by Brian Mahany
“Can taxes be discharged in bankruptcy?” is a question we hear frequently. The general answer is yes, but the question is not as simple as it sounds.
IRS tax debts are dischargeable if all of six criteria are met. The same rules generally apply for state tax debts. Property taxes are a horse of a different color and are not discussed in this post.
First, the tax must be one that is dischargeable. Most tax types including income taxes are dischargeable. Taxes that the IRS or state revenue service consider trust fund taxes may not be dischargeable, however. The two most common trust fund taxes are sales tax (state) and withholding taxes (state and federal). These are considered trust fund taxes because they were collected from a third party such as an employee or customer and were held in trust for the government.
The second criteria is that the tax debt must be at least three years old. The bankruptcy code looks at the due date of the return including any extensions on filing in calculating the 3 year time period.
Closely related to the due date is the actual filing date. In order to be discharged in bankruptcy, the return must have been filed more than two years prior to the bankruptcy filing.
The IRS must have assessed the tax at least 240 days prior to the filing as well. If you timely filed accurate returns, this provision usually doesn’t apply – you are covered by the 2 year rule above. But the 240 day rule may apply if the IRS issues an audit determination or assesses you additional taxes or penalties and that assessment becomes final.
In most cases, the date you can seek discharge is 3 years from the original due date of the return.. This assumes that taxes were properly prepared and timely filed.
Rule five is that the returns you filed were not fraudulent. Everyone makes mistakes but a frivolous or fraudulent return keeps you from obtaining a discharge in bankruptcy.
Closely related is the sixth rule; the bankruptcy code says that you can’t obtain a discharge if you intentionally attempted to evade your tax obligations. Unlike criminal tax evasion, however, the courts have given the IRS wide latitude in determining what constitutes “evasion.”
There are a few other rules to consider as well. You must be current with your tax filings to seek a discharge. In other words, you can’t seek to discharge a 2004 income tax if you still haven’t filed 2010 and 2012 returns. Ditto if you never filed a return for the year that you are seeking to return. This means if the IRS issued an assessment for an old year because you didn’t file a return, then you must actually file that return and wait the appropriate time periods if you ever hope to discharge that debt.
There are also special rules if you have unreported foreign bank and brokerage accounts.
It is impossible to discuss all the rules and exceptions in a short blog post. Obviously we can’t give legal advice by such postings. The quick takeaway to all this is that if you filed your individual income returns when due and simply can’t pay them, a bankruptcy attorney should be able to help you. If your tax debts result from a failed business, are large or result even in small part from unreported foreign accounts, seek the advice of a tax lawyer before spending thousands of dollars on a bankruptcy filing.
We said above to seek tax counsel even if there are no complicating factors in your proposed bankruptcy other than the size of the old tax debts. Why? Because if the debts are large, the IRS will look to see if you had the money during the last several years and just elected not to pay the IRS. Let’s use an example to better illustrate the point.
Say in 2006 you filed a return and owed $500,000 in taxes and didn’t pay it. If during the next few years you had great income but didn’t pay down on the old debt or lived a “lavish lifestyle”, the IRS may conclude you engaged in tax evasion and seek to deny your discharge. Remember, the definitions of evasion and standards of proof for purposes of the bankruptcy code differ from that under criminal tax law.
Mahany & Ertl is a full service boutique law firm specializing in tax and fraud matters. We can work with you before you file a bankruptcy to resolve your tax debts or better advise you or your bankruptcy lawyer on what tax debts are dischargeable. We can also help you come into compliance and assist with any offshore reporting issues such as missing FBAR filings which may hinder your bankruptcy.
We are a preferred legal services provider to the CPAmerica organization of accounting firms and founder Brian Mahany is Maine’s former state revenue commissioner. Many large firms have just one or two people with tax knowledge. At Mahany & Ertl, the entire firm is geared towards providing quality tax advice. For more information, contact attorney Bethany Kroes at or by telephone at (414) 223-0464. All inquiries are protected by the attorney – client privilege and kept in confidence.
Mahany & Ertl – America’s Tax Lawyers. Offices in Milwaukee, Wisconsin; Detroit, Michigan; Portland, Maine; Minneapolis, Minnesota and coming soon, San Francisco, California. IRS services available nationwide.