Some time ago I wrote about discharging income taxes in bankruptcy. I stated that there is a three-part test for determining their dischargeability, and started with the following executive summary:
For a tax to be dischargeable in bankruptcy, it must satisfy three requirements:
- (The three-year rule) The tax return for the tax year in question must have been due (including extensions) – but not necessarily actually filed – at least three years before the filing of the bankruptcy papers,
- (The two-year rule) The debtor must have actually filed a legitimate, nonfraudulent tax return for that tax year at least two years before the filing of the bankruptcy papers, and
- (The 240-day rule) The taxing authority cannot have assessed the tax during the 240 days prior to filing the bankruptcy papers.
The second requirement, the so-called two-year rule, has been the subject of extensive litigation throughout the country, with a wide range of inconsistent outcomes. Therefore, I suspect that the Supremes will eventually be asked to consider the matter.
My focus today is on what happens if the taxing authority files something called a substitute for return on behalf of the debtor/taxpayer. For linguistic simplicity, I will refer to the taxing authority as the IRS, though the discussion applies, mutatis mutandis, if the taxing authority is a state taxing authority such as California’s Franchise Tax Board.