What Are Dischargeable Income Tax Debts in Chapter 7 Bankruptcy?

Definition and Examples of Dischargeable Income Tax Debts

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Dischargeable income tax debts in Chapter 7 bankruptcy must meet several specific rules to qualify. "Discharging" a debt in bankruptcy effectively means that it goes away, and that can be a tricky process when the IRS is involved.

The taxpayer is no longer under any legal obligation to pay these taxes after they've been discharged, but bankruptcy laws have placed numerous restrictions on discharging more recent income tax debts versus older ones. There are also other criteria you must meet.

What Is Dischargeable Income Tax Debt?

Dischargeable income tax debt is that which derives from an income tax obligation and qualifies for discharge.

Tax revenues serve the greater good by paying for various needs and services, so tax debts are given high priority when it comes to collection. They won't qualify for discharge unless they meet a host of qualifications.

How Discharge of Tax Debt Works

Chapter 7 is often referred to as a "straight bankruptcy" because the debtor—the individual filing for bankruptcy protection—must turn over their assets to the bankruptcy trustee. They are then liquidated or sold to raise cash to pay off the debtor's creditors.

Certain property is exempt from liquidation. Any debts that aren't paid off are discharged unless they don't qualify according to bankruptcy rules.

Two firm rules for discharging income taxes in a Chapter 7 bankruptcy case include:

  • The taxes must be income taxes. Generally, only taxes based on wages, commissions, or other income or gross receipts are eligible for discharge in a Chapter 7 bankruptcy.
  • Taxes aren't dischargeable if it's found that your return was fraudulent or frivolous in any way.

Rules for Dischargeable Income Tax Debt

Your tax debt might be dischargeable if the return was due at least three years ago. Most returns are due on April 15 for the previous tax year. Taxes would, therefore, become eligible for discharge after April 15 three years after you filed the applicable return, provided all other criteria are met.

Extensions of time to file your tax return must be accounted for in this timeline. For example, if you asked for a six-month extension to file your return in 2020, the return wouldn't be eligible for discharge until October 15, 2023.

You must also have filed the return at least two years before you filed your bankruptcy petition.

The taxes must have been assessed at least 240 days before your bankruptcy was filed. The IRS "assesses" a tax debt when it enters the liability on its records, but that doesn’t necessarily happen as soon as you file your return.

The taxing authority might audit your return and assess additional taxes years after the return is filed, and this could push back the date.

This 240-day period could be "tolled" or extended if you filed an offer in compromise with the IRS, or if you filed a bankruptcy case during that time that was discharged or dismissed.

You can reach out to the IRS and request a tax transcript online, or you can call 800-908-9946 if you're unsure when your tax return was filed because you requested extensions for a given tax year.

A transcript can also tell you any interest and penalties were assessed, and when they were assessed.

Do I Need to Pay Discharged Income Tax Debt?

Income tax debt is effectively erased and ceases to exist when it's been discharged. You no longer have an obligation to pay it.

In fact, the IRS must at least temporarily stall collection efforts as soon as you file for Chapter 7 bankruptcy because an automatic stay goes into effect under the bankruptcy code, prohibiting any creditors from trying to collect from you while your case proceeds.

The stay would be lifted, however, if your tax debt didn't qualify for discharge. You would have to pay the tax debt if it doesn't meet these rules.

Key Takeaways

  • Dischargeable income tax debts in Chapter 7 bankruptcy must arise from a tax return that was filed at least three years ago.
  • The tax must have been assessed at least 240 days before the filing of your bankruptcy petition.
  • Taxes resulting from a fraudulent or frivolous return won’t qualify.
  • Discharge relieves a taxpayer of any legal obligation to pay the tax debt.

The information contained in this article is not tax or legal advice and is not a substitute for such advice. State and federal laws change frequently, and the information in this article may not reflect your own state’s laws or the most recent changes to the law. For current tax or legal advice, please consult with an accountant or an attorney.