminder, though, the calculation of the above dates and timeframes must be exact. A miscalculation of even one day can cost you thousands of dollars in tax liabilities and possible penalties and interest. You can readily find out all of the above dates by contacting either the Internal Revenue Service or your local taxing authority by requesting a tax transcript from the taxing authority.

Comments on this entry are closed.

Previous post:

Next post: