Now that tax season is nearing an end, what better time to discuss the dischargeability of taxes in bankruptcy? Receiving tax bills from the I.R.S. or New York State can be quite nerve-wracking. Additionally, the I.R.S. and New York State tax authorities can be very difficult to negotiate with. This may be further compounded by the I.R.S. with their recent significant staffing cuts. When struggling with tax debts, many potential clients often ask us “can bankruptcy eliminate my tax debt?” The question of whether tax debt can be discharged or eliminated in bankruptcy is not easy to answer, since the dischargeability of taxes depends on various factors. In this article, we will explore when tax debt can be discharged in bankruptcy and the conditions required for discharge.

What Type of Taxes Can Be Discharged in Bankruptcy?

The good news is that income tax debts are potentially dischargeable in bankruptcy. However, whether or not a tax debt is dischargeable, is subject to a number of very specific requirements. See 11 U.S.C. § 523 and 507. Not all taxes are dischargeable in bankruptcy, such as property taxes or payroll taxes. These taxes cannot be eliminated through bankruptcy. The following is a general outline of the criteria for discharging income tax debt in bankruptcy:

• Federal or state income tax debt: This is the only type of tax debt that can potentially be discharged in bankruptcy. As mentioned above, property taxes or payroll taxes are not dischargeable.
• The 3-Year Rule: In order for income tax debt to be dischargeable, the debt must be at least three years old. This means the original tax return for the debt must have been due at least three years prior to your bankruptcy filing. For example, if you file for bankruptcy after April 15, 2025, the taxes that you are seeking to discharge must have been due by April 15, 2022 (your 2021 return), or earlier.
• The 2-Year Rule (for late filed returns): To discharge tax debt in bankruptcy, you must have filed your tax return at least two years before filing for bankruptcy. If the return has not been filed or filed within the 2-year limit, the debt will not be eligible for discharge. Continuing the example above, if the 2021 return you are seeking to discharge was filed late, less than 2 years from the filing date, the debt is not dischargeable.
• The 240-Day Rule: The tax debt must have been assessed by the IRS or the state tax authority at least 240 days before you file for bankruptcy. This is referred to as the “240-day rule.” If the IRS or state has not assessed the tax debt, or if the assessment occurred within 240 days of your bankruptcy filing, you will not be able to discharge the debt. If the return that you are seeking to discharge meets both the 3-Year and 2-Year rules, but the return is audited and additional tax debt is assessed within 240 days of the filing, the debt would not be dischargeable.
• No Substitute Return Rule: If a substitute return was filed for you by the IRS or the state tax authority (typically because you did not file a return), the debt cannot be discharged. To qualify for discharge in bankruptcy, you must have filed your own tax return.

Additional Considerations Regarding Tax Debt in Bankruptcy

Even if you meet all of the above requirements, there are still certain situations that should be considered when you seek to discharge income taxes in bankruptcy.

• No Willful Evasion or Fraud: You cannot discharge tax debt if you filed fraudulent tax returns or have willfully evaded paying your income taxes.
• 1099 Income or Retirement Account Withdrawals/Distributions: Two of the most common forms of tax liability we have found are when clients do not pay taxes or sufficient taxes on 1099 income or on retirement account withdrawals. If the liability from either of those scenarios was listed in the return and the return was properly filed, those taxes may be dischargeable if the necessary period of time elapses and other statutory requirements are met. However, if the debtor files “a fraudulent return or willfully attempted in any manner to evade or defeat such tax,” the debt would not be dischargeable in bankruptcy. The Second Circuit has held that the willfulness exception to dischargeability in Section 523 of the Bankruptcy Code consists of both a conduct element (attempting to evade or defeat taxes) and a “mens rea” or willfulness requirement. It then ruled that simple non-payment of taxes does not satisfy the conduct requirement. See In re Tudisco, 183 F.3d 133 (2nd Cir. 1999).
• Credit Card Payments for Taxes: If you paid your tax debt using a credit card, the dischargeability of that debt becomes complicated. In a Chapter 7 bankruptcy proceeding, the credit card company could file an adversary proceeding to contest the dischargeability of the debt on the basis that the debt related to the payment of taxes is nondischargeable. However, in Chapter 13 bankruptcy, the balance incurred on the credit card for a nondischargeable tax debt can still be discharged if it qualifies since it is being paid in the Chapter 13 plan.
• IRS Tax Liens: If the IRS has placed a lien on real estate that you own prior to a bankruptcy filing, that tax debt will survive the bankruptcy. A lien represents a legal claim against your property, and while bankruptcy can discharge the underlying tax debt, the lien will remain in place and is unaffected by the bankruptcy. The lien will need to be satisfied if you are looking to sell or transfer your property and may place your property at risk of foreclosure.

How Will Bankruptcy Affect Future Tax Filings and Refunds?

Filing for bankruptcy does not absolve you from future tax filing obligations. However, it can affect how your taxes will be handled during and after your bankruptcy case.

• Tax Refunds in Chapter 7: If you are owed a tax refund at the time you file for Chapter 7 bankruptcy, you may be required to turn over the refund to the bankruptcy trustee as an asset of the bankruptcy estate, if there are no applicable exemptions to protect it. If it is available to you, the federal wildcard bankruptcy exemptions ($1,475 plus $13,950 of any unused portion of the homestead exemption, see 11 U.S.C. § 522) would allow you to protect most tax refunds. However, if the exemption is not available to you, the refund may be administered by the bankruptcy trustee, who will use it to pay the creditors in your case.
• Tax Filings and Refunds in Chapter 13: For those filing Chapter 13 bankruptcy, you must remain current on all tax returns during the repayment plan. The Chapter 13 trustee will often require you to provide copies of your tax returns each year during the course of your plan. Additionally, in some cases, if your plan does not pay off your entire debt (a pro-rata plan), the trustee may be entitled to any tax refunds you receive during the pendency of your Chapter 13 plan to further satisfy claims in the case.

Contact the Law Offices of David I. Pankin, P.C.

If you are struggling with outstanding tax debt, it is important to consult with a bankruptcy attorney who can evaluate your specific situation and help you understand your options for potentially eliminating tax debt through bankruptcy. Navigating bankruptcy law with respect to tax obligations requires careful consideration and expertise. An experienced bankruptcy attorney can evaluate your situation, advise you on the best course of action, and help you understand the potential outcomes of filing for bankruptcy. At the Law Offices of David I. Pankin, P.C. we have over 28 years of experience helping debtors obtain a fresh start, including the discharge of income tax debt. Please feel free to contact our office to schedule a free consultation at (888) 529-9600 or by using our easy online contact form.