Writing Off Income Taxes Through Chapter 7

Law Office of Robert L. Firth Oct. 3, 2016

If your tax debt can meet 4 conditions, you can usually write it off with bankruptcy forever.

Two Myths

Two myths about bankruptcy and taxes persist because there’s a bit of truth behind them.

First myth: You can’t discharge (legally write off) income taxes in bankruptcy.

The truth is that income taxes often can’t be discharged. That’s true under either Chapter 7 “straight bankruptcy” or the Chapter 13 “adjustment of debts.” To discharge a tax it has to meet four conditions. If it doesn’t meet any single one of them, the tax will not be discharged.

But if those conditions are met, then bankruptcy will usually discharge that tax just like a credit card or medical debt.

Second myth: Chapter 7 doesn’t help with taxes, only the 3-to-5-year Chapter 13 does.

The truth is that Chapter 13 does have a number of special tools for attacking income tax debts. Chapter 13 can be especially helpful if you owe a lot of tax debt, or owe for multiple tax years. So Chapter 13 can be the far better way to go, in certain tax situations.

But Chapter 7 can sometimes discharge all or most of your income tax debt. Then you don’t need the much longer Chapter 13 procedure.

Four Conditions

The four conditions for discharging income taxes apply both to Chapter 7 and Chapter 13. But because Chapter 13 adds some complications, we focus here only on Chapter 7. We cover the first of the three conditions in today’s blog post and then the other three in the next one.

Condition #1

The 3-Year Rule: To discharge a tax debt three years must have passed from the date that the applicable tax return was due and when you file your Chapter 7 case. (See Section 507(a)(8)(A)(i) of the U.S. Bankruptcy Code.)

This condition is relatively easy to apply. For example, if you owe $10,000 to the IRS for 2012 income taxes, that tax return was due April 15, 2013. So if your Chapter 7 case was filed before April 15, 2016, you would not meet this condition. Three years had not yet passed since the tax return due date. But if it was filed after April 15, 2016, more than three years had passed since the tax return due date and so you would meet this condition.

The Extension Twist

However, there’s a twist if you got an extension to file your tax return in the year at issue. The Bankruptcy Code says the three-year period starts on the date the tax return was “last due, including extensions.” So you have to wait longer if you asked for and were granted an extension that year.

So it’s crucial to know if you asked for and were granted an extension. If so, you have to add the length of the extension to the three years. So, in the above example, if you had gotten an extension to file the tax return from April 15, 2013 to October 15, 2013, then this three-year condition would be met only by filing the Chapter 7 case after October 15, 2013.

Careful About the Actual Tax Filing Deadline

Also, be aware that some years the tax return deadline is not on April 15 or October 15. It can be a day or two or even three later. So you have to be extremely careful about the actual tax filing due date that year. You need to account for the IRS (and state) pushing the due date to the following Monday when the 15th falls on a weekend. Plus obscure holidays can add more time occasionally. For example, in 2012 when April 15 fell on a Sunday, and then Monday was Emancipation Day, a holiday observed only in the District of Columbia but applicable to the IRS, the tax return due date was April 17. Filing bankruptcy on April 15 three years later would have resulted in not meeting the three-year rule. The tax would not have been discharged simply because the Chapter 7 case was filed two days too early.

Summary of Condition #1

As to this first condition only:

  1. Before April 15, 2016, only income taxes for the tax years of 2011 or earlier could be discharged

  2. Then, after April 15, 2016, taxes for 2012 may be able to be discharged. That would depend on whether you got an extension that year. If so that tax could be discharged after October 15, 2016.

But now you still need to meet the other three conditions, to be covered in the next blog post.