Tax Debt in Bankruptcy — IRS and DC Tax Obligations

Tax debt is one of the most misunderstood areas of bankruptcy law. Many people assume that taxes can never be eliminated in bankruptcy. That assumption is wrong. Certain income tax debts -- both federal and DC -- are dischargeable if they meet a specific set of conditions. But the rules are exacting, and getting even one element wrong can mean the difference between a full discharge and an obligation that survives bankruptcy and follows you indefinitely.

The Five Requirements for Discharging Tax Debt

To discharge income tax debt in a Chapter 7 or Chapter 13 bankruptcy, all five of the following conditions must be satisfied:

The Three-Year Rule

The tax return for the debt in question must have been due more than three years before the bankruptcy filing date. The due date includes any extensions.

For example, your 2021 federal income tax return was due on April 15, 2022 (assuming no extension). To satisfy the three-year rule, you must file your bankruptcy petition after April 15, 2025. If you obtained an automatic extension to October 15, 2022, the three-year period does not expire until October 15, 2025.

This rule is found in 11 U.S.C. Section 507(a)(8)(A)(i), which defines priority tax claims -- the three-year rule determines when a tax debt loses its priority status and becomes eligible for discharge.

The Two-Year Rule

The tax return for the debt must have been actually filed more than two years before the bankruptcy filing date. This rule, derived from 11 U.S.C. Section 523(a)(1)(B)(ii), applies regardless of when the return was due.

If you filed your 2019 tax return late -- say you did not file it until January 2024 -- the two-year clock starts on the date you actually filed. You would need to wait until at least January 2026 to file bankruptcy and discharge that tax debt.

Important: a "return" for purposes of this rule generally means a voluntary filing. If the IRS files a substitute for return (SFR) on your behalf under 26 U.S.C. Section 6020(b), that filing may not constitute a "return" for discharge purposes. Courts are split on this issue, but the safest approach is to file your own return before seeking to discharge the tax debt.

The 240-Day Rule

The tax debt must have been assessed by the IRS (or DC tax authority) more than 240 days before the bankruptcy filing date. Assessment is the formal recording of the tax liability on the government's books -- it typically occurs when you file your return or when the IRS completes an audit and issues a notice of deficiency.

This rule is found in 11 U.S.C. Section 507(a)(8)(A)(ii). The 240-day period is tolled (paused) during certain events, including:

An offer in compromise. If you submitted an offer in compromise to the IRS that was pending, the 240-day period is extended by the time the offer was pending plus 30 days.
A prior bankruptcy case. If you were in a prior bankruptcy case during the 240-day period, the clock is tolled for the duration of that case plus 90 days.

Calculating the exact 240-day deadline requires obtaining a tax transcript from the IRS showing the assessment date and any tolling events.

You Must Have Filed a Return

Tax debts for which no return was ever filed are not dischargeable under 11 U.S.C. Section 523(a)(1)(B)(i). If you owe taxes because you simply never filed the return, you cannot discharge that debt in bankruptcy -- regardless of how old it is.

This rule creates a strong incentive to file all delinquent returns before filing bankruptcy. Even if you owe money on the return, filing it starts the two-year clock and establishes a "return" for purposes of the discharge analysis.

No Fraud or Willful Evasion

Tax debts arising from fraudulent returns or willful evasion of tax obligations are not dischargeable under 11 U.S.C. Section 523(a)(1)(C). If the IRS can demonstrate that you filed a fraudulent return (intentionally underreporting income, fabricating deductions) or that you willfully attempted to evade tax (hiding assets, using nominee accounts, structuring transactions to avoid reporting), the debt survives bankruptcy regardless of whether the other four conditions are met.

Negligence, honest mistakes, and poor recordkeeping do not constitute fraud or willful evasion. The standard is intentional wrongdoing.

Priority vs. Non-Priority Tax Debts

Even if a tax debt meets all five conditions and is dischargeable, the Bankruptcy Code treats priority and non-priority tax debts differently during the case:

Priority tax debts are those that do not meet the three-year or 240-day rules. In a Chapter 13 case, priority tax debts must be paid in full through the repayment plan under 11 U.S.C. Section 1322(a)(2). There is no partial discharge -- the full amount must be paid over the three-to-five-year plan period. In Chapter 7, priority tax debts are not discharged.

