Representation before the IRS · Taxpayer financial situation
Discharge of the tax liability in bankruptcy
tax year · reviewed 2026-08-19 · I. Ohu
The rule
An enrolled agent does not practise bankruptcy law and cannot file a petition for a client. What an enrolled agent must be able to do is tell a client, before they consult bankruptcy counsel, whether the tax they are worried about is the kind that a discharge can reach — because for a large share of clients the answer is no, and the wrong assumption drives an expensive decision.
The architecture is two statutes working together. Bankruptcy Code § 507(a)(8) defines the tax claims that are priority claims. Section 523(a)(1)(A) then excepts from discharge any tax “of the kind and for the periods specified in section 507(a)(3) or 507(a)(8) of this title, whether or not a claim for such tax was filed or allowed.” Priority status and non-dischargeability are, for income taxes, the same test read twice. That final clause matters: the government does not forfeit the exception by failing to file a proof of claim.
For income tax, § 507(a)(8)(A) supplies three tests, and a tax is priority — and so non-dischargeable — if any of them is met:
- The three-year rule. The return for the year is last due, including extensions, after three years before the petition date (§ 507(a)(8)(A)(i)).
- The 240-day rule. The tax was assessed within 240 days before the petition date (§ 507(a)(8)(A)(ii)).
- The assessable-but-not-assessed rule. The tax was not assessed before the case but remains assessable afterwards (§ 507(a)(8)(A)(iii)), other than taxes described in § 523(a)(1)(B) or (C).
Section 523(a)(1) then adds two exceptions of its own that have nothing to do with priority and no time limit that ever expires:
- § 523(a)(1)(B) — tax for which a required return, or equivalent report or notice, was not filed or given, or was filed late and after two years before the petition date.
- § 523(a)(1)(C) — tax for which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat the tax.
Practitioners reduce this to a working shorthand — the three-year rule, the two-year rule and the 240-day rule — and that shorthand is sound so long as it is remembered that a fraudulent or evaded tax fails permanently, and that trust fund taxes are a separate case entirely.
Trust fund taxes never discharge. Section 507(a)(8)(C) covers “a tax required to be collected or withheld and for which the debtor is liable in whatever capacity,” which is priority under § 507(a)(8) and so excepted by § 523(a)(1)(A) — and in chapter 13, § 1328(a)(2) singles out § 507(a)(8)(C) by name so that even the broader chapter 13 discharge does not reach it. A trust fund recovery penalty assessed against a responsible person survives bankruptcy.
How it works in practice
The stay comes first, and it is automatic. Filing a petition operates as a stay under Bankruptcy Code § 362(a) against the assessment and collection of a pre-petition tax. Nothing has to be requested and no court order is needed; the stay arises by operation of the filing itself and continues until it is lifted, the case closes or is dismissed, or a discharge is granted. The IRS will halt levy and lien activity on notice of the case.
The clock stops while the stay runs. The periods in § 6501 and § 6502 are suspended for the period the Secretary is prohibited by reason of the case from assessing or collecting, and then sixty days are added for assessment and six months for collection (IRC § 6503(h)). A bankruptcy that fails to discharge the tax therefore leaves the client owing the same tax with a longer collection statute than they started with — which is the single most important thing to say to a client considering a filing on tax grounds alone.
Counting is where cases are lost. The three tests all count backwards from the petition date, and each has tolling built in. The 240-day period is computed exclusive of any time an offer in compromise was pending or in effect during that period plus thirty days, and any time a stay in a prior case was in effect during that period plus ninety days (§ 507(a)(8)(A)(ii)). The hanging paragraph at the end of § 507(a)(8) suspends any applicable period in the paragraph for time during which the government was prohibited from collecting because the debtor requested a hearing and appealed a collection action, plus ninety days, and for time a stay was in effect in a prior case or collection was precluded by a confirmed plan, plus ninety days. A prior chapter 13 that was dismissed, or a collection due process hearing, moves the dates — usually against the client.
Chapter 7 and chapter 13 do not discharge the same set of taxes. A chapter 7 discharge under § 727 is subject to the whole of § 523(a). The chapter 13 discharge on completion of plan payments under § 1328(a) is subject to a shorter list: § 1328(a)(2) excepts debts “of the kind specified in section 507(a)(8)(C) or in paragraph (1)(B), (1)(C), (2), (3), (4), (5), (8), or (9) of section 523(a).” Section 523(a)(1)(A) is conspicuously absent. Priority income taxes must be provided for in full under the plan, but the chapter 13 completion discharge is broader than chapter 7 on precisely this point — which is why a debtor with recent priority taxes and a late-filed return may find chapter 13 does something chapter 7 cannot.
A discharge kills the debt, not the lien. Section 524(a)(2) makes the discharge an injunction against collecting the debt “as a personal liability of the debtor.” It says nothing about a security interest. Section 522(c)(2)(B) then provides that exempt property remains liable for a debt secured by “a tax lien, notice of which is properly filed.” A Notice of Federal Tax Lien recorded before the petition continues to encumber the debtor’s pre-petition property after discharge, to the extent of the lien’s value in that property. The client walks away free of personal liability and still cannot sell the house clear.
Three weeks too early
Teodoro Blanchflower owes income tax for a year whose return was filed on time, on an extension that ran to 15 October. His counsel proposes to file a chapter 7 petition in late September, three years and eleven months after the original April due date. Blanchflower’s bookkeeper has told him “the three-year rule is satisfied.”
