As bills, collection notices, and other intimidating communications begin to pile up, you may find yourself with one hopeful question: does bankruptcy clear debt to the IRS? The answer, as with many things relating to tax law, is: “it depends.” Whether or not your outstanding amount owed to the IRS is eligible to be wiped out in bankruptcy will depend on several important factors, which we’ll get into below. The short answer to “does bankruptcy clear IRS tax debt?” Yes, much of it can potentially be erased… but you’ll need to meet very specific criteria, and many people are simply not eligible.
The first step to answering the tricky question of whether or not you can cure tax debt through bankruptcy is to understand the basic nature of bankruptcy itself, which has more than one form. You’ve probably heard of the bankruptcy “chapters,” specifically Chapter 7 and Chapter 13.
Under Chapter 7 bankruptcy, you’ll seek to discharge your debts (potentially including some of your tax debt), whereas Chapter 13 bankruptcy is more of a restructured repayment-based option.
If you’re planning on filing Chapter 13, you’re probably out of luck when it comes to your unpaid tax debts — you’ll still owe them in full, but you may be granted more flexibility in terms of the repayment timeline. For those looking for a true fresh start, Chapter 7 is usually the go-to choice… but even then, there’s a strong possibility that most of your tax debt will not be eligible for erasure.
In reality, you can only discharge income tax debts under Chapter 7 bankruptcy if those debts meet some pretty specific requirements. If your tax issues are related to non-income tax areas like payroll tax, however, you’re going to be stuck with those obligations regardless.
If you’re struggling to stay financially afloat with various creditors as well as the government, you’re probably starting to wonder: does filing personal bankruptcy eliminate tax debt?
As we’ve already covered, for the vast majority of filers, Chapter 7 will be the best bet to try and get at least a portion of your tax debt wiped out. However, you should approach your situation with realistic expectations and your eyes wide open: many people are not able to get their tax debts erased in a Chapter 7 bankruptcy, and for those who do find relief in Chapter 7, it is almost always for a portion of the tax debt — not the entire amount.
Ready to see if you might qualify to have some tax debt wiped out in Chapter 7 bankruptcy? Let’s take a look at a few of the most important qualifications to get that monetary amount included in your discharges.
#1 – What is the nature of the unpaid tax debt?
As we’ve said, only income tax debt is even eligible for a chance at discharge (being wiped out). If your owed amount is related to payroll taxes or the result of a bad faith or fraudulent action on your part (in the form of fees and penalties), you will be stuck with that burden even if you file for Chapter 7. Income taxes, and income taxes alone, are the specific type of tax debt with a little bit of wiggle room when you file for bankruptcy under Chapter 7.
#2 – How old is the unpaid tax debt?
You might be surprised to learn that, in order to be eligible for discharge in bankruptcy, your unpaid tax debt must be at least 3 years old at the time of filing. If the debt is any newer than that, you won’t be able to unburden yourself of it through bankruptcy or any other means.
You can understand why this is the case: bankruptcy is meant to give citizens a fresh start and freedom from crushing financial burdens that they’ve made a good faith effort to cure. If you were able to run up a huge tax debt and then magically shed it through bankruptcy as soon as your bill came due that year, the system would be broken. Instead, the rules around tax debt discharge and Chapter 7 are structured to provide relief from older tax debt that keeps following you around year after year, making it impossible to gain any headway on your finances.
#3 – Did you file a fraudulent tax return or commit willful evasion?
To expand on the above sentiment about this option being specifically for taxpayers trying to act in good faith, you’ll have no chance to discharge anything if you submitted a fraudulent tax return or willfully evaded payment. This usually takes the form of dishonest or fraudulent info being submitted on your tax return. Regardless, if the IRS busted you for something you really shouldn’t have been doing, there will be no relief from your tax debts to be found under Chapter 7.
#4 – Did you file an on-time tax return for the year(s) in question?
Your filed tax return is one of your most direct lines of communication with the IRS. As with most things relating to the Internal Revenue Service, you’ll find that simply doing the bare minimum of filing and keeping an open line of contact with the agency is going to make your life a lot easier than if you hide, obfuscate, or attempt to outsmart them.
To that end, in order for your income tax debts to have a chance at being discharged under Chapter 7, you absolutely must have filed a tax return stating those debts at least two years before actually filing for bankruptcy. In the vast majority of cases, if you never filed and simply waited for the IRS to create their own substitute return on your behalf, you will have disqualified yourself from any chance at wiping the debt clean. Again, this is a textbook example of why doing your very best to follow the IRS’ rules and procedures is also in your own best interest, should you find yourself looking for leniency later on down the line.
#5 – Do you have any tax liens?
While there is a small chance that you can in fact get income tax debts discharged under Chapter 7 bankruptcy, the news is not quite so bright for those tax liens you’ve accumulated. Tax liens are not eligible to be removed in the course of Chapter 7, and unfortunately you’ll still have to clear any property liens yourself once the dust settles on your bankruptcy case.
#6 – When was your income tax debt assessed?
The IRS has something we call the “240 day rule” when it comes to your bankruptcy claim. The tax debt you’re hoping to clear needs to have been assessed by the IRS at least 240 days before you file your petition, otherwise it will be deemed ineligible.
IRS tax debt is not to be taken lightly. Often times, you’ll only get one good shot at making your case as to why (and how) your income tax debt should be discharged under Chapter 7 bankruptcy. If you’re in a situation where you’re weighing your options in regards to tax debt and bankruptcy, it’s critical that you seek the advice of a highly qualified tax attorney like the ones at Abajian Law. It might make the difference between a fresh start… or being saddled with tax debt for years to come.