Can You File for Bankruptcy To Resolve Tax Debts?

You are facing a mountain of debt from multiple creditors and are considering filing for bankruptcy. While bankruptcy can be a debt relief solution, it cannot eliminate all debt. If you owe tax debt, it may or may not be discharged.

The type of tax obligations you owe and the type of bankruptcy you file will dictate your ability to discharge them. If you owe tax debt due to filing your tax return, several debt relief options may be more suitable than bankruptcy. Speaking with a bankruptcy lawyer can provide valuable guidance to help you achieve financial stability.

Does Filing for Bankruptcy Eliminate Tax Debt?

There isn’t a simple yes or no answer to whether tax debt is dischargeable in bankruptcy. The answer can change based on the type of bankruptcy, the types of tax debt, and the facts of your situation. The general rule is that you will likely remain liable for your tax debt. However, this isn’t always the case.

Federal income tax has the possibility of being discharged. Similarly, you may be able to discharge state income tax. If you owe payroll taxes, you won’t be able to have them discharged. Property taxes can be complicated when determining discharge eligibility. If they come due within a year of the bankruptcy case, the tax is considered a priority debt. In addition, the tax is a secured debt because it is attached to the real estate. Finally, bankruptcy proceedings won’t discharge debt that is less than three years old. So, your tax liability from the tax year you filed for bankruptcy is not eligible. This is because several payment programs are available to address this debt.

Requirements For Discharging Federal Income Tax

While federal income tax may be discharged in bankruptcy, some requirements need to be met. If a filer doesn’t meet the requirements, their tax debt won’t be discharged.

For example, if the federal income tax relates to payroll tax or fraud penalties, it can’t be discharged. Bankruptcy cannot be used as a method of fraud or willful evasion of tax debt. If you filed a fraudulent tax return and were then discovered, you can’t use bankruptcy to avoid the tax debt attributed to you later during an audit. This is why it is so important to ensure the information you enter, such as your social security number, is correct on your tax return.

Exceptions To Discharging Tax Debt Through Bankruptcy

David S. De Jong, a tax attorney at Stein Sperling Bennett De Jong Driscoll in Rockville, Maryland, explains that there are exceptions to having your tax debt discharged through bankruptcy. “If it’s income taxes, you need to meet three criteria. You must go three years from the extended due date of the return, two years out from when you actually filed the return, and 240 days from when there was an assessment.

“Payroll taxes are not dischargeable in bankruptcy. There is also an exception if you willfully ignore your tax obligation — it is not dischargeable even if you went that period of time. The IRS will, at times, claim that you have lived extravagantly and willfully, ignored your tax obligation, and will fight a discharge.”

The IRS has a 240-Day Rule for those seeking to discharge tax debt in bankruptcy. The IRS must have assessed the income tax debt at least 240 days before you file for bankruptcy or not at all. This time requirement can be even longer if the IRS has previously extended its collection time limits due to a previous bankruptcy filing or an Offer in Compromise agreement with the taxpayer.

Some states require bankruptcy filers to have filed their previous year’s tax returns if they want to discharge their tax debt. While the IRS may have filed a substitute tax return on the taxpayer’s behalf, this won’t satisfy this requirement. This requirement and the rules surrounding it can vary from state to state. Speaking with a bankruptcy attorney can guide you if you want to discharge tax debt in your bankruptcy filing.

Meeting these requirements doesn’t automatically give you approval to file for bankruptcy. There may be additional requirements that apply to your specific situation. Working with a bankruptcy lawyer can help you verify your eligibility.

Filing for Bankruptcy Does Not Remove IRS Federal Tax Liens

Filing for bankruptcy will not remove a tax lien already filed on your property. In this situation, the property’s value secures the tax debt. The IRS will receive the payment owed when the property is sold either by you or through foreclosure. Filing for bankruptcy will prevent the IRS from pursuing payment by going after your bank account or wages.

Credit Card Payments Won’t Get Around Nondischargeable Tax Debt

You cannot manipulate the bankruptcy process by paying off nondischargeable tax debt with a credit card. Normally, credit card debt is dischargeable in bankruptcy. However, the non-dischargeable status of the tax debt is transferred to credit card debt in a Chapter 7 filing. This isn’t an automatic process; the credit card company must file a challenge to the debt discharge and win an adversary proceeding to protect its right to continue collecting on the debt.

Are There Tax Debt Relief Options I Should Consider Before Bankruptcy?

Bankruptcy should be considered a last resort when all other options are exhausted. The IRS offers several options for taxpayers who cannot afford to pay their tax debt. Exploring these options can provide financial relief while also fulfilling the taxpayer’s obligation to pay their debt.

There are short and long-term payment plans that give the taxpayer more time to pay their tax debts. These installment agreements require the taxpayer to make monthly payments until the debt is paid in full. For debt that a taxpayer cannot afford to pay in full, they can submit an offer in compromise (OIC). The taxpayer will make an offer to pay a reduced amount from what they owe. A third option is to put the tax debt in a currently not collectible (CNC) status. This puts the IRS’s collection activities on hold during the bankruptcy process.

De Jong explains that while an OIC is an option, you need to meet strict requirements to qualify. “You should see if you are a candidate for an offer in compromise, which is a settlement offer to the IRS. Unfortunately, there are a lot of so-called tax resolution companies out there that will act as if everybody who owes can make an offer in compromise, but there are really strict criteria for being eligible to discharge taxes through submitting an offer to the IRS.”

Can IRS Debt Be Discharged in Chapter 7?

