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Bankruptcy and Tax Debt

There is a myriad of reasons why someone may find themselves struggling to get out of debt. They may have lost their job, become injured, or faced a serious illness. Regardless of how it happened, once the bills start to pile up, the stress often becomes unbearable. Many people often find relief by filing for bankruptcy. If you’re facing IRS wage garnishment, liens, or levies, you may be thinking that this is an option for you. Bankruptcy and tax debt, however, is not a simple process.

bankruptcy legal disclaimer

Can Bankruptcy Erase Your Tax Debt?

You may be able to erase some or all of your tax debt (state and federal), including penalties and interest, through bankruptcy. It will mainly depend on the type of taxes you owe and which chapter you file under. For example, Chapter 7 bankruptcy only discharges income tax debt and certain property taxes. If you owe payroll or employment taxes, these would not be eliminated through a bankruptcy proceeding. Tax debt from unfiled tax returns is also ineligible for discharge through bankruptcy.

Chapter 7 Bankruptcy

More people file for Chapter 7 than any other type of bankruptcy. This is because it will eliminate all dischargeable tax debts. Gaining approval for a Chapter 7 bankruptcy, however, is more difficult. To erase your tax debt, the following requirements must be met:

  • You have income tax debt. (Property taxes one year or older may also be included.)
  • You filed a tax return for the debt you want to be discharged at least two years before filing for bankruptcy.
  • The tax debt was originally due three years before you filed for bankruptcy.
  • The IRS (or state) assessed the tax debt no earlier than 240 days before you filed for bankruptcy.
  • You did not commit tax fraud or willful evasion of the tax debt.

Once your bankruptcy proceeding begins and an automatic stay is in place, the IRS will immediately cease its collection actions against you for any tax debt including in the filing. This includes wage garnishment, bank levies, tax refund offset, and property seizures.

The IRS, unfortunately, can still conduct an audit to determine your liability. It may also offset your refund due to unpaid child or spousal support. If you have unfiled tax returns, the IRS can also issue a demand or notice of deficiency. Any new taxes owed after filing are also subject to IRS collection actions and will not be included in your discharge.

Chapter 13 Bankruptcy

Under Chapter 13 bankruptcy, how your tax debt is treated depends on whether it is considered a “non-priority” or “priority” debt. If it meets the requirements for Chapter 7, it is generally considered non-priority. The court will then determine how much you can feasibly repay, and the remaining balance will be discharged. All priority tax debt, however, must be repaid in full under the court’s repayment plan. You will typically have three to five years to repay the debt under Chapter 13.

Other Types of Bankruptcies

Chapter 7 and 13 are the most common types of bankruptcy, but there are others. For farmers and fishermen dealing with tax debt, Chapter 12 bankruptcy offers similar protections as Chapter 13, but with additional special conditions and leniencies. Many corporations and partnerships opt for Chapter 11, which is more of a reorganization plan.

Tax Liens and Bankruptcy

Although bankruptcy may help erase certain tax debts, it will not remove any existing tax liens in place when you filed. This means that you will need to pay the lien before you will be able to sell or transfer your property to a new owner, which may put you right back to square one with your tax debt.

Got Tax Debt? Get Help!

If you have tax debt and are considering bankruptcy, don’t go down that path alone. Speak with an experienced attorney or tax professional who can help you determine the best course of action and guide you through the process. At Tax Defense Network, we can help you decide if bankruptcy is the right decision for you. We can also see if you qualify for other tax relief options, such as an Offer in Compromise, Currently Not Collectible status, or a long-term payment plan. Call 833-803-4222 today for your free consultation!