Discharging Taxes in Bankruptcy -

     Some taxes can be discharged ("wiped out") in bankruptcy, and some cannot. Taxes are often the most significant debt that a person may have. It is thus important to know whether or not the debt is likely to be dischargeable or non-dischargeable, before the case is filed. Good decisions are best made using the most accurate information available. This means employing competent counsel, and obtaining and analyzing copies of tax records from the tax authorities before filing the case.

Income Taxes and the Law

     Bankruptcy Code Section 523(a)(1) governs whether or not an income tax can be wiped out in bankruptcy. Generally, such taxes are dischargeable in bankruptcy if they are considered to be general unsecured claims. Income taxes which qualify as priority claims under Bankruptcy Code Section 507(3) and(8), on the other hand, cannot be wiped out in bankruptcy. Generally speaking an income tax can be wiped out if all 5 of the following criteria are met:

Criteria for Discharging Income Taxes

The tax first became due more than 3 years, including extensions, prior to the filing of the case The tax return has been on file for at least 2 years prior to the filing of the case The tax has been assessed for at least 240 days The tax cannot have been based on a false or fraudulent return The taxpayer cannot have willfully attempted to evade or defeat payment of the tax

Competent Counsel Should be Consulted

     At first blush, the above calculations may look pretty easy. In actual practice, however, this is an area fraught with the potential for big mistakes. The client with tax issues should thus employ an attorney who is conversant with the rules for dischargeability of taxes in bankruptcy. This is somewhat of a "crossover" specialty, combing knowledge of tax and bankruptcy law.

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Tax Transcripts

     First of all, the client or the attorney should not simply rely on the client's own records. They are not always complete or accurate, and may differ from the records of the tax entities. The attorney should obtain a tax transcript from the IRS or state taxing authority, and review it carefully.

Strategies in Filing a Bankruptcy Tax Case

     As a strategy, it is important not to file the case too early. There are some events which cause the 3-year, 2-year, and 240-day time periods to be suspended or "tolled". These include actions by the debtor-taxpayer preventing collection of the tax, like the filing of a prior bankruptcy case, the pendency of an offer in compromise, or the request by the debtor for a collection due process hearing and any appeal. In some instances, the running of the time periods is extended for the duration of the event, plus 30 days or more.

Date of Assessment

     The date of "assessment" is critical in these cases. Assessment refers to the determination by law by the taxing entity of the amount of tax due. For federal income tax, the assessment is made by the IRS recording the liability in its records, after the taxpayer has filed a return reporting a tax liability, and the IRS has sent out a Notice of Deficiency and the period to petition for review in tax court has expired; or if the matter went to tax court, the decision of the tax court has become final and non-appealable. The date of "assessment:" for state income taxes can vary from state to state. For instance, in California, the tax is considered to be "assessed" only when the 60-day appeal period has expired. Local law should be determined.

Conclusion

     To sum it up, if the case is filed too early, and the relevant time periods have not elapsed, the debt will be non-dischargeable. As a general rule, the Court will not allow the debtor to dismiss his case under these circumstances. The debtor will have lost the opportunity to discharge the tax.

Written by Henry Rendler