Dennis J. Shea

Discharge of Income Taxes in Bankruptcy

Discharge of Income Taxes in Bankruptcy

In general, taxes are considered to be a priority debt in bankruptcy. This means that in a taxing authority generally has a claim on any estate distributions which is superior to claims of general unsecured creditors. This priority of tax claims does not, however, affect a secured creditor’s properly-perfected security interest in collateral.

Frequently a more important issue than that of priority of tax debts is the issue of whether such debts are dischargeable. It is possible to discharge such debts, including federal and state income taxes. However, in order to discharge taxes, certain conditions must be met.

The first condition is that a discharge of taxes may only be obtained with respect to income taxes, not withholding taxes or similar payroll taxes.

Secondly, the taxes assessed cannot have been incurred by way of fraud or tax evasion. If you filed a tax return which fraudulently understated your income and resulting taxes, the taxes for that year cannot be discharged.

Third, the tax must have originally been due at least three years before the bankruptcy filing. For example, if income taxes were due on April 15, 2007, and the debtor filed a timely return but did not pay the taxes, such taxes may be discharged only if the bankruptcy case is opened after April 15, 2010. (Many taxpayers file for an extension of the filing deadline to October 15. In such cases, the three-year clock won’t begin to run until October 15.)

Fourth, the tax return for the taxes in question must have been filed at least two years before the filing of the bankruptcy petition.

Fifth, the taxes must have been assessed not less than 240 days before the filing of the petition in bankruptcy.

Income taxes are not considered "consumer debt". Therefore, income taxes are not included in totaling the debtor’s debts for purposes of the means test. This means that it may be possible to discharge income taxes even if it might initially appear that the debtor’s income is too high for the debtor to qualify to file bankruptcy.

Discharging taxes in bankruptcy is very tricky business. One illustration of the difficulty of successfully discharging income taxes is that the debtor should not rely on his or her own records to decide when the taxes were assessed, or how much is owed, or any other information critical to the filing. Those determinations should be made based on the records of the IRS. The IRS will upon request provide the reports necessary to analyze the dates of assessment, filing dates, and the like.

If you intend to attempt to discharge tax obligations by filing bankruptcy, you should consult an attorney. Each taxpayer’s situation is different, and filing bankruptcy to get out from under tax obligations is something which needs to be well-planned and fully thought out.