Bankruptcy and tax debts: what is dischargeable and what the IRS does

What happens when the petition is filed

IRM 5.9.2.10: “The filing of a bankruptcy petition immediately affects the collection of taxes.” Under the automatic stay of 11 USC 362, actions against property of the estate and actions to collect pre-petition liabilities are suspended as of the petition date. Levies that violate the stay must be released, and IRM 5.11.2.3.1 tells employees to contact Insolvency immediately and start corrective action within two workdays of learning of a potential violation. An NFTL filed in violation of the stay is the one case in which withdrawal is mandatory (IRM 5.12.9.2). One exception added by the 2005 amendments (BAPCPA): offsets of pre-petition income tax refunds against pre-petition income tax liabilities are not stayed.

The stay is weaker for repeat filers. For an individual whose prior Chapter 7, 11 or 13 case was dismissed within the past year, the stay terminates on the 30th day as to the debtor and non-estate property unless the court finds good faith; with two or more dismissals in the year, the stay does not go into effect at all without a showing of good faith by clear and convincing evidence (IRM 5.9.2.10; 11 USC 362(c)(3)-(4)).

The IRS files a proof of claim, usually generated by its Automated Proof of Claim system. A governmental unit's claim is generally timely if filed within 180 days after the order for relief (IRM Exhibit 5.9.1-1, citing 11 USC 502(b)(9)).

Priority taxes: the three-year and 240-day rules

Priority taxes must be paid in full through a Chapter 11, 12 or 13 plan and are excepted from discharge for individuals (11 USC 523(a)(1)(A)). For income taxes, 11 USC 507(a)(8)(A) gives priority to tax for a year ending on or before the petition date in three situations:

The 240-day period excludes time an offer in compromise was pending or in effect during that period, plus 30 days, and time a stay was in effect in a prior bankruptcy, plus 90 days. The time periods in 507(a)(8) are also suspended while the IRS was barred from collecting because of the debtor's request for a collection hearing and appeal, plus 90 days, and during a prior bankruptcy stay. A CDP hearing or an offer shortly before a petition therefore pushes the dates out; see CDP hearings and offers.

The prior-bankruptcy rule began as a court decision. In Young v. United States, 535 U.S. 43 (2002), the debtors filed a Chapter 13 petition, moved to dismiss it, and filed a Chapter 7 petition the day before the dismissal, by which time their 1992 return had been due more than three years earlier; the Supreme Court held that the lookback period “is tolled during the pendency of a prior bankruptcy petition” because the automatic stay had prevented the IRS from collecting, and it added that tolling applies “regardless of whether petitioners filed their Chapter 13 petition in good faith or solely to run down the lookback period.” Congress codified the result in 2005 in the unnumbered paragraph at the end of 507(a)(8), which now reads: the periods are suspended for “any time during which the stay of proceedings was in effect in a prior case under this title or during which collection was precluded by the existence of 1 or more confirmed plans under this title, plus 90 days.” Serial filings therefore never shorten the IRS's priority window; add every day of every prior case, plus 90, before concluding that a year has aged out.

Other priority taxes include taxes required to be collected or withheld, in whatever capacity the debtor is liable (507(a)(8)(C)), which covers the trust fund recovery penalty; employer employment taxes on wages for which a return was last due within three years (507(a)(8)(D)); and penalties related to a priority tax that compensate for actual pecuniary loss (507(a)(8)(G)).

A Chapter 11 plan can also steer the business's payments to the trust fund portion first, which protects the owners from the penalty. In United States v. Energy Resources Co., 495 U.S. 545 (1990), the Supreme Court held that bankruptcy courts “may order the IRS to apply tax payments to offset trust fund obligations where it concludes that this action is necessary for a reorganization's success,” even though the IRS would rather apply them to non-trust-fund taxes it can collect from no one else; the Court noted that IRC 6672 remains available against responsible persons both during and after the Chapter 11 case. Outside a confirmed plan, the ordinary designation rules for voluntary payments on the TFRP page apply, so counsel for an operating debtor with exposed officers should ask for the designation in the plan rather than assume the trustee or the IRS will make it.

