Bankruptcy and the Dischargeability of Personal Income Tax Debts

by Matthew Grech | Oct 9, 2014 | Article |

There are many types of tax debts, which of course can be affected in different ways upon the filing of a Bankruptcy petition. As such, for the purpose of this article we are going to focus on personal income tax debts ("Tax Debts") only, because our firm finds that this is the most common type of tax debt that our clients deal with.

It is a commonly held belief that Tax Debts are never dischargeable in Bankruptcy. This is incorrect. Although, it is true, as a general rule, that Tax Debts are not dischargeable in Bankruptcy, like most rules in the legal world there is an exception. Here, we often refer to that exception informally as the "3-2-2 exception," which if satisfied results in dischargeable Tax Debts.

Our analysis begins with the day upon which the actual Bankruptcy petition is filed ("Date of Filing"). This is of extreme importance, as it will help determine whether the three elements of the 3-2-2 exception have been satisfied. The first element that must be addressed is whether the due date for filing a tax return is at least three (3) years prior to the Date of Filing. For example, using a Date of Filing of October 16, 2014, this element is satisfied if the tax return filing due date was April 15, 2011, or before. In other words, in our hypothetical, any tax debts that were due on or before 4/15/11 are potentially dischargeable.

The second element is whether the tax return was filed at least two (2) years prior to the Date of Filing. Once again, using a Date of Filing of October 16, 2014, this element is satisfied if the tax return was filed on or before October 16, 2012. Here, as long as the tax returns were filed on or before 10/16/12 then the debt associated therewith is potentially dischargeable.

Our last element is whether the tax assessment is at least 240 days prior to the Date of Filing. In our hypothetical the tax assessment must have taken place on or before February 18, 2014. On a side note, the best way to verify when a tax assessment took place is to request a tax transcript for the year(s) in question from the tax agency.

In sum, when using a Date of Filing of October 16, 2014, as long as the tax return filing due date was 4/15/11 or before, the tax return(s) was/were filed on or before 10/16/12, and the tax assessment(s) took place on or before 2/18/14, then the underlying tax debts are potentially dischargeable.

It is also worth noting that for those Tax Debts that are not dischargeable, a person may consider the filing of a Chapter 13 Bankruptcy to resolve these debts by paying them back. When compared to paying the debt back directly to, let's say, the IRS, the resolution of Tax Debts through a Chapter 13 Bankruptcy has the primary advantage of automatically stopping all interest and penalties immediately upon the filing of the Chapter 13 Bankruptcy Petition, thus potentially saving a person thousands of dollars.

To further explore what Bankruptcy can offer you, please call Grech Legal at 650-549-7728 for a free debt consultation.