Dischargeability of Federal and State Income Taxes
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Most attorneys, CPAs, tax professionals, and taxpayers do not know that you can discharge back federal and state income taxes and penalties in a bankruptcy. Here is the statute.
11 U.S. Code § 523 — Exceptions to discharge
(1) for a tax or a customs duty—
(A) of the kind and for the periods specified in section 507(a)(3) or 507(a)(8) of this title, whether or not a claim for such tax was filed or allowed;
(B) with respect to which a return, or equivalent report or notice, if required—
(i) was not filed or given; or
(ii) was filed or given after the date on which such return, report, or notice was last due, under applicable law or under any extension, and after two years before the date of the filing of the petition; or
(C) with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax;
(7) to the extent such debt is for a fine, penalty, or forfeiture payable to and for the benefit of a governmental unit, and is not compensation for actual pecuniary loss, other than a tax penalty—
(A) relating to a tax of a kind not specified in paragraph (1) of this subsection; or
(B) imposed with respect to a transaction or event that occurred before three years before the date of the filing of the petition.
11 U.S. Code § 507(a)(8)
(8) Eighth, allowed unsecured claims of governmental units, only to the extent that such claims are for—
(A) a tax on or measured by income or gross receipts for a taxable year ending on or before the date of the filing of the petition—
(i) for which a return, if required, is last due, including extensions, after three years before the date of the filing of the petition;
(ii) assessed within 240 days before the date of the filing of the petition, exclusive of…
In laymen's terms: if the taxes are more than three years old from the tax return's due date, the tax return has been filed for more than two years, the IRS has had 120 days to collect, and fraud was not involved in the return, the taxes are dischargeable.
The most important aspect of this statute is that you do not need to file bankruptcy to threaten the IRS with bankruptcy. The IRS has a procedure called an Offer in Compromise, and bankruptcy is raised during the initial review. Unfortunately, some IRS examiners are not aware of this provision — or so they claim. In that situation, you need to file an appeal within the IRS, and the appellate conferees know this area of the law very well.
Next, see how an offer actually moves through the IRS, from the first form to appellate review.
Continue to The Offer Process