Taxation & Estate Planning

Chapter 7 & Back Taxes

By Darrin Mish

A taxpayer may have the right to discharge back taxes in a chapter 7 bankruptcy. Filing chapter 7 is a way to eliminate back taxes if you meet the conditions for discharging those back taxes. Chapter 7 will completely eliminate qualifying debt, including back taxes. Under recently updated bankruptcy laws back tax debt is treated the same in both chapter 7 and chapter 13 filings. However, not all back tax debt qualifies for discharge in a bankruptcy. There are five conditions that must be satisfied for back taxes to be discharged in chapter 7 bankruptcy, and these conditions apply to each tax year, each tax return and each tax assessment independently. If back income taxes tax satisfy these conditions they may be discharged in chapter 7. The five conditions back taxes must meet to be discharged in chapter 7 are: the tax return must be due at least three years ago, the tax return must have been filed at least two years ago, the tax assessment (there may be multiple assessments in a given tax year) is at least 240 days old, the tax return is not fraudulent and the taxpayer is not guilty of tax evasion.

In order for a back taxes to be dischargeable in chapter 7 they must result from an income tax return that was due at least three years before the bankruptcy petition is filed. This includes any extensions filed. In addition to being due three years prior, the return must have actually been filed at least two years before the bankruptcy petition is filed. The two year condition is most applicable to late filed returns. A taxpayer is not permitted to simply file late returns for back taxes due three years previously and then immediately file a chapter 7. The two year filing time requirement begins from the date the taxpayer actually filed the return. Tax assessments resulting in back taxes must be a minimum of 240 days old to qualify for chapter 7. The IRS may assess taxes because the taxpayer had a balance due on his or her return that was never paid, the IRS audited the return and assessed additional taxes, or a proposed assessment has become final. It is possible then for a single tax year to have multiple assessments which need to reach the 240 day threshold independently before those back taxes may be discharged in a chapter 7.

In addition to the previously discussed conditions and as in other back tax resolutions, the tax return cannot be fraudulent or frivolous and the taxpayer cannot be guilty of intentionally evading tax law. Some back taxes will not be dischargeable in a chapter 7, primarily back taxes resulting from unfiled income tax returns. However, civil penalties and trust fund recovery penalties (from back payroll taxes) will not ever be dischargeable in chapter 7 or any other bankruptcy. On a final note, from an administrative point a taxpayer seeking to discharge back taxes in a chapter 7 petition will be required to prove that tax returns for the four previous years have been filed, as well as provide a copy of their most recent tax return to the bankruptcy court. If you have back taxes and are considering a chapter 7, seek professional guidance to analyze your tax transcripts as a precaution against filing a petition too soon.

Full post as published by IRS Problem Solver Blog on August 19, 2008 (boomark / email).