Are you having a difficult time staying afloat financially due to unpaid taxes? If so, you may be wondering if bankruptcy can save you from drowning in debt. Although it’s possible for tax debt to be discharged through bankruptcy, it only happens under certain conditions. In this article, we’ll look at when you can file bankruptcy for unpaid taxes, as well as the most common types of bankruptcies used for tax debt resolution.
When Can You File Bankruptcy For Unpaid Taxes?
As we previously stated, it’s possible to have your back taxes (federal or state) discharged through bankruptcy. Not all tax debt, unfortunately, will qualify. This is because taxes are generally treated as a non-dischargeable priority debt. There are instances, however, when unpaid taxes can be considered a dischargeable debt and eliminated through bankruptcy.
Requirements For Discharging Tax Debt Through Bankruptcy
Before your tax debt can be discharged through bankruptcy, several conditions must be met:
- Type of taxes owed. Income taxes (state and federal) may be discharged (fully or partially) under certain chapters. Property taxes may also qualify in some cases. You cannot use bankruptcy to eliminate unpaid payroll, employment, trust funds, and sales taxes. Penalties for non-dischargeable taxes are also ineligible.
- Age of the tax debt. Your unpaid taxes must be at least three (3) years old, including any extensions you were given. If the tax debt is from the previous two years before filing for bankruptcy, it’s not eligible for discharge.
- When you filed your return. You must have filed a valid tax return at least two years prior to filing for bankruptcy. In some states, you are also required to file on time. That means submitting by the tax deadline or extension date (if requested). If the IRS filed a Substitute For Return (SFR) on your behalf, the state may reject your discharge request.
- How you filed your tax return. In addition to timely filing of your return, you must also file it correctly. This means that you must not commit fraud or tax evasion. Any attempt to avoid paying taxes will result in your discharge being denied.
- Assessment of tax debt. The tax authority (state or IRS) must have assessed your tax debt at least 240 days before you filed for bankruptcy. In some instances, this requirement may be met if the IRS has not yet assessed the debt.
Keep in mind that there are always exceptions to the rules. Even if you don’t meet all of the requirements above, you may still be eligible for relief through bankruptcy. It’s important to meet with a qualified tax professional who is experienced in bankruptcy law to determine if this is the best course of action for you.
Does Bankruptcy Remove Tax Liens?
If you’re filing for bankruptcy to remove a tax lien from your property, we have some bad news. Bankruptcy will not lift any liens that are in place. This means that the IRS or state will still have a claim to your property even if the bankruptcy is approved.
Once you file for bankruptcy, however, other types of collection actions will be stopped. This includes notices and letters, as well as wage garnishment and bank levies.
Common Types of Bankruptcy For Unpaid Taxes
According to the IRS, Chapter 13 is the most popular bankruptcy among individuals when tax debt is involved. Other options typically include Chapter 7 or Chapter 11 bankruptcy.
Chapter 13 Bankruptcy & Tax Debt
Chapter 13, voluntary reorganization of debt for individuals, is only available to individuals (wage earners, self-employed, and sole proprietors) who have regular income and meet the filing requirements. Under Chapter 13, you’ll create a plan to repay part of your debts to creditors within three to five years. This allows you to make smaller monthly payments and discharge any remaining balances. There are, however, some tax debts that must be paid in full under this type of bankruptcy, including:
- Any tax debt where no return was filed
- Tax debt that arose due to fraudulent actions (falsifying information or tax evasion)
- Withholding taxes
It’s important to note that the IRS may be allowed to collect on balances due under Chapter 13 if you did not give them proper notice of your bankruptcy filing.
Chapter 13 Filing Requirements
Before filing Chapter 13, here are some things you should consider:
- You must file all required returns for tax periods ending within four years of your bankruptcy filing.
- During bankruptcy, you must file all required returns or request a filing extension.
- You must also pay all current taxes as they come due.
Failure to file or pay your taxes as required may result in your case being dismissed.
Chapter 7 Bankruptcy & Tax Debt
If you’re unable to make regular payments to resolve your debts, you may wish to consider liquidation under Chapter 7 bankruptcy. Under Chapter 7, a trustee is appointed to convert your assets into cash for distribution among your creditors, including the state or IRS. If there are insufficient assets to pay your debts, all eligible debts are discharged and the creditors receive nothing. Any interest and penalties associated with your tax debt are also discharged.
Chapter 11 Bankruptcy & Tax Debt
Chapter 11 can be used by individuals whose debt exceeds the limit for Chapter 13. This type of bankruptcy is known as reorganization and allows you to create a plan to repay your creditors (including the IRS or state) over time. Chapter 11 can be very complicated, expensive, and take longer to resolve. And, unlike Chapter 7, it will not absolve you of all your unpaid tax debts.
Before determining which type of bankruptcy for unpaid taxes is best for you, we highly recommend meeting with a tax professional to weigh your options and potential outcomes. In some cases, bankruptcy may not be the best option for your situation. Thankfully, there are other ways to tackle your tax debt. You may be eligible for Currently Not Collectible status, or you could negotiate through an Offer in Compromise. To learn more about your available tax relief options, call Tax Defense Network at 855-476-6920. We offer free, confidential consultations and there’s no obligation to use our services.