Dischargeability of taxes in bankruptcy

Here at Shenwick & Associates, many clients, lawyers and accountants have called us regarding the discharge of taxes in bankruptcy filings.  Many kinds of “old” state and federal income taxes are dischargeable in bankruptcy. In the case of income taxes, they are dischargeable in Chapter 7 if all the following criteria are met:

1. The tax is for a year for which a tax return is due more than 3 years prior to the filing of the bankruptcy petition;

2. A tax return was filed more than two years prior to the filing of the bankruptcy petition;

3. The tax was assessed more than 240 days prior to filing of the bankruptcy petition;

4. The tax was not due to a fraudulent tax return, nor did the taxpayer attempt to evade or defeat the tax;

5. The tax was not assessable at the time of the filing of the bankruptcy petition; and

6. The tax was unsecured.

Section 507(a)(8) of the Bankruptcy Code provides that:

Income taxes: (i) for tax years ending on or before the date of filing the bankruptcy petition, for which a return is due (including extensions) within 3 years of the filing of the bankruptcy petition; (ii) assessed within 240 days before the date of filing the petition; (iii) not assessed before the petition date, but were assessable as of the petition date, unless these taxes were still assessable solely because no return, a late return (within 2 years of the filing of the bankruptcy petition), or a fraudulent return was filed, withholding taxes for which a person is liable in any capacity, an employer's share of employment taxes on wages, salaries, or commissions (including vacation, severance, and sick leave pay) and excise taxes on transactions occurring before the date of filing the bankruptcy petition are all not dischargeable in bankruptcy.

As part of our bankruptcy intake process, we analyze a client’s state and federal tax transcripts to determine whether their tax debts (if any) are dischargeable or not.  It’s complicated by the fact that various actions by the IRS or the taxpayer can “toll” the periods of time listed above.  And a recent case from the Bankruptcy Court for the Southern District of Georgia, Elkins v. IRS (In re Elkins), demonstrates the pitfalls of not calculating these dates correctly.  Elkins requested an extension to file his 2001 federal income tax return. As a result, his 2001 federal tax return was due on October 15, 2002.   He filed for chapter 7 relief on October 14, 2005.  Both Elkins and the IRS filed motions for summary judgment regarding the dischargeability of his income taxes. 

Elkins argued that a year was limited to 365 days (2004 was a leap year).  He also included both the day his tax return was due and the day he filed his bankruptcy petition in his calculations.  The bankruptcy court disagreed, finding that a year meant a calendar year.  As a result, the bankruptcy court ruled that Elkins filed his petition one day prior to the three-year anniversary date of when his 2001 tax return was due. Therefore, the IRS's claim for Elkins’ 2001 tax liability was non-dischargeable under §§ 507(a)(8)(A)(i) and 523(a)(1)(A).

For your questions about taxes and bankruptcy, please contact Jim Shenwick.