The rules for discharging income taxes in bankruptcy are built on timing, and the first timing rule is three years. People who learn that rule sometimes look for ways to run out the clock. Young v. United States is the Supreme Court's answer to the most common version of that strategy.
The Facts
Cornelius and Suzanne Young filed their 1992 income tax return on October 15, 1993, the extended due date, without paying. About $15,000 was owed. The IRS assessed it on January 3, 1994, and the Youngs made modest monthly payments of $40 to $300 from April 1994 until November 1995.
On May 1, 1996, they filed a Chapter 13 petition in New Hampshire. About $13,000, including interest, remained due. Before any plan was confirmed, they moved on October 23, 1996 to dismiss the Chapter 13 case. On March 12, 1997, one day before the Chapter 13 case was dismissed, they filed a new petition under Chapter 7. It was a no-asset case. They received a discharge on June 17, 1997.
When the IRS demanded payment of the 1992 tax, the Youngs reopened their case and argued the debt was discharged. Their return had been due on October 15, 1993, more than three years before the Chapter 7 petition. The bankruptcy court, district court and First Circuit all disagreed, holding the three-year period was tolled while the Chapter 13 case was pending.
The Issue
Is the three-year lookback period for income tax priority and nondischargeability tolled while a prior bankruptcy petition is pending?
The Holding
Yes. Justice Scalia wrote for the Court: "We conclude that the lookback period of 11 U.S.C. § 507(a)(8)(A)(i) is tolled during the pendency of a prior bankruptcy petition." The judgment was affirmed.
The Reasoning
How the three-year rule works
Section 523(a)(1)(A) excepts from discharge taxes "of the kind and for the periods specified in section ... 507(a)(8)." Section 507(a)(8)(A)(i) gives priority to income taxes for which a return was last due, including extensions, after three years before the petition date. If the return was due within that three-year window, the tax is a priority claim and is not discharged.
The loophole
The Court described the problem candidly. A debtor could file Chapter 13, which triggers the automatic stay and stops IRS collection, then voluntarily dismiss once the three years have run and immediately file Chapter 7. "Petitioners took advantage of this loophole."
The lookback is a limitations period
The Court reasoned that the lookback "prescribes a period within which certain rights (namely, priority and nondischargeability in bankruptcy) may be enforced." If the IRS sleeps on its rights for three years, its claim loses priority and becomes dischargeable. That serves the usual purposes of limitations periods: repose, elimination of stale claims and certainty.
Limitations periods are presumptively tolled
"It is hornbook law that limitations periods are customarily subject to 'equitable tolling,'" unless tolling is inconsistent with the statute. That is "doubly true" in bankruptcy courts, which are courts of equity. During the Chapter 13 case, the automatic stay prevented the IRS from protecting its claim. So the period the Chapter 13 case was pending was excluded from the lookback.
The hypothetical the taxpayers offered
The Youngs argued the lookback was a substantive definition of dischargeable taxes, not a limitations period, because it starts on the return's due date even if the IRS does not yet know about the debt. They pointed out that a separate rule, § 523(a)(1)(B)(ii), makes a tax nondischargeable if a late return was filed within two years before the petition, so the IRS could have less than three years in some situations. The Court answered that a limitations period can start before the claimant knows of its claim, and that § 523(a)(1)(B)(ii) shows only that "Congress put different limitations periods on different kinds of tax debts." The provisions are complementary.
Good faith does not matter
The Court held tolling applies "regardless of petitioners' intentions" in filing back-to-back cases. Whether the Chapter 13 was filed in good faith or solely to run down the clock, the IRS was disabled from acting.
The statutory arguments failed
The Youngs pointed to express tolling language elsewhere in the Code, including the 240-day assessment rule, which then tolled for pending offers in compromise. The Court said that provision "supplements rather than displaces principles of equitable tolling," because the IRS's practice of pausing collection during offers was voluntary, and voluntary inaction would not normally justify tolling.
A footnote worth knowing
The Court also noted that the Internal Revenue Code was amended in 1998 to prohibit levy while an offer in compromise is pending, in IRC § 6331(k). That is why the 240-day rule's tolling for pending offers matters: the IRS is now legally barred from collecting during that time, not just choosing not to.
What Congress Did Next
In 2005, Congress added a sentence at the end of 11 U.S.C. § 507(a)(8): "An otherwise applicable time period specified in this paragraph shall be suspended for any period during which a governmental unit is prohibited under applicable nonbankruptcy law from collecting a tax as a result of a request by the debtor for a hearing and an appeal of any collection action taken or proposed against the debtor, plus 90 days; plus 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." The 240-day assessment rule in § 507(a)(8)(A)(ii) now also excludes time a stay was in effect in a prior case, plus 90 days.
What It Means for Taxpayers Today
Prior bankruptcies extend the clock, plus 90 days
If you filed an earlier bankruptcy, add the time it was pending, plus 90 days under the 2005 language, before counting three years. The same is true for the 240-day assessment rule. Miscounting this is one of the most common reasons a planned tax discharge fails.
CDP hearings extend it too
The 2005 language also suspends the periods while the IRS is barred from collecting because you requested a hearing and appeal of a collection action, plus 90 days. A Collection Due Process hearing can be a valuable tool, as Vinatieri v. Commissioner shows, but if bankruptcy is on the horizon, factor in how it moves the bankruptcy timing rules.
Three years is only one of the tests
Even if a tax passes the three-year test, it is not dischargeable if a required return was never filed or was filed late within two years before the petition under § 523(a)(1)(B), or if the debtor filed a fraudulent return or willfully attempted to evade the tax under § 523(a)(1)(C). See In re Fahey on late returns and In re Griffith on evasion. Our article on bankruptcy and tax debt walks through the full set of rules.
Plan it, do not game it
Bankruptcy can be a legitimate and powerful way to deal with old income tax debt. It works best when the timing is calculated carefully against the actual dates on your IRS account transcripts, not when it depends on a maneuver the Supreme Court has already rejected.
The Bottom Line
The Youngs tried to use one bankruptcy to stop the IRS and a second to wipe out the debt once the clock ran. The Supreme Court said the clock never ran, and Congress later wrote the rule into the Code. Count carefully, add the tolling, and only then decide when to file.