October 17, 2014
By: Dan Gibson, CPA
There is a common misconception that all income tax debt is dischargeable in bankruptcy. In fact, you can discharge your back federal, state, and local income tax debt in Chapter 7, Chapter 13, and Chapter 11 if certain criteria are met. That’s where determining which back tax debt is dischargeable can be a little complex.
The 3-Year, 2-Year, and 240-Day Rules
The Bankruptcy code sets out specific time periods that determine if you can discharge your taxes, often called the 3-year, 2-year, and 240-day rules (or the 3-2-240 rules). Under these rules, you can discharge taxes that came due 3 years before filing for bankruptcy, as long as it has been at least 2 years since you filed the tax forms and 240 days since the taxes were assessed. These rules are often misunderstood. However, the important thing to understand is that you must meet the requirements of all three rules to discharge your taxes.
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. Typically, your 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 you can file for bankruptcy and still discharge your taxes.
Example: Joe’s 2008 federal income taxes are due on April 15, 2009. If Joe owes taxes for that year and wants to discharge them, the earliest he can file for bankruptcy is April 15, 2012 (April 15, 2009, plus 3 years).
The 2-Year Rule: Under the 2-year rule, your income tax returns must have been filed at least two years before filing your bankruptcy petition. This requirement allows you to discharge your taxes, even if you filed your tax forms late, as long as you file them at least two years before filing for bankruptcy.
Example: Jill’s 2008 income taxes were due on April 15, 2009. However, she did not get around to filing her tax forms until June 1, 2010. If Jill wants to discharge her 2009 taxes, she cannot file for bankruptcy until June 1, 2012 (two years from the date she filed her taxes AND more than three years from the date the taxes were due).
What if you did not file? 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 advised to go ahead and file the tax forms, then wait to file for bankruptcy.
The 240-Day Rule: Taxes must be assessed at least 240 days before you file for bankruptcy under this rule. As a practical matter, the date of assessment is typically on or near the date you filed your income tax form (assuming the IRS and you agree on the amount of taxes owed). However, if you file a correction or a change results from an IRS audit, the assessment date may be substantially later.
Example: Jill files her 2008 taxes on time on April 15, 2009. The IRS audits Jill’s taxes and finds that Jill made a mistake. She actually owes a few hundred dollars more than shown on her original tax form. The IRS assesses the new amount on March 1, 2011. To discharge these taxes, Jill will have to wait until October 27, 2011 to file for bankruptcy (240 days from the IRS’s new assessment).
If back taxes are an issue, it may be necessary to 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, or using IRS Form 4506T.
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 filed for bankruptcy previously, or (3) obtaining a taxpayer assistance order. However, simply entering into a payment arrangement with the IRS does not toll the statute of limitations.
If you have any questions on this issue or any other bankruptcy matters, please do not hesitate to contact your tax or bankruptcy professional.
If you want to learn more about this topic and other issues when working with the IRS, please join Tim Schuster and myself in a one hour webinar titled “Dealing with the IRS: What You Need to Know” October 23 at Noon E.T. - See more