Bankruptcy can provide a fresh financial start. Taxes can complicate this fresh start. Certain income taxes are dischargeable, while other income taxes are non-dischargeable, or remain after the bankruptcy. This article addresses what income tax debt is dischargeable and what income tax debt is non-dischargeable.
The dischargeability of income taxes depends on a three-pronged test; each prong must be met in order for the taxes to be discharged in bankruptcy. These three prongs are:
1. The tax year must be more than 3 years ago;
2. The tax return must be timely filed; and
3. The tax must not be assessed in the past 240 days.
If all of these prongs are met, the tax debt is dischargeable. But what do each of these prongs mean in turn?
1. The tax year must be three years ago to be dischargeable in a bankruptcy. This three year rule counts back to when the taxes were due. For example, the 2009 tax return was not due until April 15, 2010. Add three years to this date, and the resulting time is April 15, 2013, which is three years. However, if a consumer obtains an extension to file taxes, to October 15, 2010 for the 2009 tax year, then the three-year period is not reached until October 15, 2013.
2. The tax return was timely filed. For a tax return to be timely filed for the purpose of dischargeability in bankruptcy, the return must have been submitted to the IRS or Oregon Department of Revenue (ODR) more than 2 years ago. Therefore, in the example from above for tax year 2009, we meet the three year test (tax year was more than three years ago) and if the return was timely filed, meaning it was filed more than 2 years ago (today is 1/13/2014; two years prior would be before 1/13/2012), then we have met the second prong of the test. [However, if a failure to file (Oregon Department of Revenue) or a Substitute for Return (IRS) is filed by the taxing authority on your behalf, then the return is not timely filed. In this set of circumstances, the return will never be timely filed if the ODR or IRS files a failure to file or Substitute for Return on your behalf, despite submitting a return later on for the same year in question.]
3. The tax return was not accessed in the last 240 days. Tax returns are usually assessed right around the time the returns are submitted to the IRS or ODR.
How do you determine if your tax debt is dischargeable? Ordering tax transcripts from the ODR and IRS will provide useful insight into when tax returns were submitted, when tax returns were assessed, if tax returns were not filed, and if the ODR or IRS filed a failure to file or substitute for return after non-receipt of a tax return. I usually have my clients sign a power of attorney form so that I may directly obtain these transcripts from the ODR and IRS.
Taxes and bankruptcy can be a complicated matter. In some instances, we must wait to file bankruptcy until we meet the above three-pronged test to make certain that tax debt is dischargeable.
If you have tax liability and you want to know if it will be discharged in bankruptcy, please call for a free consultation.