THE 3 YEARS, 2 YEARS, AND 240 DAY RULES

The Bankruptcy Code sets out specific time periods that determine if you can discharge your taxes, commonly called the 3-year, 2-year, and 240-day rules (the “3-2-240 rules”). Under these rules, you can discharge income taxes that came due three years before you file for bankruptcy, as long as it has been at least two years since you filed the tax forms and 240 days since the taxes were assessed. There are some exceptions, and these rules do not apply to other types of taxes, such as property taxes.

To discharge back income taxes you must meet the requirements of all three rules.

1. The 3-Year Rule. This rule states that to discharge your back income taxes, they must become due at least three years before you file for bankruptcy. Bankruptcy Code §507(a)(8)(A)(i). Typically, your federal and most state income taxes are due April 15^th of each year.

*Remember however that if you get an extension of time to file, the three-year period runs from the date that the taxes are due under the extension.
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2. The 2-Year Rule. Under the 2-year rule, your income tax returns must have been filed at least two years before you file your bankruptcy petition.
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3. The 240-Day Rule. Taxes must have been assessed by the taxing agency at least 240 days before you file for bankruptcy under this rule or not assessed at all.
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Tolling. Some actions can add additional time to some or all of the 3-2-240 time requirements, including (a) making an offer in compromise, (b) having filed for bankruptcy previously, or (3) obtaining a taxpayer assistance order. The time periods noted above are tolled (suspended) while any of these events are pending. However, entering into a payment arrangement with the IRS or another taxing agency does not toll the time periods under the 3-2-240 rules.

INTEREST AND PENALTIES

For the most part, interest and penalties are treated the same in Chapter 7 and 13. However, there are some differences, with regard to priority debts, which we will discuss.

• Discharging interest on back taxes. In both Chapter 7 and Chapter 13, if the taxes are dischargeable, the interest is dischargeable as well.
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• Penalties and interest on priority tax debts in Chapter 7. In Chapter 7, penalties and interest on priority tax debts are not dischargeable.
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• Penalties and interest on priority tax debts in Chapter 13. All penalties and post-petition interest are discharged in Chapter 13, if the debtor completes the Chapter 13 plan. Therefore, if you have significant penalties on priority tax debt, filing under Chapter 13 may be a better option, particularly if you cannot wait for the taxes to qualify under the 3-2-240 rules.
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• Penalties and interest on secured tax debts. Interest and penalties on secured tax debt are not dischargeable up to the value of the security interest in the debtor’s property.
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• Post-petition interest on secured debts. Taxing agencies may be entitled to post-petition interest on secured tax debt, which the debtor must pay as part of the plan in a Chapter 13 case.

BUSINESS TAXES

Income taxes that you incur personally as a result operating a business are dischargeable in bankruptcy under the 3-2-240 rules. However, different rules apply to other business-related taxes:
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Payroll Trust Fund Taxes. Trust fund taxes are not dischargeable in bankruptcy. Trust fund taxes include payroll taxes that employer withholds from an employee’s pay on behalf of the government. If you fail to withhold required taxes or withhold the taxes from an employee’s check but fail to pay the withheld funds to the taxing authority, the taxes are not dischargeable.
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Employer’s Portion of the Payroll Tax. The employer’s part of the payroll tax (the tax paid directly by the employer for Social Security and Medicare) is dischargeable in bankruptcy under rules similar to the 3-2-240 rules. The debtor must file for bankruptcy a minimum of three years from the date that the IRS 941 form was due and two years from the date the debtor filed the tax forms.
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Payment of a Tax Lien in Chapter 13. In Chapter 13 cases, the debtor must pay the tax lien through the Chapter 13 plan as a secured debt. (The IRS will generally reduce the lien to the value of the debtor’s property when it files its proof of claim.) Once the lien is paid in bankruptcy and the debtor receives a discharge, the IRS or other taxing agency will remove the lien.
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Expiration of Federal Tax Liens. Most IRS tax liens expire when the 10-year period of collectability ends. IRC §6322. Therefore, sometimes it is possible to wait out a tax lien, although it would be unwise to do so without consulting an attorney.