April 18, 2019

Tax Liability and Bankruptcy: What Tax Debts Can Be Discharged?

One frequent misunderstanding about bankruptcy is that tax debt is not dischargeable. It is true that many types of tax debts will survive bankruptcy. However, some tax debts can be discharged, but in order to do so, certain specific rules must be met. This article provides a brief summary of some general rules you can use to determine whether tax obligations might be discharged in a bankruptcy proceeding.

In order for back income taxes to be dischargeable, all aspects of the “3/2/240 rule” must be met. The 3/2/240 rule states that your back income taxes must have been due more than three years before filing for bankruptcy, you must have filed your tax return two years or more prior to filing bankruptcy, and your back income taxes must have been assessed at least 240 days before filing for bankruptcy.

3-Year Rule:

This part of the rule is simply adding three years to the due date of the tax returns in question to determine if they qualify. If your client’s 2015 tax returns were due on April 15, 2016, then the earliest a bankruptcy could be filed to attempt a discharge of the debts would be April 15, 2019. Any extensions will affect this deadline, and the three years will run from the due date of the extension.

2-Year Rule:

To fulfill the 2-year rule requirement, returns must be filed at least two years before filing for bankruptcy regardless of previously filing for an extension or not. The 2-year rule allows for potential opportunity to discharge your back taxes even though you may have originally filed your income tax returns after their due date. It is important to note that some courts have taken the position that any late filed tax returns, even if one day late, may not be discharged. The 6th Circuit has not followed this and instead uses a slightly more forgiving approach, but it is important to note that any late filed return creates an additional layer of issues that must be looked at.

240-Day Rule:

This requires that the taxes were assessed at least 240 days prior to filing for bankruptcy. While this date is typically near the time the taxes were filed, the assessment date can be delayed as a result of audits or corrected returns.

Exceptions and Potential Issues:

There are a number of exceptions to the 3/2/240 rule, including fraud, tax evasion, and the filing of substitute forms by the IRS. In addition, the various timelines can be tolled by certain events, such as time in a previous bankruptcy or an offer in compromise.

While the facts related to any tax liability must be closely reviewed to determine if discharge in bankruptcy is an option, it is important to understand that it is possible in the right circumstances.  If you have any questions about tax liability and bankrutpcy, please contact one of the attorneys at Keller & Almassian, PLC.

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