Dealing with IRS & State Priority Taxes

Dealing with Priority Taxes in Chapter 13

3-2-240 Rule

The 3-2-240 Rule is a shorthand reference to the time-related criteria that tax debts must meet to be considered dischargeable in bankruptcy. It encompasses three critical timelines related to the tax return’s due date, the actual filing date, and the IRS’s assessment of the tax debt. Let’s break down each component:

The Three-Year Rule

The first part of the rule stipulates that the tax debt must be related to a tax return due at least three years before the bankruptcy filing, including any extensions.

The Two-Year Rule

The second component requires that the tax return was actually filed at least two years before the bankruptcy petition. This rule emphasizes the importance of filing tax returns, even if you can’t pay the tax owed at the time. It’s crucial to note that this applies to returns filed by the taxpayer, not substitute returns filed by the IRS on behalf of a taxpayer who failed to file.

The 240-Day Rule

Finally, the tax debt must have been assessed by the IRS at least 240 days before filing for bankruptcy or not assessed at all. This part of the rule accounts for the IRS’s actions in determining the amount owed. The assessment period can be extended if the IRS suspended collection activity due to an offer in compromise or a previous bankruptcy filing.

Exceptions and Considerations

While the 3-2-240 Rule provides a framework for discharging certain tax debts, there are exceptions and additional considerations:

– Fraud and Willful Evasion: Tax debts related to fraudulent tax returns or willful attempts to evade taxes are not dischargeable, regardless of the 3-2-240 Rule.

– Tax Liens: If the IRS has placed a tax lien on your property before you file for bankruptcy, the lien may remain attached to the property, even if the underlying tax debt is discharged. Federal Tax Liens can’t be discharged. If the IRS recorded a tax lien on your property before you file for bankruptcy. You’ll have to pay off the tax lien, which you may be able to do in Chapter 13.

– Non-Dischargeable Taxes: Certain taxes, such as payroll taxes or penalties related to non-tax debts, are not dischargeable in bankruptcy.

Navigating Your Bankruptcy and Tax Debt Strategy

Understanding the nuances of the 3-2-240 Rule and its application to your specific situation requires careful analysis and strategic planning. Here are steps to consider:

1. 1. Review Your Tax History: Assess your tax returns, payments, and IRS assessments to determine if your tax debts meet the 3-2-240 criteria.
   2. Consider Timing: The timing of your bankruptcy filing can significantly impact the dischargeability of tax debts. Strategic planning can maximize the debts eligible for discharge.

Why timely filing matters in Chapter 13

1. No return, no discharge, even after a full plan. If no valid “return” was filed (including an SFR-then-late-1040 scenario under Moroney), the tax survives the completed plan. You can pay a pro rata share of it as a general unsecured claim through the plan and still owe the remainder to the IRS afterward.
2. Timely filing keeps old taxes out of the nondischargeable category. A timely filed return is the starting point for the usual dischargeability analysis. Income taxes on it are dischargeable if they meet the timing rules: return due at least three years before the petition, assessed at least 240 days before, and no fraud or evasion. A late return adds the “filed more than two years before the petition” requirement in § 523(a)(1)(B)(ii) as an extra hurdle, and in the Fourth Circuit a post-assessment filing may not count as a return at all.
3. It determines what the plan must pay in full. Taxes that are recent enough to be priority claims under § 507(a)(8) must be paid in full over the plan (§ 1322(a)(2)). Taxes that are neither priority nor excepted can be paid at the plan’s unsecured rate and discharged. Whether a tax falls into which bucket depends on whether and when a return was filed, so a missing or late return can push a large amount from “partly discharged” to “paid in full or left over.”
4. Chapter 13 itself requires returns to be current. Under § 1308, the debtor must file all returns due for the four years before the petition by the day before the § 341 meeting. Failure can lead to dismissal or conversion and blocks confirmation (§ 1325(a)(9)). So unfiled returns can end the case, separate from the dischargeability issue.
5. Filing lets you contest the IRS’s number. If the IRS files a proof of claim based on an SFR or estimated assessment, a return you file before the claim is fixed can reduce it. Once an SFR is assessed, a later return generally will not restore dischargeability in the Fourth Circuit, though it may still correct the amount owed.