It is not. Section 507(a)(8)(A)(i) counts from the date the return was last due, including extensions — 15 October, not 15 April. A petition filed in late September falls inside three years of that date, the tax is priority, and § 523(a)(1)(A) excepts it from discharge. Waiting until after 15 October costs three weeks and changes the outcome entirely. The enrolled agent’s contribution here is not legal advice about bankruptcy; it is producing the account transcript that shows the extension and the actual filing date, and flagging that the extension moves the date.
The return the IRS filed
Perpetua Nakamura did not file for three years. The IRS prepared substitutes for return and assessed. Six years later she files chapter 7, reasoning that all three years are well outside any three-year window.
The three-year rule is satisfied, but § 523(a)(1)(B)(i) is not: the exception applies to tax “with respect to which a return, or equivalent report or notice, if required, was not filed or given.” A substitute prepared by the Service is not a return filed or given by the debtor, and the exception has no expiry. Had Nakamura filed her own returns — even very late — the tax would have become dischargeable two years after those filings under § 523(a)(1)(B)(ii). The practical advice, given years before any bankruptcy is contemplated, is the same advice that is right for a dozen other reasons: file the returns, and start the two-year clock.
Discharged, and still cannot sell
Kwabena Lindholm receives a chapter 7 discharge covering an old income tax liability that clears every test. Two years later he tries to sell the home he owned before the petition and the title company reports a Notice of Federal Tax Lien filed before his case.
Both things are true at once. Section 524(a)(2) enjoins any attempt to collect the tax as his personal liability — no levy on wages, no lien on property he acquired after the filing, no demand. But the lien that attached to the equity in the house before the petition was not avoided in the case and survives it, and § 522(c)(2)(B) makes even exempt property liable for a properly filed tax lien. The lien is limited to the value it had in that pre-petition property, and the practical resolution is usually a payoff or discharge-of-property application at closing rather than litigation. The error was not the sale; it was nobody checking the recorded lien during the case.
How this has changed
The three-year, two-year and 240-day tests have been in the Bankruptcy Code since it was enacted in 1978 and have proved durable. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 made the changes a practitioner still meets today: it added the tolling language inside § 507(a)(8)(A)(ii) for offers in compromise and prior-case stays, and added the hanging paragraph at the end of § 507(a)(8) suspending the periods for collection due process hearings and prior confirmed plans. The same Act inserted the phrase “or equivalent report or notice” into § 523(a)(1)(B) and, in an uncodified definition, addressed what counts as a return for the purpose — the source of two decades of litigation about late-filed returns and substitutes for return that has not fully settled.
The interaction with the collection statute has been stable since IRC § 6503(h) took its present form, and the six-month post-stay addition to the collection period remains the number to remember.
Exam focus
The SEE tests the effect of the filing more often than the arithmetic of discharge. Know that a petition triggers an automatic stay halting assessment and collection without any request or order, and that the stay — not a discharge — is the immediate consequence of filing. Know that bankruptcy suspends the collection statute. If the exam reaches the discharge tests, it will want the three-year rule measured from the due date including extensions, the two-year rule running from the date a late return was actually filed, and the proposition that withheld employment taxes and fraudulently evaded taxes never discharge.
Check yourself
1. An individual with an unpaid assessed income tax liability files a bankruptcy petition. What is the immediate effect on IRS collection?
A. The liability is cancelled on filing B. An automatic stay halts assessment and collection until the stay is lifted or the case ends C. Collection continues unless the debtor obtains a court order D. The IRS receives an automatic one-year extension of the collection period
Answer: B. The stay arises by operation of the filing itself; nothing has to be requested.
2. A taxpayer filed a return on time under an extension that ran to 15 October. For the three-year priority test, the period is measured from which date?
A. The original April due date B. 15 October, the date the return was last due including extensions C. The date the return was actually filed D. The date the tax was assessed
Answer: B. Section 507(a)(8)(A)(i) counts from when the return is last due, including extensions.
3. A taxpayer never filed returns for three years and the IRS prepared substitutes for return. Ten years later the taxpayer files chapter 7. What happens to those liabilities?
A. They are discharged because all the time periods have run B. They are excepted from discharge because no return was filed or given C. They are discharged only if the IRS failed to file a proof of claim D. They are discharged two years after the substitutes were prepared
Answer: B. The exception for tax on which a required return was not filed or given has no expiry, and the discharge exception does not depend on a proof of claim.
4. Which liability cannot be discharged in either chapter 7 or a completed chapter 13 plan?
A. Income tax for a year whose return was filed on time eight years before the petition B. A penalty for late payment on an old dischargeable year C. Withheld employment tax for which the debtor is liable D. Income tax assessed 300 days before the petition on a timely old return
Answer: C. Tax required to be collected or withheld is priority under § 507(a)(8)(C) and is named expressly in the chapter 13 discharge exceptions.
5. A debtor receives a discharge of an income tax liability. A Notice of Federal Tax Lien was properly filed before the petition and was not avoided. What is the result?
A. The lien is extinguished with the debt B. Personal liability is discharged, but the lien continues to encumber pre-petition property C. The lien attaches to property acquired after the discharge D. The lien survives only if the IRS filed a proof of claim
Answer: B. The discharge enjoins collection of the debt as a personal liability; a properly filed tax lien continues against the property it attached to before the case.
Change log
- Initial draft.
Related topics
- Taxpayer's ability to pay the tax (e.g., installment agreements, offer in compromise, currently not collectible) 3.2.3.a
- Collection notice and Notice of Federal Tax Lien 3.3.1.i
- Collections statute of limitations 3.3.1.m
- General financial health (e.g., filed for bankruptcy, lawsuits, garnishments, cash flow, assets, and insolvency) 3.2.3.b