Timing: Writing Off Income Taxes
Usually you can discharge—write off—an income tax debt by just waiting long enough. Here’s how to discharge a tax debt under Chapter 7.
Timing is Just About Everything
If you owe an income tax debt and file a Chapter 7 “straight bankruptcy” case, one of two things will happen to that debt:
- It will be discharged—permanently written off—just like any medical bill or other ordinary debt, or else
- Nothing will happen to that tax debt; you’ll continue to owe it as if you hadn’t filed bankruptcy.
The difference, most of the time, is timing—when you file your Chapter 7 case.
The Timing Rules
In most situations a Chapter 7 case will discharge an income tax debt if you meet two timing conditions. The date you and your bankruptcy lawyer file that case must be both:
- at least 3 years after the tax return for that tax was due, and
- at least 2 years after that tax return was actually submitted to the IRS or state tax authority.
See Sections 507(a)(8)(A)(i) and 523(a)(1)(B) of the U.S. Bankruptcy Code.
One important twist: IF you got an extension to file the applicable tax return, then the above 3-year waiting period doesn’t begin until the end of the extension. Section 507(a)(8)(A)(i). For example, let’s say you got a 6-month extension from April 15 to October 15 of the pertinent year. So then the 3-year period starts on that October 15 instead of on the usual April 15 return filing due date.
These Rules Applied
Assume you owe $7,500 in income taxes for the 2013 tax year. You’d asked for a 6-month extension to October 15, 2014. But then you didn’t actually submit the tax return until December 31, 2014.
If you’d file a Chapter 7 case at any point before October 15, 2017, you’d continue owing the $7,500 tax. If you’d file on or after October 15 you would likely not owe a dime.
That’s because on October 15, 2017:
- At least 3 years would have passed since the extended due date of October 15, 2014, and ALSO
- At least 2 years would have passed since actually submitting the tax return on December 31, 2014.
Or, take with same $7,500 tax debt for the 2013 tax year with similar facts but a couple differences. You didn’t ask for an extension, but also didn’t submit the tax return until December 31, 2015.
Under these facts you’d have to wait until after December 31, 2017 to file the Chapter 7 case.
- 3 years since the tax return was due—on April 15, 2014—would have passed on April 15, 2017, but
- 2 years from the day the return was actually submitted would not pass until December 31, 2017.
Earlier we said that “in most situations” Chapter 7 discharges income taxes debt when you meet the two timing conditions. So what are the other situations when taxes would not be discharged, even after meeting the 2-year and 3-year conditions?
There are two sets of them.
The first set comes into play if you made an “offer in compromise” to the IRS or state to settle the debt, or if you had filed a prior bankruptcy case involving this same tax debt. Since these are unusual situations, and the rules are detailed, talk with your bankruptcy lawyer if they apply to you.
The second set applies in situations in which the taxpayer “made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.” Section 523(a)(1)(C). Different bankruptcy judges interpret this language differently. For example, is it a willful attempt to evade a tax to merely not submit its tax return when due, even if you submitted it voluntarily a year later? How about if you didn’t submit the tax return until the IRS personally contacted you to do so? Again, talk with your bankruptcy lawyer about how this part of the Bankruptcy Code is interpreted by your court.