Be wary of greedy companies or financial service providers who claim to eliminate tax debts through bankruptcy. It’s not as easy as it seems. But genuine tax debt relief companies or attorneys will tell you that most tax debts aren’t dischargeable in bankruptcy. You’ll still need to pay them at the end of a Chapter 7 case. Apart from that, paying off tax debt in full under a Chapter 13 repayment plan will be your next option.

However, suppose you wish to discharge tax debts imminently. In that case, Chapter 7 bankruptcy is the better alternative, but only when your tax liability qualifies for discharge and you qualify for Chapter 7 bankruptcy.

When can you discharge tax debt?

Before you can use Chapter 7 bankruptcy and reduce tax debt, you must meet the following requirements:

The tax debt should be at least three years old

Before filing bankruptcy, the tax return had to be due for at least three years.

The taxes should be income taxes

To get tax debt relief, your income should be taxed under federal taxes. Other taxes, including payroll taxes or fraud penalties, cannot be discharged in bankruptcy.

You must have filed tax returns

Bankruptcy must have been filed at least two years before you want to get rid of debt. You can’t get out of paying taxes in most court proceedings if you file a late return. The IRS may issue a substitute return on your behalf, considering your extensions have run out and you haven’t filed a “return.” Courts in some places let people get rid of a tax debt caused by a late return if they meet other criteria.

You shouldn’t perform fraudulent activities or intentionally avoid taxes

In this case, bankruptcy can’t provide you with tax debt help. If you submitted a deceptive tax return or tried to escape paying off tax debt, bankruptcy couldn’t guide you.

You comply with the “240-day rule.”

The IRS should have calculated your tax debt at least 240 days before you submit your chapter 7 bankruptcy, or you will not be able to file it. If the IRS suspends collection operations due to an offer in settlement or a past bankruptcy filing, the time limit may be extended.

There are also additional criteria in some regions. Also, if you used a credit card to pay off a nondischargeable tax debt under Chapter 7, the credit card amount will be a nondischargeable debt as well.

What are the 3 time specific rules that can help you discharge tax debt?

There are three rules for discharging income tax debts in a bankruptcy proceeding based on timing.

The 1st RULE – 3 Year rule

According to this regulation, the most current submission deadline for the tax year should be three years ago. For example – the taxation period in 2018. The 2018 tax return was due April 15th, 2019. As a result, the three-year period from the due date for the tax year in question would be April 16th, 2022 (three years and one day after the original deadline). You must also remember that many “tolling events” might push that due date back.

The 2nd RULE – 2 Year rule

This rule only applies to tax returns that are filed late. If the tax return is submitted on time, the Two Year Rule has always been met.

The rule states that the tax return for such tax year in question must have been filed with the taxation authority (state or federal) at least two years before the chapter 7 bankruptcy was filed.

So, if somehow the 2018 tax return isn’t filed till October 10th, 2021, the bankruptcy case won’t be filed until October 11th, 2023, more than two years after the tax return is filed.

The rule does not consider the tax return’s deadline; instead, it considers the date the return was submitted. So, even if the three-year requirement is met, if the return was late and hadn’t been filed for two years, it won’t be discharged in bankruptcy.

The 3rd RULE – 240 Day rule

The 240 Day Rule states that the taxation authority must assess the tax discharged over 240 days before the actual bankruptcy petition’s filing date. However, the time frame in question in this regulation may be “tolled” or extended. The time limit is extended during the term following the assessment. The taxpayer or his representative should submit an “offer in compromise” for the tax in question, and an extra 30 days should be considered after the offer is refused or approved.

To fulfill the 240 Day Rule, the tax in question should have been assessed for at least 240 days, including any period an offer in compromise was pending. Apart from that, the additional 30 days before the bankruptcy petition’s filing date must also be considered. The 240 days would be tolled for the duration of the automatic stay in a previous bankruptcy filing, plus an extra 90 days.

An IRS Account Transcript will provide the date of assessing the tax in question; however, the date of assessment of a State tax is more challenging to consider and varies by state.

Depending on how much you estimate to repay this year, you may be better off deferring your bankruptcy filing until January 2, 2022.

Modifications to this regulation are permissible in the following circumstances:

The time is extended to the next working day if the 240th day falls on a weekend or holiday.
The 240-day period can be extended if a compromise offer is under consideration for 96 days or more.

Final takeaway

Only Chapter 7 bankruptcy allows you to get tax debt solutions and discharge your income tax debt through bankruptcy. Consumers can accomplish this by following three timing-based rules.

According to the three-year rule, taxes cannot be discharged unless three years have elapsed after the last tax return was due.

The “two-year rule” states that if a tax return was not submitted on time, it must have been on file for at least two years in favor of being discharged in bankruptcy.

Even if the other two conditions are met, the “240 day rule” prevents taxes imposed within 240 days of the bankruptcy petition from being canceled.

It takes a lot of time and effort to discharge taxes in bankruptcy. So, get professional legal guidance from a bankruptcy attorney if you want expert bankruptcy tax debt help.

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