Many times, the debtor remains liable for tax debt even after bankruptcy. In certain circumstances, however, bankruptcy law permits the discharge of tax debt.
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Chapter 7 bankruptcy is more likely than Chapter 13 bankruptcy to discharge tax debt. Chapter 13 allows tax debt to be discharged along with any other debt. Chapter 7 bankruptcy allows debtors to eliminate certain types of debt such as credit card debt, medical bills and, in certain cases, federal tax debt.
Can I file bankruptcy on tax debt?
Some types of tax debt may allow you to file bankruptcy. If certain conditions are met, you might be able to pay off income tax debt.
To qualify for Chapter 7 bankruptcy, you must pass the means test. The means test measures your disposable income against the state median income for your household size. If you have a high income and fail to pass the means test you can file Chapter 13 and create a plan for repaying your debts over a period of time.
Qualifying for discharge: Bankruptcy and taxes
The type of tax you have to pay, the age of the tax debt, the filing status of your bankruptcy, and whether you filed a return will all affect whether you are able to discharge tax debt. If you satisfy all the following conditions, federal income taxes in Chapter 7 can be discharged:
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The discharge is only for income taxes. Payroll taxes, penalties for fraud and payroll taxes are not eligible.
You have filed valid tax returns: A tax return was filed for the relevant tax year at least two years prior to filing for bankruptcy.
Tax liability must be at least 3 years old. This is a tax debt that is derived from a tax return originally due at most 3 years prior to filing bankruptcy.
The 240-day rule applies to you: The IRS must have assessed your tax debt no later than 240 days prior to the filing of bankruptcy. The applicable date can be extended if the IRS suspends collection activity during negotiations.
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You didn’t commit willful tax fraud: These actions could include changing your Social Security Number, your name or spelling, repeated failure to pay taxes, filing a tax return blank or incomplete, withdrawing cash from a banking account, and hiding it.
You have not committed tax fraud. The IRS has no information in the return that could be used to deceive it.
- Tax Debt Not Eligible for Discharge
- These types of tax debt cannot be discharged in Chapter 7 bankruptcy.
- Tax penalties for tax debts that are ineligible to being discharged
- Unfiled tax returns can lead to tax debts
- Employer withholding taxes from the paycheck of employees or trust fund taxes
If a debtor is unable to pay tax debt under Chapter 7, they may look into other options, such as an installment agreement or an offer of compromise from the IRS. This will allow the debtor to settle the tax debt at a lower amount than the original amount.
Is Bankruptcy a Clearcut for Tax Debt?
If you meet the above conditions and the debt is not for income tax, you can clear or discharge your tax debt.
Penalties for taxes that can be discharged are also available for discharge. You will be free from tax liability and you won’t have to pay taxes again. The IRS will not garnish your bank accounts or wages.
Bankruptcy and Taxes – Federal Tax Liens
Even though Chapter 7 discharges tax debt, a federal tax lien was placed by the IRS on your property before bankruptcy. It will still remain even after bankruptcy. It is therefore necessary to pay off the lien before you sell the property.
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Ask a bankruptcy lawyer for more information
It is difficult to understand the interplay between taxes and bankruptcy. You should speak with a local bankruptcy attorney if you have tax debts that are adding to your debt nightmare.