I often receive questions about tax debt and whether it can be relieved through filing for bankruptcy. Many types of debt, such as credit cards and unsecured loans, can be discharged through filing either Chapter 7 or 11. When it comes to owing money to the Internal Revenue Service, the answer depends on several factors. First and foremost, I always recommend to my clients who owe taxes to first explore an IRS payment plan or an offer in compromise. In the event those are not possible, bankruptcy may be an option. I am not a bankruptcy specialist but it is important to consider whether tax debt can be discharged through filing for bankruptcy.
Before you consider filling and contacting a bankruptcy attorney, you must file all required tax returns for the tax periods ending within four years of your bankruptcy filing. If you’ve listed the IRS as a creditor on your bankruptcy application, they will receive an electronic notice from the U.S. Bankruptcy Courts. During your bankruptcy, you must continue to file all required returns and pay all current taxes as they are due.
Generally the following conditions must be met before eliminating federal income taxes through Chapter 7 bankruptcy. First, you must have filed a tax return for the debt you wish to discharge at least two years before filing bankruptcy. Second, the taxes owed must be income tax. Taxes other than income, such as payroll taxes or fraud penalties, cannot be eliminated in bankruptcy. Third, you did not commit fraud (e.g., you did not file a fraudulent tax return with incorrect information, or willfully try to avoid paying taxes). Finally, you must pass the “240-day rule.” The IRS must have assessed the income tax debt at least 240 days before you file your bankruptcy petition.
Even if you meet all these requirements, it does not guarantee bankruptcy will wipe clean your tax debt. For example, if the IRS has already put a lien on your property. Bankruptcy will not discharge a lien that already exists.
Chapter 13 bankruptcy involves repayment of your debt at a manageable amount and over a set period of time. While your tax debt may not be completely discharged by the IRS, this type of bankruptcy may make paying taxes a bit easier. For example, dischargeable taxes may be forgiven without any payment, depending on the amount of disposable income you have after your reasonable and necessary expenses are deducted from your pay. This is typically only for tax debt older than three years. It is important to discuss all of your options with a bankruptcy attorney.
Additionally, the dischargeable taxes will not incur additional interest or penalties. However, you will likely still have to pay interest on nondischargeable tax. Finally, the IRS is obligated to abide by the plan as long as you include all your outstanding income tax and keep your tax returns and post-bankruptcy tax obligations current. All that said, any non-dischargeable tax that does not go away in bankruptcy (generally tax debt that’s incurred during the last three tax years) must be paid in full during the Chapter 13 multi-year plan.
Nobody wants to owe tax debt to the IRS. While filing for bankruptcy is an option for discharging certain debts, it does not always guarantee your back taxes and interest will be forgiven by the IRS. If you are facing tax debt and are considering bankruptcy, speak with an experienced tax attorney before taking any action and see what the tax lawyer recommends is your best course of action.
Allison Soares is a partner and tax attorney at Vanst Law. Before starting her own practice, Soares was a partner at a tax law firm where she honed her skills handling a wide variety of tax and employment-related cases. In addition to her legal work, she has worked in accounting and utilizes that knowledge to her advantage while handling cases involving EDD audits.
