Many individuals believe that they may not discharge taxes in a bankruptcy case, and they would be correct in most, but not all, cases. While most taxes are not dischargeable in bankruptcy, income taxes may, in fact, be discharged in chapter 7, 11, and 13 cases. However, once the IRS has placed a lien on a debtor’s property, the underlying tax debt transitions from a priority debt to a secured debt and typically must be paid despite the filing of a bankruptcy case.
Whether bankruptcy debtors may discharge tax debt depends on the type of tax, the length of time the tax debt has existed, whether the debtor has filed a return and the type or chapter of bankruptcy. If an income tax debt meets the requirements for discharge so will any penalties and/or interest attached to it and they may be discharged as well. To determine if any delinquent taxes are dischargeable requires a complicated legal analysis and therefore the assistance of a qualified and experienced bankruptcy attorney.
Federal bankruptcy law details specific time periods used to determine if income taxes may be discharged. Bankruptcy professionals refer to these time periods and their requirements as the 3-year, 2-year, and 240-day rules. Individuals must meet all of these requirements or may not discharge any tax debt. Note that a taxpayer/debtor may not discharge any tax debt if guilty of tax fraud or tax evasion.
Thus, individuals may discharge taxes that became due 3 years before the bankruptcy filing, as long as at least 2 years have passed since the tax returns were filed and 240 days since any assessment of such taxes has passed. The 3-2-240 rules apply to federal, state, and local income taxes, but do not apply to other types of taxes such as property taxes.
However, while discharging income taxes in bankruptcy will not remove a tax lien, the lien which existed before the filing of the bankruptcy petition is still valid and may not be discharged unless the lien is paid in full or some other resolution is negotiated with the IRS. Title to the property will continue to be encumbered by an IRS tax lien despite a bankruptcy case.