Wouldn't it be great to get rid of your tax debt without any consequences? Unfortunately, it's not a common option. At least, not without understanding how the IRS sees discharging or expiring your tax debt.
Tax discharge and expiration are different, and both can be tricky. The IRS likes to think the law is straightforward — and it is — but it contains so many clauses, exceptions, and other legal language that it takes a legal or tax expert to figure it out.
That’s why we are undertaking this post. To help you understand some of the minutiae of tax law that lets you, at the very least, reduce your tax burden and stress.
Discharge vs. Expiration
A tax discharge means that, under specific circumstances, the IRS allows a taxpayer to discharge or “eliminate” a tax debt, meaning that tax debt is no longer due. You don’t have to pay it. You do need to jump through some hoops to get there.
A tax expiration means the statute of limitations has run out for the IRS to collect a tax debt. Typically, the expiration date for tax debt is 10 years from the date of assessment. Still, that date can get pushed around by other activities. Things like extensions can make time act weird, and 10 years can stretch onward, at least for a while.
As mentioned above, you can discharge your tax debt in some highly regulated situations instead of paying it. Bankruptcy is the most common method of attempting to discharge tax liabilities. However, not all debt is dischargeable under bankruptcy, including some tax debts.
Debts you cannot discharge can include:
- Various debts for public policy reasons
- Debts used to deter certain actions by individuals seeking bankruptcy relief
- Income taxes in certain situations
The tax code contains the narrowest of provisions for tax discharge, and the law evolves constantly. Also, it is incredibly complex and unlikely to become clear anytime soon.
Using Bankruptcy to Discharge Tax Liabilities
Chapter 7, Chapter 11, and Chapter 13 bankruptcy allow for income tax liability discharge.
Chapter 7 is available to individuals, businesses, corporations, and partnerships. The purpose of Chapter 7 bankruptcy is to allow the liquidation of assets. A trustee controls the assets and attempts to sell them to pay creditors. Because businesses are liquidated, there is no need to discharge the tax debt. Only individuals can discharge tax liabilities under Chapter 7.
It can take 90 to 120 days to complete Chapter 7 bankruptcy, and the debtor must file tax returns for the past four tax periods.
Chapter 11 bankruptcy is for individuals, corporations (including LLCs), and partnerships. Chapter 11 allows the reorganization of debt so the entity can settle for a lower payment in the hopes of staying in business.
It can take five years to complete Chapter 11, and you must file returns for the last four tax periods. Chapter 11 can include the dismissal or discharge of tax liabilities.
Chapter 13 bankruptcy includes individuals and sole proprietors. In this case, debts are “adjusted,” and a trustee distributes the debtor payments to creditors. It can take five years to complete Chapter 13. If it’s due to hardship, you can do it in three.
What You Must Do to Take Advantage of Bankruptcy Tax Debt Discharge
First, all tax returns (for the debt in question) must be filed on time. Many jurisdictions count the filing as late, even if it is just one day past due. It gets murky.
The IRS wants a more lenient approach, believe it or not. They prefer interpreting the effect of a late-filed return on bankruptcy proceedings and tax debt discharge.
If you filed late, you must wait two years since the returns for the tax liability in question were filed to petition for bankruptcy. You have to count two years after the filing date, not that year's due date. You cannot use the tax return signature date or the date you mailed the return or filed it electronically.
To consider tax debt for discharge, the tax returns must be due to be filed for at least three years, including extensions. This rule applies to each tax year for which you owe taxes, and each return is individually considered.
The tax debt must be assessed at least 240 days before the bankruptcy filing to be considered for bankruptcy discharge. For example, if the IRS audited you and assessed taxes due, you must wait 240 days before filing for bankruptcy to make the taxes eligible for discharge.
Furthermore, the following applies:
- You may not evade or defeat taxes by intentional dishonesty or failure to report income, among other things.
- The tax liability cannot be due to a fraudulent tax return.
- The tax cannot be assessable at the time of bankruptcy filing (see the 2-year, 3-year, 240-day rules above).
- There can be no liability due on a trust fund tax.
- The tax cannot be unsecured.
The best way to determine the dates for each rule is to obtain a tax transcript from the IRS.
By the way, tax liens are not discharged by bankruptcy without a court order from the bankruptcy court.
The statute of limitations for collecting taxes eventually expires, and the IRS must cease and desist collection efforts. So, you can try to outlast them by waiting 10 years.
Except…. it’s not that easy.
Yes, the IRS has a legal period of 10 years to collect a tax debt. It begins on the date of the tax assessment. The IRS must send a notice letter notifying you of the expiration. And if the collection statute date runs out, the tax debt may become null and void.
That last one is a big IF. There are many situations where the 10 years may be extended, so one cannot just assume the taxes expire ten years from the assessment date. Never assume expiration. Always check with the IRS to determine if you have taxes due and whether any have expired.
Believe us, they keep close track.
You can discharge tax debt or let the collection period expire, but neither is straightforward.
Attempting to discharge tax debt by bankruptcy means following the 2-3-240 rules scrupulously. It must be 2 years since the returns under consideration were filed. The last due date for filing the returns must be at least 3 years. And you must wait at least 240 days to petition for bankruptcy after the date of assessment.
Also, there can be no tax fraud, evasion, or defeat due to intentional dishonesty or failure to report income.
To make sure of all dates, obtain a tax transcript from the IRS for every return in question, and keep in mind none of this includes the discharge of tax liens or trust fund taxes.
We can help you straighten everything out. Contact Top Tax Defenders today.