Taxes excepted from discharge

11 USC 523(a)(1) excepts from an individual's discharge any tax:

• (A) of the kind and for the periods in 507(a)(3) or 507(a)(8), whether or not a claim was filed or allowed;
• (B) for which a required return was not filed, or was filed late “after the date on which such return, report, or notice was last due, under applicable law or under any extension, and after two years before the date of the filing of the petition”; or
• (C) “with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax”.

Tax penalties are treated under 11 USC 523(a)(7): a tax penalty is excepted from discharge unless it relates to a tax that is itself dischargeable or was imposed for a transaction or event more than three years before the petition. IRM 5.9.17.8.2 covers how the IRS develops the fraud and willful evasion exception, which is litigated in an adversary proceeding.

Late returns and substitutes for return

Whether a document is a “return” decides many cases under 523(a)(1)(B). IRM 5.9.2.10.1.2 states the IRS position after the 2005 amendments: a return prepared by the IRS under IRC 6020(a) (with the taxpayer's cooperation) or a stipulated judgment counts, but “a return prepared under IRC 6020(b) is not a return for the purpose of discharge.” An agreed substitute for return where the taxpayer signed only Form 4549 or Form 870 on or after September 12, 2005, is not a return unless accompanied by a document signed under penalties of perjury that purports to be a return (Rev. Rul. 2005-59).

When the taxpayer files a Form 1040 after the IRS has assessed a substitute for return, Chief Counsel Notice CC-2010-016, as summarized in IRM 5.9.2.10.1.2, says it is a return for bankruptcy purposes only to the extent it reports new, previously unassessed tax. In practice, the SFR assessment for that year stays with the taxpayer. Pull the account transcripts for every year (look at the TC 150 and the blocking series the IRM describes) before advising on dischargeability; see reading an account transcript, substitutes for return and ASFR and the transcript code decoder.

The late-return split. The courts disagree about whether any late return counts, and the answer depends on where the case is filed. The 2005 amendments added the definition quoted above: a return is one “that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements)”. Two circuits read the parenthetical literally. In Mallo v. IRS, 774 F.3d 1313 (10th Cir. 2014), the debtors filed their Forms 1040 years late, after the IRS had assessed, and the Tenth Circuit held “that, because the applicable filing requirements include filing deadlines, § 523(a)(*) plainly excludes late-filed Form 1040s from the definition of a return,” so the tax was never dischargeable no matter how long before the petition the return was filed. In re Fahey, 779 F.3d 1 (1st Cir. 2015), reached the same result for Massachusetts returns, holding that a return filed after the state's due date is not a return under 523(a), and the Fifth Circuit had already so held for Mississippi returns in McCoy. On that reading the two-year rule in 523(a)(1)(B)(ii) has almost no work left to do, since only an IRC 6020(a) return prepared with the taxpayer's cooperation, or a stipulated judgment, can be both late and a return. The Eighth Circuit takes the opposite view. In In re Colsen, 446 F.3d 836 (8th Cir. 2006), a pre-2005 case, the debtor filed Forms 1040 for 1992 through 1996 after the IRS had assessed those years, and the court applied the Beard test and held “that the honesty and genuineness of the filer's attempt to satisfy the tax laws should be determined from the face of the form itself, not from the filer's delinquency or the reasons for it,” so the late forms were returns and the tax was discharged. The IRS does not take the Mallo position. As the Tenth Circuit described the Chief Counsel notice, the IRS “agrees with Taxpayers that 'section 523(a) in its totality does not create the rule that every late-filed return is not a return for dischargeability purposes,'” and argues instead that a debt assessed before the Form 1040 is filed is a debt for which no return was filed. That is the position reflected in IRM 5.9.2.10.1.2 above: a return filed late but before any assessment, and more than two years before the petition, remains dischargeable in the IRS's view, while the post-SFR return counts only for newly reported tax. For a client in the First, Fifth or Tenth Circuit, assume a late return defeats discharge regardless of the IRS's view; elsewhere, the two-year rule and the SFR analysis control.

