Bankruptcy is an important safety valve recognized by the legal system which gives individuals strapped with unmanageable debt the opportunity to either catch up on that debt by reorganizing themselves financially or by liquidating assets and paying off creditors. Whether bankruptcy proceedings involve a business or an individual debtor, one of the most important aspects of the process is discharge.
Discharge works differently in different forms of bankruptcy, but it refers to the ability of bankruptcy courts to remove a debtor’s legal obligation to pay any debts that are discharged. Not every type of debt may be discharged in bankruptcy, and some types of debt may be dischargeable under certain conditions.
When it comes to tax debt, there is no hard and fast answer as to whether tax debts are dischargeable. One basic rule that has been followed in bankruptcy courts, though, is that “fresh” tax debts are not dischargeable, while old or “stale” tax debt may be discharged. Federal law prescribes certain requirements that must be met in order for individual income tax debt to be dischargeable:
- The debt must be at least three years old
- The tax return for the debt must have been filed more than two years before the bankruptcy petition is filed.
- At least 240 days must have passed since the date of IRS assessments associated with the debt
Some types of tax debt, such as withheld payroll taxes, trust fund penalties, most state sales taxes, and some excise taxes, may not be discharged in bankruptcy.
In our next post, we’ll look at the issue of discharging tax debt from late filed tax returns, and the importance of working with an experienced attorney to obtain relief from tax debt.
Journal of Accountancy, “Discharging Taxes in Bankruptcy,” Donald L Ariail, et al., August 2010