Can You Discharge IRS Debt Under Section 523?

Section 523 of the U.S. Bankruptcy Code outlines specific debts that are exceptions to a bankruptcy discharge. For federal tax debts owed to the Internal Revenue Service (IRS), this section has complex applications. Filing for bankruptcy does not automatically eliminate tax liabilities, as only certain debts that meet a strict set of criteria can be discharged. The possibility of discharging a tax debt depends on the type of tax, its age, and the taxpayer’s history of compliance.

This framework is designed to provide a fresh start for debtors while preventing the evasion of tax responsibilities. The following sections detail the specific conditions under which federal income taxes may be discharged and which tax-related debts are permanently excluded from such relief.

Conditions for Discharging Income Tax Debt

For older federal income tax debts to be eligible for elimination in a Chapter 7 bankruptcy, a series of timing requirements must be satisfied. The first condition is the three-year rule, which requires the tax return’s due date to be at least three years before the bankruptcy petition is filed. If a taxpayer received an extension to file, the extended due date is the one that is used for this calculation.

A second condition, the two-year rule, focuses on when the return was actually filed. The tax return for the debt in question must have been filed at least two years prior to the bankruptcy filing date. For example, if a 2018 tax return due in April 2019 was not filed until June 2022, the taxpayer would have to wait until at least June 2024 to file for bankruptcy for that specific debt to meet this requirement.

The final timing requirement is the 240-day rule, which pertains to the date of tax assessment. The IRS must have formally assessed the tax liability at least 240 days before the bankruptcy case begins. An assessment is the official recording of the tax debt on the IRS’s books, and this period can be extended by events like a pending Offer in Compromise.

To successfully discharge an income tax debt, the liability for a given year must independently satisfy all three rules. Verifying these dates requires obtaining an official IRS Account Transcript for each tax year to confirm the return due dates, filing dates, and assessment dates.

Taxes That Are Never Dischargeable

Certain tax-related debts are explicitly excluded from discharge in bankruptcy, regardless of how much time has passed. These exceptions reflect public policy against allowing relief for debts incurred through misconduct or for certain high-priority obligations.

Any tax debt connected to a fraudulent tax return is permanently non-dischargeable. This also applies to any liability where the filer engaged in a willful attempt to evade or defeat the tax, which can include using a false Social Security number.

Another bar to discharge involves unfiled tax returns. If a required tax return was never filed for a particular year, the associated tax debt cannot be eliminated. This rule extends to situations where the IRS creates a Substitute for Return (SFR), which is a return the IRS prepares for a non-filer based on information from third parties. Because the taxpayer does not voluntarily submit an SFR, courts have held that it does not count as a “filed” return for discharge purposes.

A significant category of non-dischargeable tax debt involves trust fund taxes. These are taxes a business is required to collect from others and hold “in trust” for the government, such as payroll taxes withheld from employee wages. The personal liability for the trust fund portion of these taxes cannot be discharged in bankruptcy.

The Role of Tax Liens in Bankruptcy

A distinction exists between discharging a tax debt and resolving a federal tax lien. Even if the underlying income tax debt meets all the timing rules for discharge, a Notice of Federal Tax Lien filed by the IRS before the bankruptcy case begins will survive the process. The bankruptcy discharge eliminates the filer’s personal liability for the debt, meaning the IRS can no longer take collection actions like garnishing future wages or levying bank accounts.

However, the lien remains attached to the property the person owned at the time the bankruptcy was filed. This gives the IRS a secured claim against that property, including real estate and vehicles. The IRS retains the right to seize and sell that property to satisfy the lien, even though it cannot pursue the individual for any shortfall.

The lien does not, however, attach to property or income acquired after the bankruptcy filing date. For instance, if a tax lien is attached to a primary residence, the filer may be unable to sell or refinance the home without first paying off the lien amount.

If the property has little to no equity, the practical impact of the surviving lien may be minimal. However, the lien itself remains a formal encumbrance on the property title until it is paid, settled, or expires, which is generally 10 years from the assessment date.

Determining Dischargeability in a Bankruptcy Case

While the rules for discharging tax debt are set by statute, obtaining legal certainty about a specific tax liability often requires a formal court action. A debtor can seek a definitive ruling from the bankruptcy judge on whether a particular IRS debt is dischargeable. This is accomplished by filing a specific type of lawsuit within the main bankruptcy case known as an adversary proceeding.

The purpose of filing an adversary proceeding is to receive a declaratory judgment from the court, which provides a final, legally enforceable answer. This prevents the IRS from attempting to collect on a discharged debt in the future. The complaint filed to start the proceeding must identify the tax debts in question and state the reasons why they meet the discharge criteria under Section 523.

Without such a formal determination, a debtor is left to rely on their own interpretation of the complex timing rules, which can lead to disputes with the IRS after the bankruptcy case is closed. An adversary proceeding provides an opportunity to present evidence, such as tax transcripts and filing records, to the court for a clear and final resolution.