Owing the Internal Revenue Service (IRS) won’t prevent you from filing a bankruptcy case. In fact, bankruptcy can be useful in managing your IRS debt. This article explains when you can eliminate tax debt in Chapter 7 bankruptcy and how Chapter 13 can help you pay tax debt over time without fear of IRS action.
Discharging Taxes With Chapter 7 Bankruptcy
Most people who file a bankruptcy case hope to wipe out or "discharge" debt. You can discharge past due federal income tax if it meets certain conditions. However, these conditions can be complicated and rely on the IRS's timing of tax returns and other IRS actions.
We have simplified them here to help you understand the general requirements. To find out if your tax debt qualifies for discharge, you should visit with a qualified bankruptcy lawyer who can provide a detailed analysis and make a knowledgeable recommendation.
Here are the basics:
- the tax is on your income
- your return was due at least three years before you file your bankruptcy case
- you filed the return at least two years before your bankruptcy case
- the tax debt wasn’t assessed within 240 days before you filed your bankruptcy case, and
- the return isn’t fraudulent, and you didn’t willfully attempt to evade taxes.
As you can see, timing is crucial in determining whether taxes can be discharged. Your tax transcript will have the information you and your attorney need when calculating the dischargeability of your income tax debts. Get a copy by visiting the IRS Transcript Types and Ways to Order Them webpage.
Tax Liens Don’t Go Away
Attorneys often advise clients to wait to file a Chapter 7 case until all or most of their tax debt is dischargeable. For some, this strategy could prove risky.
If your tax debt is high, the IRS might file a tax lien against your property, making managing the debt more difficult because the lien will attach to your real and personal property. As a result, even if the tax debt gets wiped out in bankruptcy, you’ll still have to pay the lien once the property gets sold.
Managing IRS Debt With Chapter 13 Bankruptcy
For taxes that aren’t dischargeable in a Chapter 7 case, or if the IRS has filed a lien, Chapter 13 bankruptcy might be a good choice. In a Chapter 13 case, you’ll propose a repayment plan over three to five years. The monthly amount will depend on the type of debt, the amount you owe, and how much disposable income you have.
Some debts get special treatment because of their importance, like recent income taxes, child support, and alimony. These “priority” debts must be paid fully in the payment plan. Nonpriority debts, like older taxes and credit cards, might or might not be paid depending on how much disposable income remains after accounting for your reasonable and necessary expenses.
Any dischargeable nonpriority debts not paid through the plan will be discharged at the case's end. You'll remain responsible for paying the balance of any nondischargeable nonpriority debt after your Chapter 13 case ends.
Because priority debts, car loans, and car loan and mortgage arrearages are typically paid in full through the plan (unless you have more than five years of car payments when you file), and most other debts are discharged, it's typical to exit Chapter 13 with only student loans (a nonpriority nondischargeable debt) and mortgage debt remaining.
Other Nondischargeable Debt
The above rules only apply to taxes on your income. Other types of tax will never get discharged in a Chapter 7 case (but you can pay them in full as part of a Chapter 13 plan).
- Trust fund taxes. The income and Social Security taxes you withhold from your employees’ paychecks are called trust fund taxes because you hold that money in trust for the federal government.
- Excise taxes are paid on the sale, use, or consumption of various products or activities. Some common products for which we pay excise taxes include gasoline, cigarettes, and alcohol.
- Estate taxes. Tax on a property transfer from the estate of a deceased person to heirs isn’t dischargeable.
- Tax fraud penalties. You won’t get out of paying fines assessed for filing a fraudulent return or willfully evading a tax.
Questions for Your Attorney
- Are state income taxes dischargeable?
- How do I know if the IRS has filed a lien?
- Can the IRS take my home or personal property to pay my taxes?