Are Income Taxes Dischargeable in Bankruptcy

Individuals with financial problems frequently fall behind in paying their income taxes for a number of reasons. People, who are self employed, may be short on funds, when their estimated tax payments are due. Or if they are subject to wage withholding, they may be unable to pay any additional balance due, when they file their annual tax returns. One mistake individuals sometimes make, which compounds this problem, is withdrawing funds from retirement accounts in an effort to catch up on their late bills. Unfortunately withdrawing from retirement accounts creates taxable income, and if the debtor is under the age of fifty-nine and a half he or she will probably also be subject to a ten percent penalty for premature withdrawal.
A bankruptcy can discharge income tax liability, but there are a number of circumstances which will prevent the taxpayer from receiving a discharge, and if you owe income taxes you need to discuss the problem with your bankruptcy attorney, so he or she can properly advise you how the rules apply in your case.
The general rule is that income taxes will be discharged, if they are more than three years old provided the tax return was timely filed. The three year period is counted from the due date of the tax return.
Example: Orrin Oxford from Libertyville, Illinois decides to file a bankruptcy on April 1, 2011, and among his debts is $5,000.00 of unpaid Federal Income Taxes for the year 2007. He may assume that 2011 is four years after 2007, and he will receive a discharge for the taxes. However, the due date for his 2007 tax return was April 15, 2008, and his filing date for the bankruptcy, April 1, 2011, is less than three years later. His bankruptcy attorney will no doubt advise Orrin to postpone filing until the second half of the month, so he can obtain relief from the Internal Revenue Service along with the rest of his creditors.
The above example assumes that the debtor filed his 1040 on time. If a taxpayer fails to file a tax return, the taxes will not be discharged in bankruptcy, even if they are more than three years old. If the tax returns are filed late, the bankruptcy must occur at least two years after the taxpayer filed the return to allow a discharge.
Even if the taxpayer files taxes on a timely basis, the taxes will be nondischargeable, if fraud was involved, and the Internal Revenue Service sometimes takes an unreasonably aggressive approach in opposing the discharge on the ground of fraud. The government does not do particularly well in court, when debtors challenge such claims, but unfortunately many people in bankruptcy cannot afford to take the issue to court.