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ELIMINATING TAX DEBTS THROUGH BANKRUPTCY:
Contrary to common knowledge, it is entirely possible to completely eliminate (i.e., "discharge") tax debts (which could be either Federal, state and/or local taxes) through a Bankruptcy filing. However, in order to do so, you must meet five different rules in order to eliminate such tax debt. If you meet all five rules for a given tax year, then that tax year's tax debt is considered to be "Non-Priority Tax Debt". You also need to meet all five rules for each tax year separately. In other words, it is possible that you might meet all these rules for some tax years, but not others.
So what are these rules? In a Chapter 7 Bankruptcy, you can eliminate tax debt that is considered "Non-Priority Tax Debt" .
Non-Priority Tax Debts:
Non-Priority Tax Debt is tax debt, for a given tax year, that meets all of the following five rules:
Rule No. 1: Income Taxes: The taxes that you are trying to eliminate are income taxes. If the taxes you wish to eliminate are not for income taxes, then you cannot eliminate them in a bankruptcy filing. For example, if your tax debt is for payroll taxes, or for fraud penalties, or sales and use tax or excise tax, these type of taxes cannot be eliminated in a bankruptcy filing.
Rule No. 2: No Fraud or Willful Tax Evasion: You did not commit fraud or willful tax evasion. If you filed a fraudulent tax return or otherwise willfully attempted to evade paying taxes, such as using a false Social Security Number on your tax return, you will not be able to eliminate that tax through bankruptcy.
Rule No. 3: Three Year Rule: You must meet the "three year rule". The three year rule requires that it has been more than three years after the due date for filing the tax return for a given year's tax debt that you are trying to eliminate in a bankruptcy, at the time that you file the bankruptcy. This usually means April 15th of the year the tax return was due. However, if you received an extension to file your tax return, for a given tax year, the three year period does not start to run until the date that the tax return is now due, including the extension.
For example, if you are trying to eliminate tax debt for tax year 2010, the due date of the tax return for 2010 is normally April 15, 2011. Therefore, in order to meet the three year rule for tax year 2010, you cannot file your bankruptcy any earlier than April 16, 2014. If you received an extension to file your 2010 taxes until October 15, 2011, then the three year rule is met if you then file your bankruptcy on or after October 16, 2014.
Rule No. 4: Two Year Rule: You must meet the "two year rule". The two year rule requires that it has been more than two years, at the time that you file the bankruptcy, after the time that you had filed the tax return. For example, if you filed your 2010 tax return on April 15, 2011, then in order to meet the two year rule, you cannot file your bankruptcy any earlier then April 16, 2013, in order to meet the two year rule for tax year 2010. If the taxing authority files the tax return for you (what is referred to as a "substitute return"), then you can never meet the two year rule for that tax year.
Rule No. 5: 240 Day Rule: You must meet the 240 Day Rule. The tax debt must have been "assessed" by the taxing authority at least 240 days before you file for bankruptcy, or alternatively, the tax has not been assessed as of the time that you file the bankruptcy. "Assessed" means that the taxing authority has made a formal determination as to what amount you owe in taxes for a given tax year.
Additional Time Requirements:
If any of the following situations apply to you, you will have to add extra time to the three year rule, two year rule and 240 Day rule requirements in order to have your tax debt eliminated in your bankruptcy:
1. You filed an "Offer in Compromise" with the applicable taxing authority. If you submitted an Offer in Compromise, the 240 day rule time period stops running during the time period from when the OIC is made until when the taxing authority rejects the OIC, or you withdraw it, plus an additional 30 days.
2. You had filed a previous bankruptcy. If you had previously filed for bankruptcy, then the three year rule, the two year rule and the 240 Day Rule, all stop running, for the time that your prior bankruptcy case is pending. In other words the time periods for all three rules do not continue to run, during the time that your prior bankruptcy is active or pending.
Consequences of Being Considered Non-Priority Tax Debt:
If you can meet all five of the above rules for a given tax year, then that year's tax debt is considered to be Non-Priority Tax Debt. If you cannot meet all five rules for a given year's tax debt, then that year's tax debt is considered to be Priority Tax Debt.
If your tax debt is Non-Priority Tax Debt, then you can eliminate it completely in a Chapter 7 bankruptcy. If your tax debt is Priority Tax Debt, then you cannot eliminate it in a Chapter 7 bankruptcy. In a Chapter 13 bankruptcy, you can repay Non-Priority Tax Debt the same percentage repayment that any other unsecured creditor is being repaid through your Chapter 13, which is usually much less than 100% repayment. In a Chapter 13 bankruptcy, you must repay Priority Tax Debt in full over the life of your Chapter 13 plan. See our page on Chapter 13 bankruptcy, for more information about Chapter 13.
Effect of Tax Liens:
Even if your tax debt is considered to be Non-Priority Tax Debt, there may still be issues involving tax liens that were recorded by the taxing authorities prior to your bankruptcy filing. If you have such prior recorded tax liens, the taxing authority may still attempt to collect from your property to which the prior recorded tax lien has attached. In other words, the effect of having Non-Priority Tax Debt is that you are thereby eliminating your personal obligation to repay that tax to the taxing authorities. However, the taxing authorities can still attempt to collect from your property to which the prior tax liens have attached.