A Chapter 7 bankruptcy filing, often called a liquidation bankruptcy, is filed by individuals who cannot afford to pay their debts. Filing a Chapter 7 bankruptcy discharge is for individuals who have no other option. Debt will be discharged based on its classification. Priority debt is debt that will not be discharged. Some types of tax debt will fall into this category, and others won’t.

Tax debt that is priority debt is income taxes that have become due in the three years leading up to the bankruptcy filing. Taxes that have been held from an employee are also a priority, such as trust fund taxes. Finally, you cannot avoid penalties, duties, or customs debt incurred from a federal, state, or local government.

Qualifying For Chapter 7 Bankruptcy

To qualify for a Chapter 7 bankruptcy discharge, a taxpayer would need to have an average monthly income that is lower than their state’s median income for their household size. If they don’t, they would need to pass the means test. You also can’t have filed another Chapter 7 bankruptcy in the last eight years or a Chapter 13 bankruptcy in the last six years. You cannot have attempted to file for Chapter 7 or 13 bankruptcy in the last 181 days where the case was tossed out.

Future Tax Refunds

In some situations, future tax refunds are exempt from the bankruptcy filing, allowing you to keep them. This isn’t the case in all situations, and you could lose your refund if yours isn’t exempt. Some filers choose to wait until after receiving their refund to file for bankruptcy so they can use the funds for living expenses.

Can IRS Debt Be Discharged in Chapter 13?

A Chapter 13 bankruptcy is for taxpayers who have an income that can support a repayment plan but are overwhelmed by debt. The bankruptcy enables them to negotiate a full or partial repayment plan over the next three or five years. At the end of the repayment plan, the outstanding debts are canceled.

Some of your tax debts may get discharged, but you must repay the non-dischargeable tax debt in full. If you have dischargeable tax debt, you can likely negotiate to pay less.

Qualifying For Chapter 13 Bankruptcy

There are several requirements that an individual must meet to qualify for a Chapter 13 bankruptcy filing. Your income needs to be able to cover the monthly payments required in your bankruptcy plan. Your unsecured and secured debt must be under certain thresholds. These amounts change every three years, so speaking with a bankruptcy lawyer can let you know the applicable limits. You cannot have attempted to file within the last 181 days and have that filing tossed out. You must have filed your federal income tax return for the last four years. Additional requirements may apply to you, which a lawyer can explain after analyzing your situation.

Future Tax Refunds

Because you agree to a multi-year repayment plan, you must continue filing your annual tax returns to comply with your bankruptcy requirements. The trustee in your bankruptcy case is entitled to review your tax filings. If your income significantly increases or you are owed a large return, it can raise a red flag. The trustee may petition the court to increase your payments or seize the return to repay your creditors.

Can IRS Debt Be Discharged in Chapter 11?

If a small business needs to file for bankruptcy, it may opt for Chapter 11, which is often referred to as a reorganization bankruptcy. Because the goal is to save the business instead of liquidating it, tax debts are treated differently than in other bankruptcy proceedings. Federal tax debts may or may not be discharged, depending on the specific facts and circumstances of the bankruptcy case.

What Happens If I File for Bankruptcy?

When you file for bankruptcy, your case will go through the federal court system. A trustee will be assigned to process your filing. They will organize your assets and coordinate with creditors. A judge will determine your bankruptcy eligibility and approve your debt discharge. The bankruptcy process can take a few months to complete. However, bankruptcy can stay on your credit report for seven to ten years.

The process of bankruptcy should begin with you considering all your financial options. If you have other viable options, you may choose to put filing on hold or avoid it altogether. If you decide bankruptcy is your best option, the next step is to decide which type of bankruptcy filing is best for your situation. If you choose to hire a lawyer, this is the time to do so.

You will need to complete a court-approved credit counseling course before filing. To initiate the bankruptcy proceedings, complete and submit the required forms and pay the necessary fees. Once filed, an automatic stay takes effect that stops creditors from pursuing you for repayment. This includes a stay on Tax Court proceedings, which can extend the deadline for filing a petition in Tax Court.

During the proceedings, you will meet with creditors, work with the trustee, and complete a debtor education course. A judge will also review your case to verify that you aren’t attempting to defraud your creditors by filing a fraudulent bankruptcy claim. You know your proceedings are completed when you receive a notice of debt discharge from the court.

Do I Need a Lawyer for Filing Bankruptcy on Tax Debt?

It can be tempting to file for bankruptcy on your own without consulting an attorney. After all, you are filing for bankruptcy because you are struggling to pay your debt. The last thing you need is another bill from a lawyer. However, not consulting a lawyer can have several negative consequences.

Filing a bankruptcy petition requires you to meet several requirements and fill out multiple forms. The bankruptcy code is detailed and extensive. You risk making mistakes that can incorrectly disqualify you. A lawyer can also outline the potential outcomes of each bankruptcy type and how they apply to your situation. There is often a strategy that comes with filing for bankruptcy, and a lawyer can guide you on the best course of action.

Many lawyers offer free consultations and only charge clients when representing them in bankruptcy court. This allows you to get a professional evaluation of your situation before committing.

Find Experienced Legal Help

For taxpayers who are facing a significant amount of debt, bankruptcy may be the only viable option. However, filing for bankruptcy may not be the catch-all solution they are looking for. You must qualify for the type of bankruptcy that you hope to file for. Then, not all tax debts are dischargeable in bankruptcy. Speaking with a bankruptcy lawyer can help you understand your financial options and determine the best course of action.

Visit the Super Lawyers directory to begin your search for an experienced tax attorney. For more information, read our guide on bankruptcy law.