If you owe income taxes, especially on more than one tax year, or you owe a large amount, Chapter 13 is often the better way to go. But you CAN also write off ("discharge") certain income taxes with a straightforward Chapter 7 filing. To do so, however, the tax debt that you are trying to discharge has to meet some very strict conditions. If it does meet those conditions, a Chapter 7 may well be your better choice.
Before listing those conditions, please understand that discharging taxes in bankruptcy is one of the more complicated issues in consumer bankruptcy law. I'm tackling this tough issue in a blog, because it's important for you to be informed about it. But part of being well-informed is understanding when you definitely need an attorney's help. This is definitely one of those areas.
So, here are the four main conditions that must be met to write off an income tax debt.
1. Three years must have passed since the applicable tax return was due. Every income tax debt has a specific date when its tax return must be filed. That makes calculating whether or not you've met this condition very straightforward. But there's an important twist here: if you requested an extension of time to file the tax return, the three-year period does not begin until the extended due date for filing the tax.
2. Two years must have passed since the applicable tax return was actually filed. No matter how long since the applicable tax return was due, at least two years must pass from the actual tax return filing date to the date of the bankruptcy filing. The important twist here: the tax return must have been filed by you, the taxpayer, NOT by the IRS or the California Franchise Tax Board. Such a "substitute for return"-the procedure in which the tax authority prepares a tax return on your behalf based on whatever information it has available-does not count as a filed return for the purposes of this two-year period. Some courts may treat as
non dischargeable taxes where a substitute tax return was filed. The taxes may still meet this rule where you filed a tax return after the "substitute for return" and before the taxes were assessed based on the substitute tax return.
3. 240 days must have passed since assessment of the tax. Assessment is the tax authority's formal determination of your tax liability, which normally happens after it reviews and accepts your tax return. Usually the assessment happens within just a few weeks after you file the return. So this condition is easily met in these normal situations because that 240-day period is over long before the above three-year and two-year requirements. It comes into play when there has been a delay in the assessment, such as when the amount of a tax is in dispute because of a tax audit or litigation in Tax Court. By the time the dispute is resolved and the accurate tax amount is assessed, the above three-year or two-year time periods may have passed. So in that situation, the tax can be discharged only if the bankruptcy case is filed more than 240 days after assessment. The extra twist here: this 240-day period is put on hold if you make an "offer in compromise" on the tax. That's a settlement proposal you make to a tax authority to pay less money or agree to certain payment terms. The idea is that the tax authority should have time to consider your offer without the threat of the deadline running while the offer is pending.
4. No filing of a fraudulent tax return or intentional attempt to evade the tax. If you were dishonest on your tax return-failed to include some of your income, for example--or tried to avoid paying a tax some other way, that tax cannot be written off in bankruptcy, even if all the time-based conditions have been met.
If you apply these four conditions to each one of your tax debts, you should get a good idea whether each of them can be discharged in a Chapter 7 bankruptcy case. But sometimes there are other considerations. Prior recorded tax liens and prior bankruptcy filings can affect the outcome. And where is the line drawn between a debtor's honest mistake on a tax return vs. intentional tax evasion?
So while Chapter 7 can definitely discharge income taxes in the right combination of circumstances, you need to have an experienced attorney guide you through ALL the rules pertinent to your case.