Non-priority tax debts -- those that satisfy the three-year and 240-day rules -- are treated like general unsecured debts. In Chapter 7, they are discharged. In Chapter 13, they receive the same percentage distribution as other unsecured creditors and the remaining balance is discharged upon plan completion.

The classification of a tax debt as priority or non-priority is therefore the threshold question. If the debt is still within the priority window, it survives Chapter 7 and must be paid in full in Chapter 13.

DC Income Tax Treatment

The District of Columbia imposes its own income tax, and DC tax debts are subject to the same five-condition analysis as federal tax debts. The three-year, two-year, and 240-day rules apply to DC income taxes just as they apply to IRS obligations.

DC tax returns are due on April 15 (or the next business day), the same as federal returns. The DC Office of Tax and Revenue (OTR) assesses DC tax liabilities and is treated as a governmental unit for purposes of the Bankruptcy Code.

If you owe both IRS and DC tax debts, each debt must be analyzed independently. It is possible that your federal tax debt meets all five conditions while your DC tax debt does not (or vice versa), depending on filing dates and assessment dates.

Tax Liens Survive Discharge

One of the most significant limitations on discharging tax debt is the survival of tax liens. Under 11 U.S.C. Section 522(c)(2)(B), a tax lien that was properly recorded before the bankruptcy filing survives the discharge. The discharge eliminates your personal liability -- the IRS or DC OTR cannot garnish your wages or levy your bank accounts -- but the lien remains attached to any property you owned at the time of filing.

For example, if the IRS filed a federal tax lien against your real property before you filed bankruptcy, and the underlying tax debt is discharged, the lien remains on the property. If you sell the property, the IRS is entitled to payment from the proceeds up to the amount of the lien.

In Chapter 7, you can sometimes address a tax lien through lien avoidance (if the lien impairs an exemption) or by negotiating a lien release with the IRS after discharge. In Chapter 13, the tax lien is typically paid through the plan, which can be advantageous if the value of the lien is less than the full tax liability (a concept known as "lien stripping" for wholly unsecured liens).

IRS Installment Agreements vs. Bankruptcy

Many taxpayers with IRS debt enter into installment agreements under 26 U.S.C. Section 6159, which allow monthly payments over up to 72 months. An installment agreement can be a viable alternative to bankruptcy if:

The tax debt is the only significant financial problem
The monthly payment is affordable
Interest and penalties will not cause the balance to grow faster than you can pay it down

However, an IRS installment agreement has significant disadvantages compared to bankruptcy:

Interest and penalties continue to accrue. The IRS charges interest (currently tied to the federal short-term rate plus 3 percent) and a failure-to-pay penalty of 0.25 percent per month during the agreement.
The full amount must be paid. An installment agreement does not reduce the principal balance. Bankruptcy can discharge the debt entirely.
The agreement can be defaulted. If you miss a payment, the IRS can terminate the agreement and resume full collection activity -- including levies and liens.
Collection limitations period continues to run. The IRS has 10 years from assessment to collect a tax debt (26 U.S.C. Section 6502). If the 10-year period expires during an installment agreement, the remaining balance becomes uncollectible. But the filing of bankruptcy tolls this period.

For large tax debts that meet the discharge conditions, bankruptcy is almost always the more efficient resolution. For smaller tax debts or debts that do not yet meet the discharge rules, an installment agreement may bridge the gap until a bankruptcy filing becomes optimal.

Practical Steps for DC Filers With Tax Debt

File all delinquent tax returns. You cannot discharge tax debt on unfiled returns, and filing starts the two-year clock.
Obtain IRS account transcripts. Request transcripts for all years in question to determine exact due dates, filing dates, and assessment dates. Use IRS Form 4506-T or access transcripts through your IRS online account.
Request DC OTR records. Obtain similar information from the DC Office of Tax and Revenue for any DC income tax debts.
Calculate the three-year, two-year, and 240-day dates. Each tax year must be analyzed independently. A single miscalculation can result in a non-dischargeable debt.
Check for recorded tax liens. Search DC land records and UCC filings for any IRS or DC tax liens. If liens exist, factor them into your bankruptcy strategy.
Time your filing carefully. If you are close to satisfying one of the time-based conditions, waiting a few weeks or months to file can mean the difference between discharging the debt and carrying it indefinitely.

Tax debt in bankruptcy is technical, deadline-driven, and unforgiving of errors. But when the conditions align, bankruptcy offers a complete resolution that no installment agreement or offer in compromise can match.