Can Income Tax Debts Be Discharged in a Chapter 7 Bankruptcy in California?

Discharge of Tax Debts in San Jose BankruptcyToday is April 15, and while taxpayers get two additional days to file their income tax returns this year, today presents the perfect opportunity to discuss one of the most vexing issues in consumer bankruptcy—whether or not taxes can be discharged in bankruptcy. The short answer is that while most tax debts cannot be discharged in Chapter 7 bankruptcy, some tax debt is dischargeable, if it meets several criteria. Analyzing whether a particular individual’s tax debts can be discharged is complicated, but I’ll present the basic rules outlined in Bankruptcy Code sections 507(a)(8) and 523 as they apply to individual income tax debts.

In addition to analyzing the threshold issues in any consumer bankruptcy case, such as determining whether or not the debtor’s income is above or below her state’s median income, and if above, whether her debt is primarily consumer debt, whether she passes the Means Test, and other critical issues, individuals with tax debts arising from past unpaid state and federal income taxes need to obtain a tax transcript from the IRS and all notices they’ve received from the California Franchise Tax Board and IRS. The IRS tax transcript provides a timeline with the all-important dates when tax returns were filed, when tax liabilities were assessed, and when any tax liens may have attached.

For past income taxes to be discharged in a Chapter 7 bankruptcy in San Jose or any other bankruptcy court, your bankruptcy attorney must perform a complex analysis of the bankruptcy debtor’s tax debts, when his or her tax returns were due, when they were actually filed, and when the taxing authority, such as the IRS, assessed the taxes. This is why the bankruptcy attorney needs a copy of the tax transcript.

The first date to pin down is when was the tax return due for the tax year that gave rise to the particular tax debt? In order for the tax debt to be discharged, the tax return must have been first due to be filed more than three years before filing the bankruptcy petition. Next, if the debtor filed that return late, then it must have been actually filed at least two years before the bankruptcy petition is filed. Those are the easy ones. The next critical date is generally not something the debtor knows, and that is why our bankruptcy attorneys need a copy of the tax transcript. This is the date that the IRS assessed the tax liability. To be discharged in bankruptcy, the tax debt must have been assessed more than 240 days before the bankruptcy petition is filed. Additionally, the 240-day assessment period is tolled (meaning the clock stops) during any period when the debtor has made an Offer in Compromise with the IRS and such offer is pending. On the date such an Offer in Compromise is denied, the 240-day assessment period starts up again from when the clock was stopped, but in this situation, the Bankruptcy Code adds another 30 days to the 240 days before the bankruptcy petition should be filed.

Of course, all of the above age requirements that income tax debts must meet in order for the tax debts to be discharged in bankruptcy depend on the fact that the debtor actually filed her tax returns. Additionally, tax debts can never be discharged if the debtor is found to have willfully attempted to evade the taxes or if she filed a fraudulent tax return.

Analyzing whether individual income tax debts can be discharged in Chapter 7 bankruptcy requires an experienced bankruptcy attorney. Our San Jose bankruptcy lawyers offer free consultations to anyone considering filing bankruptcy in the Bay Area. Call us to schedule an appointment with us.

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