(1) The tax debt is for income taxes. Either chapter can eliminate income taxes owed. Taxes owed for payroll withholding taxes for employees, sales taxes and other “trust fund” taxes cannot be eliminated in a bankruptcy. Penalties and interest on taxes owed for fraud may not be eliminated. However, penalties and interest owed on income taxes may be discharged. Even if the tax cannot be discharged by the bankruptcy, interest and penalties may be eliminated on the non-dischargeable tax.
(2) The tax debt is at least three (3) years old. The taxable year does not necessarily indicate the age of the tax debt. For example, if you did not file your 2012 income tax return until October of 2015, the tax debt will not be three years old until October of 2018. However, if you filed your 2012 tax return on or before April 15, 2013, then your tax debt for 2012 is older than three years.
(3) The return has been filed within the last two (2) years. The return for the year owed must be filed for at least two years to qualify for a bankruptcy discharge. The two-year requirement begins once the tax authority has received the return from the tax payer. For example, if your 2013 return was not filed until November 12, 2016, then the tax return for that year will not meet this requirement until November 12, 2018. If the taxing authority has filed a return on your behalf, your tax return has not been filed by you and this requirement is not met.
(4) The tax debt must be assessed for at least 240 days prior to the bankruptcy. The date of the tax assessment is not necessarily the date the tax return was filed. Typically, the IRS will assess the tax upon receipt of the tax payer’s return. However, there are intervening factors that may delay the assessment of tax. Random audits, target audits, amended returns and offers in compromise may delay the date of assessment. The IRS has a three (3) year look back period to examine the tax payer’s income and deductions. For most tax payers, the assessment of the tax is when the return is filed.
(5) No fraud or evasion. Tax returns that purposefully mislead the taxing authority are not dischargeable. This would include taxes filed for identity theft or misuse of a social security number and knowingly understating income and deductions.
If a client meets the above criteria, the bankruptcy code can afford relief. Chapter 7 and Chapter 13 would eliminate the income tax debt once a discharge issued by the Court. Even if the client does not meet all the above, the client may be well served with a Chapter 13 bankruptcy. A Chapter 13 will allow the client to propose a repayment of any non-dischargeable income tax debt over three to five years and can eliminate interest and penalties.