Yes, under the right circumstances. Income taxes (not trust-fund or withholding taxes) are dischargeable in a Chapter 7 Bankruptcy if certain conditions are met.
Has it been more than three years since the original due date, including extensions, for the return? If not, the taxes are not dischargeable. (Three Year Rule).
If the tax return was filed after the original due date, has it been more than two years since the late return was filed? If not, the taxes are not dischargeable. (Two Year Rule). Some added caution is necessary for state tax obligations. The Fifth Circuit Court of Appeals, In re McCoy, 666 F.3d 924 (5th Cir. 2012) petition for cert filed, 80 U.S.L.W. 3680 (U.S. Apr 2, 2012)(No. 11-1469), recently held that the obligations from a late filed state return are not dischargeable in bankruptcy as the late filed return was not a “return” for bankruptcy purposes.
Has it been more than 240 days since the taxes were assessed? If not, the taxes are not dischargeable. (240 Day Rule)
There are other conditions that can prevent a discharge. Are the tax obligations due to the taxpayer’s fraud or misrepresentation? If so, that may render the taxes not dischargeable in a Chapter 7. Interestingly, the fraud penalty itself may still be dischargeable. Is the tax obligation the result of the Internal Revenue Service filing returns for the taxpayer because the taxpayer failed to file? If so, the taxes may not be dischargeable as the returns should be filed by the taxpayer, not the IRS.
The discharge does not automatically eliminate a lien for the taxes. While liens don’t affect the dischargeability of the tax, the lien may survive the bankruptcy thereby making the discharge practically ineffective. If you file the bankruptcy prior to the Internal Revenue Service filing its Notice of Federal Tax Lien (NFTL), then you may have the opportunity to completely avoid the tax claims. However, if the Internal Revenue Service filed a NFTL against you prior to you filing bankruptcy, the bankruptcy may discharge the debt, but the liens may continue to encumber your property. For example, if the IRS lien encumbered your homestead which had $20,000.00 of equity, the Internal Revenue Service’s underlying tax may be discharged, but the Internal Revenue Service would still have a lien against the home for the equity in your property. If you have no equity in any assets, then the lien loses its importance, but must still be removed from the county and state records after the bankruptcy. This can be accomplished with an Application for Release of Federal Tax Lien.
A Chapter 13 Bankruptcy is not designed to discharge all debts completely. Instead, it is a way to force your creditors into a long-term installment arrangement (for example, five years). A Chapter 13 bankruptcy may be appropriate if you do not want to file a Chapter 7 bankruptcy, or if your taxes would not be entirely discharged in a Chapter 7 bankruptcy.
Authorities. IRM Section 5.9; In re McCoy, 666 F.3d 924 (5th Cir. 2012) petition for cert filed, 80 U.S.L.W. 3680 (U.S. Apr 2, 2012)(No. 11-1469).
Comment. If you are interested in discharging taxes in bankruptcy, work closely with a bankruptcy attorney experienced in dealing with the IRS and the MDR.