Bankruptcy and Taxes: Eliminating Tax Debts in Bankruptcy

In many cases, a debtor is still liable for tax debt after bankruptcy. However, bankruptcy law allows the discharge of tax debt in some circumstances.

A debtor is more likely to have tax debt discharged in Chapter 7 bankruptcy than in a Chapter 13 bankruptcy. In Chapter 13, tax debt, along with other debt, enters a repayment plan. Chapter 7 bankruptcy, on the other hand, allows a debtor to discharge certain kinds of debt, such as credit card debt and medical bills, and in some instances, federal tax debt.

Can I File Bankruptcy on Tax Debt?

You may be able to file bankruptcy on some types of tax debt. For instance, you may be able to discharge income tax debt if certain conditions are met (see below).

Note that you will need to pass the means test to qualify for a Chapter 7 bankruptcy in the first place. The means test compares your disposable income to the state median income for your household size. If your income is too high and you can't pass the means test, you can file for Chapter 13 instead and develop a plan to repay your debts over the course of a few years.

Bankruptcy and Taxes: Qualifying for Discharge

Whether you can discharge tax debt will depend on the type of tax, how old the tax debt is, if you filed a return, and the type of bankruptcy. Federal income taxes in Chapter 7 are dischargeable if you meet all of the following conditions:

  • The discharge is for income taxes: Payroll taxes and penalties for fraud are not eligible for discharge.
  • You filed legitimate tax returns: You filed a tax return for the relevant tax years at least two years before filing for bankruptcy.
  • The tax liability is at least three years old: The tax debt is from a tax return that was originally due at least three years before filing for bankruptcy.
  • You are eligible under the 240-day rule: The IRS assessed the tax debt at least 240 days before you filed for bankruptcy. If the IRS suspended collection activity during negotiation, the applicable date may be extended.
  • You did not commit willful tax evasion: Possible evasive actions include changing your Social Security number, your name, or the spelling of your name; repeated failure to pay taxes; filing a blank or incomplete tax return; and withdrawing cash from a bank account and hiding it.
  • You did not commit tax fraud: The return contains no information that was intended to defraud the IRS.

Tax Debt Not Eligible for Discharge

The following types of tax debt are not dischargeable in Chapter 7 bankruptcy:

  • Tax penalties from tax debt that is ineligible to be discharged
  • Tax debts from unfiled tax returns
  • Trust fund taxes or withholding taxes withheld from an employee's paycheck by the employer

A debtor unable to discharge tax debt under Chapter 7 may consider other arrangements, such as entering into an installment agreement with the IRS or making the IRS an offer in compromise which will result in the settlement of the tax debt for less than the amount owed.

Does Bankruptcy Clear Tax Debt?

You can clear or discharge tax debt if you fulfill the conditions listed above and the debt is for income tax.

Penalties on taxes that are dischargeable are also eligible for discharge. After the discharge of tax liability, you will no longer be responsible for paying the taxes and the IRS may not garnish your wages or bank accounts.

Bankruptcy and Taxes: Federal Tax Liens

Even if the discharge of tax debt occurs under Chapter 7, if the IRS placed a federal tax lien on your property prior to the bankruptcy case, it will remain after discharge. As a result, it is necessary to clear the title by paying off the lien before selling the property.

Get More Answers From a Bankruptcy Lawyer

The interplay of taxes and bankruptcy is complicated. If you have old tax debt that is adding to your debt nightmare, consider speaking with a local bankruptcy lawyer about your options.

Was this helpful?