Are "Priority Income Tax Debts Discharged in Chapter 7 Bankruptcy?

 Posted on September 12, 2016 in Income Taxes

Income tax debt may be discharged—legally written off—in a Chapter 7 case. It just needs to meet some conditions.

Our last blog posts have been about “priority” debts, such as child/spousal support and income taxes. A key point has been that your Chapter 7 trustee pays priority debts ahead of your other debts. But that’s irrelevant if the trustee doesn’t have any money to pay ANY of your debts. And that’s what happens in most Chapter 7 cases. That’s because in most cases everything the debtor owns is protected through property exemptions.

But some of the priority debts are also “nondischargeable”—they cannot be written off in bankruptcy. That’s always relevant—you definitely want to know whether a debt will be discharged or instead you will still need to pay it.

Priority vs. Dischargeable Debts

Because some priority debts are not dischargeable but some are, this can get confusing. For example, a child/spousal support debt is always a priority debt and simultaneously is always not dischargeable. But an income tax debt is a priority debt only under certain conditions. That very same debt would not be discharged under similar but not exactly the same conditions. Yes, it’s confounding!

Luckily, all we care about here is whether an income tax can be discharged or not. So we’ll give you the main rules, and a practical example to make sense of this.

The Main Rules for Discharge of Income Taxes

We’ve got to emphasize that there is more to this than what we’re about to say. But the following is a good start.

To discharge an income tax in bankruptcy, that tax must meet both of 2 conditions:

• More than 2 years must have passed between the date that you submitted the tax return to the IRS or state tax agency and the date you file your bankruptcy case.
• More than 3 years must have passed between the legal due date for that tax return and the date you file your bankruptcy case.

There are other conditions but they seldom come into play. (Your bankruptcy lawyer will review them with you to make sure, but they’re not worth getting into here.)

Example

Assume that you are considering whether to file bankruptcy in mid-September 2016 when this blog post is being written. You owe federal income taxes for the 2011, 2012, and 2013 tax years, $5,000 each year, a total of $15,000. You filed all three years of tax returns on April 15, 2014 (the due date for the 2013 income tax, which was late for the other 2 earlier years of taxes). Are these three years of taxes dischargeable now or not?

You meet the 2-year rule for all three tax years—April 15, 2014 is more than 2 years ago.

You meet the 3-year rule for 2011 and 2012—their tax returns were due in April 2012 and April 2013, respectively, more than 3 years ago.

So those two years of taxes, totaling $10,000, would very likely be discharged in a Chapter 7 bankruptcy. They meet both the 2-year and 3-year rules.

However, the 2013 tax return was due on April 15, 2014 (regardless when it was filed). Since that’s less than 3 years ago, the 2013 tax debt does not meet this necessary condition. So that $5,000 debt would NOT be discharged in a Chapter 7 case.

At least not yet. It may or may not be worth waiting to file bankruptcy long enough until that final $5,000 tax debt could be discharged. But DON’T act on this without having an experienced bankruptcy lawyer review this carefully with you. As mentioned above, there might be some other conditions that could come into play. You would hate to incur the risks and disadvantages of waiting only to find out that waiting didn’t do you any good.