Income tax debt can be discharged in bankruptcy, but only when specific conditions are all met at the same time. This is one of the most misunderstood questions in tax law — the short answer is yes, under the right circumstances, but the conditions are strict and they all have to line up.
The rule is sometimes called the 3-2-240 test. To discharge income tax debt in a Chapter 7 or Chapter 13 bankruptcy, you need to satisfy all three of the following: the tax debt must be for a return that was due more than three years ago (counting extensions); you must have actually filed that return more than two years before you file for bankruptcy; and the IRS must have assessed the tax more than 240 days before your bankruptcy filing. Each of those is a separate, independent requirement. All three must be true for the same tax period or the debt does not qualify.
Two other conditions apply regardless. The return cannot have been fraudulent, and you cannot have willfully attempted to evade the tax. If either of those is true, discharge is off the table — period — under 11 U.S.C. § 523(a)(1). Fraud and willful evasion are separate from ordinary negligence or failure to pay. Most taxpayers with unpaid income tax do not have fraud or evasion issues; they simply ran out of money. But this is worth verifying before you file.
There are things this rule does not cover. Payroll taxes — the trust fund portion of FICA, the employer’s share, the amounts you withheld from employees’ paychecks — are not dischargeable in bankruptcy. Period. Neither are tax penalties that are punitive in nature. If your primary tax problem is payroll tax debt, bankruptcy will not solve it.
The three-year clock for the due date is measured from the original due date, not any extended due date. The two-year clock for when you filed runs from the actual filing date — a return filed the day before you petition for bankruptcy does not qualify. The 240-day assessment period can also be tolled if you were in an offer in compromise or a prior bankruptcy during that window.
Bankruptcy is one tool in a broader toolkit for resolving tax debt. It makes sense for some people. For others, an offer in compromise, installment agreement, or currently-not-collectible status is a better fit. The analysis depends on your specific numbers. Book a free 15-minute call at (619) 378-3138.
