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Are Taxes Dischargeable In Bankruptcy?

An unfortunate fact is that many people who have financial difficulty also have problems with their taxes. While the persons most likely to have tax debt continue to be businesspersons and independent contractors, there also seems to be an increasing number of wage-earners who have tax problems.

For whatever reason, the general perception is that taxes are not dischargeable in bankruptcy. Many people are therefore surprised to learn that the reality is less restrictive: in certain circumstances, filing bankruptcy may allow individuals to discharge tax debts or repay them under advantageous terms.

Legal Analysis Of Tax Debt

In legal terms, the Bankruptcy Code provides for the discharge of certain taxes in both liquidation case (chapter 7) and reorganization cases (chapters 11 and 13). Whether a particular tax debt is dischargeable mostly depends on:

  • The type of tax owed;
  • The circumstances surrounding the debt; and
  • The chapter of bankruptcy filed.

This article deals with the discharge of tax debts in chapter 7 bankruptcy. To discuss the dischargeability of taxes under a different chapter of the bankruptcy code, please contact us directly.

What Types of Taxes are Dischargeable?

In general, only income taxes are dischargeable; other types of taxes, such as withholding taxes and sales taxes, typically cannot be discharged.

What are the Requirements to Discharge Income Tax Debt in a Chapter 7 Bankruptcy?

Under section 727 of the Bankruptcy Code, income tax debt must meet at least the following requirements to be dischargeable:

  • The Three Year Rule. For a tax debt to be dischargeable, the tax return for that debt must have been due (whether filed or not) at least three years prior to filing bankruptcy. For the purposes of the Three Year Rule, the due date for a tax return is the last day on which the return could have been filed without being overdue. Extensions to file tax returns also extend this period.
  • The Two Year Rule. Under chapter 7, the tax return must have been actually filed at least two years before the bankruptcy petition is filed. (Chapter 13 cases have a different rule).
  • The 240 Day Rule. The tax debt must also have been assessed at least 240 days before the chapter 7 is filed. The 240 day rule typically applies when additional taxes are assessed as a result of an audit or the taxpayer's filing of an amended return. In those situations, a tax debt is deemed assessed after the taxpayer has been given notice and an opportunity to challenge the deficiency. The date of assessment is usually the date on which the tax becomes final.
  • Tax Debts Cannot Be Fraudulent. Generally, if the taxpayer files a fraudulent return or willfully atempts to evade or defeat taxes, the taxes are non-dischargeable. The IRS generally has the burden of proving fraud by clear and convincing evidence.

 

The above information is, of course, just a guideline for the dischargeability of tax debt in chapter 7 bankruptcy. Dealing with tax debt in any type of bankruptcy is complex, and you should always contact an experienced bankruptcy attorney to discuss the particulars of your situation.

To discuss your financial situation and options in more detail, please contact us or use our online scheduler for a free consultation. You may also submit your information for review by a Minnesota bankruptcy attorney.

To read about whether student loans are dischargeable in bankruptcy, click the 'Next' button.


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