Tax debt is one of the hardest types to deal with, and the IRS has a lot of power when it comes to trying to collect. Usually, you can’t wipe out (discharge) taxes by filing a Chapter 7 bankruptcy unless it is old and you meet some very specific requirements. A Chapter 13 bankruptcy, however, can help you spread out the debt payment over three to five years. An experienced lawyer can help you work through the complex rules governing taxes and bankruptcy.
Discharging Taxes in Bankruptcy
In some situations, you’ll be able to get rid of taxes in a Chapter 7 bankruptcy. However, you’ll need to meet specific factors:
- Your return was due more than three years ago.
- You filed your return more than two years ago (a late return is one that was filed less than two years before the bankruptcy).
- The tax agency assessed the tax more than 240 days ago (tax is “assessed” when the IRS says that you owe the money).
- The tax owed is income tax.
- The tax isn’t the result of a fraudulent tax return or willful tax evasion.
Example.Suppose you file for bankruptcy on January 5, 2013. Taxes due on April 15, 2009, might be dischargeable because more than three years elapsed since the due date. If you filed that return on April 12, 2009, you'd have met the “must be filed more than two years before the bankruptcy” requirement. You'd meet the third prong if the IRS assessed the tax on July 1, 2009, more than 240 days before your January 5, 2013, bankruptcy filing date. Therefore, as long as the tax return wasn’t knowingly false—you weren’t attempting to pay less than you owed—then all five rules should be met, and the tax should qualify for discharge.
In most cases, if you owe tax, you also owe penalties and interest. The general rule is that if the tax is dischargeable, so are the penalties and interest.
Taxes That Don’t Go Away
Some taxes, such as sales tax or payroll taxes, are never dischargeable. If you owe this kind of tax debt, you might want to consider filing a Chapter 13 bankruptcy. A knowledgeable bankruptcy attorney can explain what will be best in your situation.
(Learn about other debts that don’t go away in Nondischargeable Debts: Debts You Can’t Discharge in Bankruptcy.)
Different Rules For Federal Tax Liens
One way that the IRS can collect your unpaid tax debt is by putting a lien on your property. A federal tax lien attaches to the real estate and personal property (everything that isn’t real estate) that you own.
If you owe a tax debt that meets the five requirements listed above and you discharge it in bankruptcy, you won’t have to pay the debt personally. However, if the IRS has filed a lien, the lien will stay on your property, and when you sell the asset, the IRS will be entitled to payment. In this case, a discharge alone might not be enough.
How a Chapter 13 Bankruptcy Can Help
If you don’t meet the five requirements to discharge taxes, or if the IRS filed a tax lien, a Chapter 13 bankruptcy might be a good option. In this chapter, you’ll enter into a three- to five-year repayment plan to pay the nondischargeable portion. If successful, any dischargeable amount will get wiped out at the end of the plan.
Because of the complicated nature of taxes and bankruptcy, it’s important to talk with a knowledgeable attorney who will evaluate your situation and advise you about your best course of action.
Questions for Your Attorney
- Can I discharge the taxes I owe?
- Can I make the taxes I owe be dischargeable by waiting to file my bankruptcy case?
- Would a Chapter 13 bankruptcy be a better option to handle my tax debt?