Bankruptcy updated 1/14/10

Taxes are generally not dischargeable in bankruptcy. Most rules have exceptions, and the exception for discharging taxes in bankruptcy is:

  1. Income taxes;
  2. Where the income tax return has been filed by the due date as extended, not to exceed 6 months * (an IRS "substitute for return" does not count);
  3. The return due date (e.g., April 15 of the following year) was more than 3 years before the date the bankruptcy petition is filed;
  4. If the return is filed late, it was filed more than 2 years before filing of the bankruptcy petition;
  5. The tax was "assessed" more than 240 days prior to filing of the bankruptcy petition (this applies where there is a later assessment after the return is filed, e.g., through an audit);
  6. There is no fraud involved in filing the return; and
  7. Some other minor conditions.

Taxes other than income taxes, such as sales taxes, employment taxes (forms 940 and 941), and the trust fund recovery penalty (personal liability of persons in charge for a corporation's or other entity's failure to pay employment taxes), cannot be discharged in bankruptcy.

The National Bankruptcy Forum is a consumer bankruptcy site, with bankruptcy attorneys all over the country contributing posts on various topics. You'll see posts on automatic stays, cars and bankruptcy, marriage and bankruptcy, protecting your property, tax issues, and much more. http://www.nationalbankruptcyforum.com/ new 1/14/10

Due date

Internal Revenue Code ("IRC") §§ 6072(a) and 6081(a) operate together to require that individual taxpayers must file an income tax return before April 15 of the year following the taxable year or within a period of time granted by an extension not to exceed six months (effectively denominating a late filed return an unfiled return). Thus, a late filed return cannot qualify as a return for determination of dischargeability.

While this appears insurmountable, a debtor confronted with a late filed return may still receive a discharge of the underlying tax debt under the “safe harbor” provision in § 6020(a), specifically mentioned in the “dangling paragraph” of amended § 523(a). The untimely filing taxpayer can disclose all the information necessary for the preparation of the return to the IRS, the “Secretary” may prepare the return, and, if signed by the taxpayer, it may be received by the “Secretary” as a timely return.

Date of bankruptcy filing

The timing of filing the bankruptcy petition is very important as to which tax years may be discharged. Filing a bankruptcy petition too early can prevent taxes from being discharged.

Statute of limitations suspended

Filing bankruptcy extends the normal 10 year statute of limitations on collections for the time the bankruptcy is pending plus 6 months, including if the bankruptcy is dismissed and no discharge is granted.

Tax lien NOT discharged

Discharge of liability for the tax does NOT extinguish the tax lien.

A general discharge in an individual's 2004 Chapter 7 bankruptcy case did not relieve him of his 1994-1998 federal income tax debt because the taxes remained assessable after his bankruptcy case was filed. the IRS issued a notice of deficiency, taxpayer filed a Tax Court petition, but filed the bankruptcy petition prior to trial in Tax Court. The 5th Circuit remanded the case to the bankruptcy court to determine whether the proposed tax penalties were nondischargeable. In the Matter of Charles R. Hosack Debtor. Charles R. Hosack, 2007-1 USTC ¶50,474 (5th Cir. 07-10828, May 2, 2008). Unpublished opinion affirming in part, remanding in part, per curiam , a DC Texas decision. new 5/21/08

Lien stripping

An IRS tax lien may be subject to "lien stripping" (liens reduced to the property value) in Chapter 11. The Supreme Court had held that a tax lien on real property could not be stripped down in Chapter 7 liquidation case. The Bankruptcy Court in Johnson v. IRS, Bktcy Ct PA, 101 AFTR 2d 2008-1798, held the IRS lien against Chapter 11 debtor's residence was null and void pursuant to 11 USC 506 because other priority liens pre-dating the IRS lien collectively exceeded residence's fair market value (FMV), so there was no equity in residence to which IRS lien could attach. The Bankruptcy Court held that in the Chapter 11 reorganization context, lien stripping is “ingrained” and crucial to achieving the Bankruptcy Code's rehabilitation and fresh start goals, and there was nothing inherent in an IRS lien allowing it to be treated differently from any other lien so as to be exempt from lien stripping. new 5/8/08

Marshalling

The IRS was denied dismissal of the Chapter 7 trustee's marshaling request to compel the IRS to levy and sell the residence for which taxpayer had claimed homestead exemption before other assets. The trustee was barred from selling the residence due to homestead exemption, so marshalling would preserve other bankruptcy estate assets for unsecured creditors without prejudicing the IRS. In Re: Szwyd, Bktcy Ct MA, 101 AFTR 2d ¶2008-789. new 5/20/08