Most lawyers and CPAs will tell you that income tax debt is dischargeable in bankruptcy. Sure, there is a waiting period and some exceptions too. If the IRS can prove you engaged in tax evasion, your tax debt doesn’t get discharged.
Some new rulings are creating major uncertainty, however, to the general premise that income tax debt is dischargeable.
The U.S. Bankruptcy Code determines what tax debts can be discharged. If the court discharges the debt, the debtor can get a clean start and not have to worry about paying old tax bills. Certain taxes – trust funds taxes such as sales or withholding taxes – are generally not dischargeable. Taxes are also not dischargeable if the debtor fails to file a return. That makes sense; the court needs to have an accurate picture of one’s assets and liabilities before determining what needs to be paid and what can be discharged.
Section 523(a) of the bankruptcy code says that unfiled tax liabilities can’t be discharged. As noted above, no return means no discharge. There was little dispute over that provision of the code until 2006 when Congress amended the law and defined “return” as one that satisfies “applicable filing requirements.”
The Massachusetts Department of Revenue seized on that language and argued that a late filed return doesn’t satisfy state filing requirements. In a pair of recent rulings, bankruptcy courts split on the issue. Some federal bankruptcy judges have continued to follow the long standing precedent that income tax debts are dischargeable absent fraud or evasion. At least one judge agreed with the state, however, and said a late filed return does not qualify. That has created a split among courts.
Nationally, the 5th Circuit Court of Appeals (Louisiana, Mississippi and Texas) ruled last year that a late filed return can never qualify for dischargeability.
It is important to note that the taxes that seem to be impacted are state income tax debts. We are not aware of any cases where the IRS is arguing for nondischageability but with 94 federal judicial districts nationwide, anything is possible.
The takeaway from all this is to file timely, even if you can’t pay your taxes. The federal bankruptcy code was designed to give debtors a fresh start. Those protections aren’t available, however, if you have engaged in fraud or haven’t filed returns. Even a late filed return may cause problems down the road. If you own a business and don’t have enough money to pay all your taxes, speak to a lawyer or CPA. Generally, income taxes are dischargeable but some business taxes are not.
The tax lawyers at Mahany & Ertl help businesses and individual taxpayers with a wide variety tax controversy problems including audit defense, criminal tax investigations, penalty abatement, U.S. Tax Court appeals, trust fund recovery penalty audits and prebankruptcy tax planning. Have questions? Give us a call. All inquiries are protected by the attorney – client privilege and kept in strict confidence.
For more information, contact attorney Bethany Kroes at or by telephone at (414) 223-0464.
Mahany & Ertl – America’s Fraud Lawyers. Offices in Milwaukee, Wisconsin; Detroit, Michigan; Minneapolis, Minnesota; Portland, Maine and San Francisco, California. IRS services available in all jurisdictions.
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Posted by Brian Mahany, Esq.