Discharge of Income Tax Obligations in Bankruptcy

Discharge of Income Tax Obligations in Bankruptcy

Many attorneys who do not regularly handle bankruptcy cases as well as many tax professionals routinely advise clients that federal and state income taxes are not dischargable in bankruptcy. While this advice may be true in some specific cases, most bankruptcy attorneys know that many income tax obligations are, in fact, dischargable in bankruptcy.

The general rule is that a Discharge Order entered in a bankruptcy case discharges all obligations of the Debtor which were owed on the date of filing the bankruptcy the bankruptcy case. However, Bankruptcy Code Section 523(a)(1) creates exceptions for certain taxes which cannot be discharged in a bankruptcy case. The exceptions created in Section 523(a)(1) refer to definitions contained in Bankruptcy Code 507(a)(3) and (8).

In an effort to simplify these provisions, I offer the following summary of the income tax obligations which are not dischargable in bankruptcy:

1. Income taxes for which returns have never been filed;

2. Income taxes for which returns were filed late, if the return was file within 2 years prior to the bankruptcy petition;

3. Income taxes for which the return was last due (including any extensions) within 3 years prior to filing of the bankruptcy petition;

4. Income taxes not assessed until within 240 days prior to filing the bankruptcy petition; or

5. Income taxes for which a fraudulent return was filed.

Here's a fairly simple example. Lets assume that a client filed his income tax returns for tax years 2000 through 2007 on April 15th of the year following the end of each tax year. If the client files a Chapter 7 bankruptcy petition on April 20, 2009, the income taxes due for the 2005 and prior tax years would be discharged. The income tax due for the 2006 and subsequent tax years would not be discharged.

If after filing bankruptcy, the taxing authority attempts collection of the discharged taxes, or if the client simply desires a specific judicial declaration that certain income tax obligations have been discharged, it may be necessary to file an Adversary Complaint with the Bankruptcy Court.

For more information about discharging income tax obligations in Bankruptcy, please contact us for an appointment at (815) 229-5333.