IRS Law Blog

You have tried and failed at settling your tax debt with the IRS – your offer in compromise was rejected – and are now considering bankruptcy for relief from the taxman.

But before you jump in with the bankruptcy filing, it is important to understand how your offer in compromise could have complicated success with your bankruptcy discharge.

The bankruptcy code has several rules that must be followed to discharge a tax debt.  Most of the timing rules are based on the passage of time, including the time an offer in compromise was pending with the IRS.

An offer in compromise can upset the timing rules and delay your bankruptcy filing.

There are three primary timing rules when it comes to filing bankruptcy after an offer in compromise was submitted.

The first timing rule requires that your bankruptcy must be filed more than three years after your tax return was due to be filed.  This is known as the Three Year Rule.

The second bankruptcy timing rules involves the date you actually filed your tax return.  If you filed your tax return late, the bankruptcy must also be filed more than two years after the return was filed.  We call this the Two Rule.

The third rule is that bankruptcy must also be filed more than 240 days after the IRS placed your tax debt on its books (called an “assessment”).  This is the 240 Day Rule, and is where your offer in compromise comes into play and could trip up your bankruptcy filing.

If you filed your offer in compromise within those first 240 days after the IRS placed your tax debt on its books (“assessment”), the clock stops, and the 240 days stops running. That’s not a good thing, because the passage of time is essential to discharging taxes in bankruptcy.

That’s right, the bankruptcy code has specific language that limits the dischargeability of taxes if an offer in compromise was filed within 240 days of assessment.

The bankruptcy code wants to give the IRS a chance to collect taxes before they can be discharged – that’s why we have the Three Year Rule, Two Year Rule, and 240 Day Rule – it gives the IRS a head start.

Here’s the catch:  While your offer in compromise is pending, the IRS cannot collect the taxes from you. That would give you an advantage – the 240 days ticks, but the IRS can’t act.  Congress acted to prevent that result by making the 240 days after assessment rule stand still if you submitted an offer in compromise within that timeframe.  For good measure, Congress added 30 days to the 240 days in offer in compromise situations.  This is in bankruptcy code section 507(a)(8)(A)(ii)(I).

Example:

Let’s say that you owed the IRS taxes for 2010, but did not get around to filing your tax return until May 1, 2013.  The IRS took your return, processed it, and put the balance owed (assessed) on its books on June 15, 2013.

After you filed your return, you immediately jumped right in with the filing of an offer in compromise on July 15, 2013, within 240 days of assessment.  It was rejected on December 15, 2014.

Your offer was pending a total of 17 months, from July 15, 2013 – December 15, 2014.  It was also filed only 30 days into the 240 day period, leaving 210 days (7 months) left that had not yet run.

Since the offer in compromise was filed within 240 days of assessment, we must take the time left on the 240 day period, add in the time the offer was pending, then add 30 more days, to determine the offer’s impact on your bankruptcy.

Here’s the calculation of how much additional time your offer in compromise added to your bankruptcy filing date:

Time the offer was pending:  17 months

Time left on 240 days when offer in compromise was submitted: 210 days (7 months)

Plus 30 days: 25 months

Quick math recap:  Assessment date June 15, 2013 + 17 months + 7 months + 1 month (30 days) = 25 months.

The offer in compromise, being submitted within 240 days of assessment, made you have to wait 25 months total to file your bankruptcy, until July 15, 2015.

Note that we still have to apply the Three Year and Two Year Rules, but your offer in compromise will result in a later bankruptcy filing date.  July 15, 2015, from the 240 Day/Offer in Compromise Rule, is the latest date, and the earliest the bankruptcy can be filed to discharge your 2010 taxes.

Filing an offer in compromise, getting a rejection, and then desiring bankruptcy is potent mix, full of Congressional traps to give the IRS time to collect and stymie your discharge.  Before filing bankruptcy on the IRS, it is essential to know the rules of discharge and the bankruptcy code calculations necessary to get a fresh start.  Not following the timing rules could result in a after-bankruptcy surprise that your taxes were not discharged.