You may be able to get rid of some tax debts by filing for bankruptcy, but there are very strict rules that may prevent you from discharging all of your tax debt in bankruptcy. Generally, bankruptcy can only eliminate income taxes that are at least three years old, so you need to proceed cautiously.
For guidance, contact an attorney who’s experienced with both tax debt and bankruptcy – to get help now, contact us at Damien’s Law today.
Key takeaways
- You may be able to discharge certain taxes in bankruptcy.
- To qualify, the taxes usually need to be at least three years old and you must be personally liable for them.
- Filing for bankruptcy creates a stay which prevents the IRS from pursuing involuntary collections against you.
Bankruptcy and taxes: an introduction
The most common types of bankruptcy for most individuals are Chapter 7 and Chapter 13.
- In a Chapter 7 bankruptcy, also known as a “liquidation” bankruptcy, the court will appoint a trustee to oversee the case. The bankruptcy trustee will then sell off any non-exempt assets of the debtor in order to pay creditors. Any remaining debt, including qualifying tax debt, is discharged – in other words, it doesn’t need to be repaid.
- In contrast, a Chapter 13 bankruptcy is also known as a “reorganization” bankruptcy. In this type of bankruptcy, the debtor will work with the court to develop a repayment plan to pay back creditors, including the IRS, over a three- to five-year period. After that point, the remaining debt (including qualifying tax debt) is discharged.
Which tax debts are dischargeable in bankruptcy?
Dischargeable tax liability is one that meets the following conditions:
- The taxes are at least three years old.
- You’re personally liable for the taxes.
- You didn’t commit tax fraud or willfully evade paying taxes.
Generally, the return must have been filed at least two years ago, and the taxes must have been assessed at least 240 days ago, but there are some exceptions depending on the laws in your state. These time limits, along with the rule about the taxes being at least three years old is sometimes referred to as the 3-2-240 rule.
If you’re not sure whether or not the debt you owe the IRS can be wiped out in bankruptcy, you should contact the IRS or reach out to a tax attorney. They’ll be able to answer your questions and help you know what to expect.
Can you discharge penalties in bankruptcy?
You may be able to get certain penalties discharged through bankruptcy. For example, failure to file or failure to pay penalties may be dischargeable. However, it can depend on when the penalties were assessed relative to when you file for bankruptcy.
What happens if I file for bankruptcy & my taxes can’t be erased?
If you can’t discharge your tax liability through bankruptcy, then you will continue to owe back taxes to the IRS. If you don’t pay, the agency can file tax liens and take collection actions against you, including wage garnishments and asset seizures.
Fortunately, the IRS cannot collect tax liabilities once 10 years have passed since the liability was originally created. That is called the collection statute of limitations, and in some cases, you can work it to your advantage when you owe back taxes.
Can businesses discharge taxes in bankruptcy?
Businesses may be able to discharge certain taxes in bankruptcy, but the rules vary. Talk with a tax or bankruptcy attorney who has experience with business taxes.
Can you discharge payroll taxes in bankruptcy?
In certain situations, you may be able to discharge the employer portion of payroll taxes in bankruptcy. However, you cannot discharge trust fund payroll taxes in bankruptcy or the trust fund recovery penalty.
What Happens If You File Bankruptcy When You Owe the IRS?
When you file for bankruptcy, the court will put an automatic stay on collection actions against you. An “automatic stay” is a court order that prevents creditors from contacting you or taking legal action against you in an attempt to collect payment on your liability. The stay also prevents the IRS from pursuing collection actions against you.
The automatic stay remains in effect throughout the duration of your bankruptcy case. That means that while you’re dealing with the bankruptcy case, the IRS cannot garnish your wages, levy your assets, or start any new collection actions. The agency also cannot demand that you make payments on an installment agreement.
What if you’re on an IRS payment plan when you file for bankruptcy?
The IRS will pause your payment plan, but they will not terminate it or put it into default. The IRS cannot take payments from you, but if desired, you can send in voluntary payments.
Can you apply for a settlement while you’re in bankruptcy?
No, you cannot apply for an offer in compromise while you’re in an active bankruptcy case. However, if you have tax debt that survives the bankruptcy, you can apply for an offer in compromise on that debt once the bankruptcy case is closed.
Bankruptcy and Unfiled Taxes
You can only include taxes that have been assessed for at least three years when you file for bankruptcy. Of course, that means that you cannot include taxes that you may owe from an unfiled return. It’s also important to consider how your bankruptcy case may affect any unfiled returns that you have.
First, be aware that the IRS requires you to be compliant with tax filing requirements when you’re dealing with a bankruptcy case. If you don’t file all required returns, you may not be able to discharge taxes in bankruptcy (even if they meet the usual requirements to be discharged).
Second, if you file a tax return that shows a refund due, you may not get to keep it if you’re in an active bankruptcy case, but that depends on a few factors.
Can I file bankruptcy on taxes assessed with a Substitute for Return?
This depends on the laws in your state. Some state laws will not let you include taxes assessed through a substitute for return, but other states do allow that.
Can I keep tax refunds when I file for bankruptcy?
If you file a return for a tax period that’s prior to the bankruptcy filing, you generally cannot keep that refund. Instead, the IRS will send it to the bankruptcy trustee, who will apply it to your tax debt (or potentially other debts) as they see fit.
For example, say that you’re filing for bankruptcy in 2025 and you have unfiled returns for tax years 2023 and 2024. Since those years are before the bankruptcy case, you generally will not be entitled to the refunds. However, that’s also true if you hadn’t claimed bankruptcy – if you owe taxes, the IRS almost always keeps your tax refunds and applies them to your tax debt.
However, you may be able to keep refunds for years that fall after the bankruptcy filing. Say, for example, that your 2025 return shows a refund. You may be able to keep that, but it depends on the details of your bankruptcy case.
Should I File Bankruptcy If I Only Owe Tax Debt?
Talk with an attorney about your specific situation before making this decision, so that you can get advice customized to you. However, generally speaking, bankruptcy is not the right option if you only owe tax debt. In most cases, you should really only consider bankruptcy if you have a lot of unsecured consumer debt with no repayment options and you need relief.
If you only owe tax debt, you may instead want to consider one of these options:
- Installment agreement – make monthly payments for up to 10 years or until the collection statute expiration date (CSED) if sooner.
- Partial payment installment agreement – if you can’t afford the minimum payments on a standard installment agreement, make smaller payments until the CSED and get the remaining balance waived.
- Offer in compromise – settle the tax debt for less than owed, by making an offer based on the equity in your assets and your disposable income.
- Currently non-collectible – prove that you can’t pay anything and the IRS will stop all collections until your financial situation improves. If you reach the CSED while on CNC status, the tax debt will become uncollectible and not need to be paid.
In all cases, you should also request penalty relief. That can help to substantially reduce your tax bill, if you qualify – and it never hurts to ask.
If you have more questions about how to deal with your tax liability during bankruptcy, bankruptcy filings, or learn more about your options, reach out to our tax attorney at Damiens Law Firm for assistance. We understand that having any kind of liability can be overwhelming, so we especially appreciate the burden people feel when they owe a debt to the IRS.
Having someone on your side with in-depth knowledge of how to navigate bankruptcy is best for protection and reassurance. We may be able to help you get rid of your income tax liability, Contact us or call (601) 476-2693 to learn more.
