Owing taxes to the IRS can quickly become a heavy burden. Interest grows fast, and penalties increase the amount owed. If you find yourself struggling, you may consider bankruptcy as a solution. Whether it can help depends on your particular tax details and how the IRS treats your debt.
How Bankruptcy Treats Tax Debt
Bankruptcy offers relief from a variety of debts, including credit card balances, medical expenses, and personal loans. Tax debt, however, follows stricter rules. While most taxes stay with you even after bankruptcy, some older federal income taxes may qualify for discharge.
Qualifying for Tax Discharge in Bankruptcy
Not all tax debts are treated the same. To have IRS debt erased through bankruptcy, your situation must meet several criteria:
- The debt must involve federal income taxes. Payroll, trust fund, and property taxes aren’t eligible.
- The tax must be at least three years old based on when the return was originally due.
- A valid tax return must have been submitted for the debt. Late returns or those filed by the IRS on your behalf usually do not qualify.
- The IRS needs to have officially assessed the tax at least 240 days before you filed for bankruptcy.
- The debt cannot be connected to any fraud or deliberate attempts to avoid paying taxes.
Meeting all these conditions may allow bankruptcy to eliminate eligible tax debt, giving you a chance to regain financial control.
What Happens If You Don’t Qualify?
Even if you meet the rules above, tax liens may complicate things. A lien placed by the IRS before filing for bankruptcy stays attached to your property. Bankruptcy won’t remove it. You’ll need to settle the lien before selling the asset.
Another issue is using a credit card to pay off non-dischargeable tax debt. In Chapter 7, this credit card balance may not be wiped out. The credit card company can challenge it in court. However, in Chapter 13, you may still be able to discharge it along with other debts.
Chapter 7 vs. Chapter 13: Which One Helps More?
Can you file bankruptcy on IRS debt through both Chapters 7 and 13? Yes, but they work differently.
In Chapter 7, dischargeable tax debt goes away in about four months. You need to meet the requirements of the means test, which evaluates whether your income falls below a certain threshold. If your income is too high, you might be ineligible.
Chapter 7 may also require selling non-exempt assets. The trustee uses this money to pay creditors, often starting with tax debts, since these are high priority. For some filers, this reduces how much tax debt remains after bankruptcy.
Chapter 13 lets you keep your property while following a repayment plan over three to five years. You may pay some tax debt in full or partially. Taxes that cannot be discharged must be paid completely within the plan.
Some people choose Chapter 13 even if they qualify for Chapter 7. It allows them to keep their property, catch up on mortgage or car payments, and avoid foreclosure or repossession.
However, Chapter 13 can get expensive. You’ll pay interest on tax debts and cover the trustee’s fee, which may be up to 10 percent of the amount paid to creditors.
How Bankruptcy Affects Tax Refunds and Filings
If you expect a tax refund and plan to file Chapter 7, the trustee may take it to pay your debts. This applies even if you haven’t filed your return yet.
Some people delay filing for bankruptcy until after they receive and spend their refund on basic needs. Just keep detailed records of how you spent the money.
In Chapter 13, you must stay up to date with tax filings during your plan. The trustee may review your tax returns each year and adjust your payments if your income goes up. A large refund may also lead to a closer look at your financial situation.
Trying to hide money by increasing your withholdings could be considered fraud. Being honest with the court and your trustee avoids legal problems.
Should You File Bankruptcy Before or After Filing Taxes?
For Chapter 13, you must provide tax returns for the past four years. If you’re not current, your case can be dismissed. Chapter 7 doesn’t require that level of documentation, but the trustee will still want to see your most recent return.
If you are exempt from filing taxes, expect to explain that in writing.
Is Bankruptcy the Right Move for Tax Debt?
Bankruptcy can help you eliminate IRS debt, but it’s not the only option. The IRS offers payment plans and other programs, like an Offer in Compromise.
Some companies claim to negotiate tax debt, but not all are trustworthy. Working with a licensed attorney who handles both tax and bankruptcy cases can save time and stress.
Don’t Let Tax Debt Decide Your Future
Delaying action on tax debt can reduce your choices. Instead of hoping things improve on their own, take action now. Tax and bankruptcy rules are strict but designed to offer a fair path to recovery. Consulting an expert familiar with these rules helps you make informed decisions. Having a solid plan today can prevent years of worry. Understanding your options gives you control over your financial future.