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Timing and discharge of tax debts in bankruptcy

Of all the debts that can be discharged in bankruptcy, past due federal taxes might be subject to the most complicated timing rules. There are generally no exceptions, so get a date wrong and you might not receive a discharge.

We’ll discuss one case that highlights what can go wrong. Bringing in the assistance of an attorney who understands both bankruptcy and tax law can avoid any timing problems.

A review of the basic rules

There are three dates that must be considered. They are:

  • Three years that need to pass from the date the tax liability became due. Applying for a collection due process hearing or innocent spouse relief can extend this time frame.
  • The tax return needs to be filed at least two years before petitioning for bankruptcy.
  • 240 days must have passed since the date of the IRS assessment.

If you have been accused of willfully attempting to evade taxes or filing a fraudulent return, your tax debt will not be discharged. 

Complicated rules require some advance planning

Pulling a tax transcript is the first way to determine what tax debts might be dischargeable.

But what is the right date to use for the three-year look back on assessment of penalties? This was the issue in a tax court case. The taxpayer asked for an extension to file for 2008. It was due on October 15, 2009. The taxpayer didn’t file the tax return until February 2011. The IRS assessed penalties for failing to file and failing to pay.

After filing for Chapter 7 bankruptcy in July 2012, the trustee used estate funds to pay the non-dischargeable tax bill from 2008. There was not enough left to cover penalties.

Later, the IRS took a California income tax refund and Social Security benefits to cover the penalty. The taxpayer fought back and the IRS agreed that the failure-to-pay penalty had been discharged. The failure-to-file was another story.

A court ultimately determined that the event that triggered that penalty was the failure to file by the extension date of October 15, 2009. This was not more than three years before the bankruptcy petition and this not discharged. Avoid this type of issue by planning ahead before filing for bankruptcy.

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