Discharging Taxes and the Exceptions to Discharge
Section 727(a) of the US Bankruptcy Code provides individuals filing Chapter 7 bankruptcy a general bankruptcy "discharge." The general discharge eliminates a debtor’s obligation to pay most debts that arose before the date the bankruptcy case is filed. Similarly, Section 1328 of the Bankruptcy Code provides a discharge to individuals filing Chapter 13 bankruptcy. The general discharge is granted to debtors who complete all payments under a confirmed repayment plan. The court grants each debtor a discharge of all debts provided for by the plan.
Pursuant to these Code sections, general unsecured income taxes would be discharged upon the successful completion of a Chapter 7 or Chapter 13 case and the entry of the general discharge by the bankruptcy court. Also discharged would be the interest, penalties, and late fees associated with the discharged taxes.
However, not all debts are discharged and some debts can survive the general discharge ordered by the court. Section 727(a) and Section 1328 incorporate some exceptions to this general discharge. The exceptions to discharge are setforth in Section 523 of the Code.
Section 523 of the Code identifies certain debts that are "excepted" from the general discharge, meaning that debtors would be still obligated to pay these excepted debts even though these same debtors were granted a general discharge by the court.
First, "priority" income tax debt is one category of "excepted" debt identified in Section 523. Section 523 states that a discharge entered under Section 727 or 1328 does NOT discharge an individual taxpayer from any debt relating to priority income taxes.
Second, tax debt related to unfiled income tax returns is not discharged. Third, tax debt related to "late filed" tax returns is not discharged if the return was filed within two years of the bankruptcy filing date.
Fourth, tax debt is not dischargeable if it relates to a fraudulent return. Fifth, tax debt is not dischargeable if the taxpayer willfully attempted to evade paying taxes. Finally, tax debt is not dischargeable if the taxpayer attempted to defeat the taxing body’s efforts to collect the taxes.
6-Part Test: Law Relating to the Discharge of Income Taxes
Section 523 of the Code provides exceptions to the general discharge order entered pursuant to Section 727 (Chapter 7) or Section 1328 (Chapter 13). Section 523(a)(1) does not discharge a taxpayer from income tax debt if the taxpayer violates any of the following 6-part test:
The six-part test examines the taxpayer’s actions—
- Taxpayer filed a fraudulent tax return;
- Taxpayer willfully attempted to evade the payment of taxes or the government’s collection of the tax debt;
- Taxpayer failed to file a tax return;
- Taxpayer filed an untimely tax return less than two (2) years before the bankruptcy case was filed;
- Government assessed the income tax less than 240 days before the bankruptcy case was filed; and
- The tax return due date was less than three (3) years before the bankruptcy case was filed.