Discharging Income Taxes in Chapter 7 Bankruptcy

Income taxes are discharged in a Chapter 7 Bankruptcy unless excepted from the discharge under 11 U.S.C. Section 523(a)(1).  There are a number of requirements in Section 523 which may except the income taxes from the discharge.  Only one of these requirements is needed to make income taxes nondischargeable.  The following is a discussion of those requirements. 

Income Tax Due Date

The income taxes must have come due at least 3 years before you filed the Bankruptcy case.  Income taxes ordinarily become due on April 15^th. 

2018 income taxes were due on April 15, 2019.  These income taxes are less than 3 years old.  As a result, they would not yet be old enough to discharge in Bankruptcy.  However, income taxes owed for 2017 and before would be old enough to discharge in Bankruptcy. 

Income Tax Return File Date

The income tax return was filed at least 2 years before you filed the Bankruptcy case.  As a result, a late-filed income tax return may still satisfy this requirement.

The income tax return for the 2017 Tax Year was due on April 15, 2018.  However, the 2017 return may be filed as a late July 5, 2019, and still satisfy this requirement. 

You may obtain from the IRS the date on which a tax return was filed.  You may do so by requesting an “Account Transcript.”  An “Account Transcript” may be requested online. 

Income Tax Return Assessment Date

The income taxes were not assessed within 240 days of filing the Bankruptcy case.  Income taxes are ordinarily assessed when the tax return is filed.  However, the assessment date could be a later date if the IRS conducts an audit and determines that you owe more taxes. 

You also may obtain from the IRS the date on which an income tax return was assessed.  This information would be reflected in an “Account Transcript.”    

Fraudulent Return

Income taxes are nondischargeable if they are the result of a fraudulent tax return.   The IRS has the burden of proof.  It must prove the following by a preponderance of evidence:

1. Debtor had knowledge of the falsity of the return,
2. Debtor had an intent to evade the taxes, and
3. There was an underpayment of taxes. 

Courts look at the totality of the circumstances when determining the second requirement – Intent.  Further, courts may consider “badges of fraud” when determining intent.  The badges of fraud include: 

1. large understatements of income made consistently over time,
2. failure to keep adequate records,
3. failure to file tax returns,
4. implausible or inconsistent behavior by the debtor,
5. concealing assets,
6. failure to cooperate with tax authorities,
7. and the sophistication of the debtor.

Evade or Defeat Tax

Income taxes are also nondischargeable if debtor attempted to evade or defeat the taxes.  The attempt to evade or defeat the taxes must be willful.  And, debtor must have engaged in conduct evidencing his intent to evade or defeat the taxes. 

Willful attempt to evade or defeat tax – the IRS must prove by a preponderance of evidence that:

1. debtor had a duty to file income tax returns and pay tax,
2. knew he had such a duty, and
3. voluntarily and intentionally violated that duty.

Courts again look at “badges of fraud” to determine whether debtor intended to violate the duty to pay tax.

Evasive Conduct – IRS must show debtor’s failure to pay is coupled with an affirmative act evidencing his attempt to evade or defeat payment.  Courts may look for the following conduct: transfers of property for little or no consideration, concealing assets, or using significant income to maintain an extravagant lifestyle.

Self-Executing Discharge and Adversary Proceedings

Income taxes are discharged if they do not satisfy all of the above referenced requirements.  No action is required by the Debtor other than filing the Bankruptcy Case.  However, the IRS may disagree about whether all of the requirements are met.  In that case, Debtor will need to file a lawsuit in the Bankruptcy Case against the IRS.  The lawsuit is called an Adversary Proceeding.  The Bankruptcy Court will decide whether Debtor failed to satisfy any of the requirements for discharging the income taxes.  However, the IRS will have the burden of proof in the Adversary Proceeding.  The IRS will have to show by a preponderance of evidence that Debtor failed to satisfy one of the requirements discussed above.

Conclusion

Discharging income taxes in bankruptcy can quickly become a complicated process.  If you have any questions about the process or bankruptcy in general, feel free to call the Law Office of Brent M. Myer PLLC at 727-487-9030.