Paying taxes is often painful. But owing taxes that you’re unable to pay can be intolerable. Thankfully, income tax debt can often be erased in Chapter 7 and Chapter 13 bankruptcies. However, each of the following rules must be satisfied:
- The income tax must have been due over 3 years before the bankruptcy was filed. For example, income tax debt from 2009 (due April 15, 2010) can be discharged in a bankruptcy filed after April 15, 2013. However, if an extension to file the return was requested, the 2009 tax wasn’t due until October 15th, 2010. The bankruptcy filer would then have to wait until October 16, 2013, to erase the 2009 tax debt.
- The tax return must actually have been filed at least 2 years prior to filing the bankruptcy. If the 2009 tax return wasn’t filed until June 1, 2011, the bankruptcy filer would then have to wait until June 2, 2013, to erase the 2009 tax debt.
- The tax had been “assessed” by the IRS for at least 240 days before the bankruptcy is filed. If the IRS audits a tax return, and determines that additional taxes are owed, the bankruptcy must wait until 240 days after the audit to erase the additional tax, interest, and penalty.
- The taxpayer must not have engaged in fraud, or a willful attempt to evade or defeat the tax. If the taxpayer lies on a tax return, gets caught, and is further assessed, the bankruptcy will not erase the additional tax.
As you can see, as long as the bankruptcy is not filed too soon after the tax return is filed, income taxes can be discharged. This is known as the “Gallo Rule”: Just as Ernest and Julio Gallo advertise that they will sell no wine “before its time”, the debtor owing income tax debt should wait for the right time to file the bankruptcy.
If you can’t remember when you filed your tax return – not to worry. This information can be obtained from a tax transcript by filing IRS Form 4506 and Nebraska Tax Form 23.
Discharging income taxes in bankruptcy can be a tricky matter. Traps await to surprise the inexperienced. If you have any questions, contact the lawyers and staff at the Steffens Law Office.
We’re dedicated to helping you achieve a fresh financial start.