Discharge by chapter

For joint liabilities where only one spouse files, IRM 5.9.17.8 says a liability non-dischargeable for the debtor is non-dischargeable for the non-debtor spouse, and a liability discharged for the debtor generally remains collectible from the non-debtor spouse, except that in community property jurisdictions the non-debtor spouse receives a hypothetical discharge.

Liens that survive discharge

A discharge bars collection of the debt from the debtor personally; it does not necessarily remove the lien. IRM 5.9.2.10.1.1: “If the IRS has properly filed a pre-petition NFTL, and the NFTL is still valid (e.g., refiled correctly, if applicable), the NFTL survives the bankruptcy discharge (11 USC 522(c)(2)(B)).” The IRS can then collect the discharged tax from exempt property. The statutory lien, even without an NFTL, also survives as to abandoned or excluded assets, such as retirement plans excluded under 11 USC 541(c)(2). Form 12153 makes the same point for CDP purposes: pre-bankruptcy property may remain subject to the lien. See federal tax liens. Discharge also does not count as “fully satisfied” for a post-release NFTL withdrawal (IRM 5.12.9.9).

Offers, agreements, CDP and innocent spouse claims

• Offers in compromise. IRM 5.8.10.2.1: “The IRS will not consider an OIC under its administrative OIC procedures while a taxpayer is in bankruptcy.” An offer submitted during bankruptcy is returned as not processable with no appeal; one pending when the petition is filed is returned. After a Chapter 7 discharge the IRS can consider a doubt as to collectibility offer on the surviving taxes; in Chapters 11, 12 and 13, after plan completion or dismissal (IRM 5.9.4.11).
• Installment agreements. IRM 5.9.4.20 says a bankruptcy petition is not one of the statutory grounds for terminating an installment agreement; the agreement is suspended, not terminated, and terminating it during the case could violate the stay. See installment agreements.
• CDP. If the stay bars a Tax Court petition from a CDP determination, IRC 6330(d)(2) suspends the 30-day petition period while the debtor is barred and for 30 days after.
• Innocent spouse. The automatic stay does not stop the IRS from issuing a final determination on Form 8857, but the Tax Court petition period is suspended while the debtor is barred and for 60 days after (IRM 5.9.4.18; IRC 6015(e)(6)). See innocent spouse relief.
• Assessment statute. For cases filed after October 22, 1994, bankruptcy does not directly suspend the assessment statute unless the stay suspends the Tax Court petition period (IRM 5.9.4.3).

Testing a year for dischargeability

A hypothetical individual Chapter 7 petition filed November 2, 2026, looking at tax year 2022 (not an IRS example):

1. Three-year rule: find the 2022 return's due date, including any extension. If that date falls after November 2, 2023 (three years before the petition), 2022 is a priority tax and not dischargeable; if it falls on or before that date, this test is passed. An extension can make the difference.
2. Two-year rule: was a return filed, and if late, more than two years before the petition (before November 2, 2024)? A return filed in December 2024 fails. A 6020(b) substitute for return is not a return.
3. 240-day rule: was the tax assessed more than 240 days before the petition, after adding any days an offer was pending (plus 30) or a prior bankruptcy stay was in effect (plus 90)? An audit assessment in June 2026 fails.
4. Tolling: add any time collection was barred by a CDP hearing request and appeal (plus 90 days) or a prior stay to the three-year and other lookback periods.
5. Fraud or evasion: any indication of a fraudulent return or willful evasion makes the year non-dischargeable regardless of dates.
6. Liens: check for a pre-petition NFTL. If one was filed, discharged tax may still be collected from exempt property it reaches.

Run the dates against the account transcript, not the client's memory, and use the statute date calculator for the collection statute that will apply if the case is dismissed.

Questions practitioners ask