income tax debt and certain other tax related debt is dischargeable (the obligation to pay it can be eliminated) in bankruptcy if certain requirements are met. The requirements in their most basic form are:
a. The tax return that forms the basis for the debt must have been due for filing more than 3 years before the bankruptcy is filed.
b. The tax debt can't have been assessed (determined to be a debt formally) within 240 days of the bankruptcy filing date.
c. The taxpayer cannot have committed fraud or “willful” evasion in relation to the debt.
d. The taxpayer must have filed the tax return more than 2 years before the bankruptcy case is filed.
There are two issues I often confront in relation to the above rules.
The first issue is what my client has done to stop the clock from running on the above time frames. Prior bankruptcy filings, prior offers in compromise and certain types of appeals may serve to extend some or all of the dates and make the bankruptcy filing more difficult.
The second issue has to do with the 4th item above, and that is whether the taxpayer filed the tax return at least two years prior to the bankruptcy filing and whether the taxpayer filed the tax return before the IRS or state taxing agency assessed a debt based on a return it created.
A new issue is slowly spreading across the US in relation to the 2-year rule however.
Specifically, some courts are using a decision out of the US Court of Appeals for the Fifth Circuit, McCoy v. Mississippi State Tax C.pdf, 666 F.3d 924 (5th Cir, 2012) to interpret the bankruptcy code in a way that will be very detrimental to delinquent tax return filers.
Several Courts have now interpreted a provision in the bankruptcy code to mean that if a tax return was filed late, by even one day…the 2-year rule doesn't matter, and the debt can never be discharged.
The reasoning these courts are using has missed a step and the IRS' own litigation position on the issue CC 2010 016 (1).pdf differs from these opinions. Nonetheless, this line of reasoning is spreading.
Right now the IRS is not challenging the discharge of debt related to late-filed income tax returns in Arizona bankruptcy cases. However, there is no Arizona case that speaks to this issue directly and the Ninth Circuit Court of Appeals hasn't faced the issue either.
It is possible as a result, that a late-filed return may never be considered dischargeable in a bankruptcy case at some point in the future.
My advice to those who think they may have a large tax debt remains the same. Have the return created, take it to an experienced tax resolution attorney and consider filing it before the IRS creates a return for you.
An obvious addendum to the advice – file your returns on time.