For individuals struggling with overwhelming debt, bankruptcy may seem like a way to wipe the slate clean.
However, not all types of debt are dischargeable in bankruptcy, and tax debt is one of the most complicated areas of this process.
While bankruptcy can provide significant relief, it’s essential to understand which tax debts can and cannot be discharged and the steps involved in eliminating them.
If you’re considering bankruptcy and have significant tax liabilities, this article will help clarify the nuances of tax debts in bankruptcy. We’ll cover what you need to know about the dischargeability of tax debts, what the IRS thinks about bankruptcy filings, and why hiring a bankruptcy attorney is crucial in these cases.
The short answer is: It depends. Some tax debts can be discharged (wiped out) in bankruptcy, while others cannot.
The rules governing tax debt discharge are complex, and multiple factors determine whether or not a specific tax liability is eligible for discharge.
Certain tax debts can be discharged in bankruptcy, but only under specific conditions. Generally, the IRS allows the discharge of income taxes under the following circumstances:
The Taxes Are Income Taxes: Only income taxes, such as federal and state income taxes, can potentially be discharged in bankruptcy. Sales tax, property taxes, and other types of taxes generally cannot be discharged.
The Taxes Are More Than Three Years Old: In Chapter 7 and Chapter 13 bankruptcies, the tax debt must be at least three years old. This means that you must have filed your tax returns for the relevant tax year at least three years before filing for bankruptcy. For instance, if you’re filing for bankruptcy in 2025, any tax debt from 2021 or earlier could be eligible for discharge.
Your Tax Returns Were Filed on Time: If you never filed the tax return for the debt in question, that debt will not be discharged in bankruptcy. The IRS will generally only discharge tax debts if you filed the relevant returns on time, even if you owe back taxes. If you filed late, the tax debt may not qualify for discharge.
The Taxes Were Not Fraudulent: If you were involved in any fraudulent activities related to the taxes (such as underreporting income or intentionally failing to file returns), the IRS will not discharge that tax debt. Bankruptcy courts take fraud seriously, and the burden of proof lies with you to show that your tax debts are legitimate.
The Taxes Are Not Subject to a Tax Lien: If the IRS has already placed a lien on your property, those tax debts cannot be discharged in bankruptcy. A lien is a legal claim against your property and remains in place even after your bankruptcy is complete. However, if the lien was filed more than 240 days before filing for bankruptcy, there may be options to address it during your bankruptcy proceeding.
Several types of tax-related debts cannot be discharged through bankruptcy. These include:
Payroll Taxes and Withholdings: If you owe payroll taxes (taxes that were withheld from employees’ wages but not remitted to the IRS), these debts are not dischargeable in bankruptcy. This is considered a trust fund tax, and the IRS takes a harsh stance on these types of debts.
Recent Tax Debts: If your tax debt is less than three years old or if you haven’t filed a tax return for the relevant year, the IRS will likely not discharge that debt in bankruptcy.
Property Taxes: Property taxes are generally non-dischargeable in bankruptcy. While income taxes might be eligible for discharge, taxes related to your property, such as real estate taxes, must still be paid.
Fraudulent Tax Debts: As mentioned earlier, any tax debt resulting from fraudulent actions, such as evading taxes or intentionally misreporting income, is not dischargeable.
Certain Penalties: While some penalties related to income taxes can be discharged, others—especially penalties related to fraud or civil penalties—are typically non-dischargeable. This means that while the underlying tax debt may be eligible for discharge, the penalties you owe may not be.
When you file for bankruptcy, the IRS is one of the many creditors you are legally obligated to notify.
The IRS has specific procedures for handling bankruptcy cases, and understanding how they view bankruptcy filings is essential to navigating this process:
Automatic Stay: Once your bankruptcy case is filed, an “automatic stay” goes into effect, which means that the IRS must halt all collection actions, including garnishments, levies, and attempts to seize your assets. This provides immediate relief if the IRS is aggressively pursuing you for tax debt.
Filing a Proof of Claim: In bankruptcy, the IRS will file a “proof of claim,” which details the amount of tax debt they believe you owe. The IRS’s claim may or may not be accurate, so it’s important to review this document and dispute any discrepancies.
Tax Liens and Bankruptcy: While the IRS may stop collection actions during bankruptcy, any existing tax liens may remain attached to your property even after the bankruptcy is complete. Bankruptcy doesn’t eliminate liens; it just addresses the underlying debt.
Post-Bankruptcy Compliance: After your bankruptcy case is discharged, the IRS expects you to stay compliant with your taxes going forward. This means filing your tax returns and paying your taxes on time. Failure to comply could result in further IRS collection actions.
Given the complexity of bankruptcy law, especially when it comes to tax debts, hiring a qualified bankruptcy attorney is crucial. A bankruptcy lawyer will help you navigate the process and ensure that your case is handled appropriately.
Here’s why an attorney is important when dealing with tax liabilities in bankruptcy:
Understanding the Law: Bankruptcy laws, particularly around tax discharge, can be intricate and vary by jurisdiction. An experienced attorney will understand the nuances of tax discharge eligibility and ensure that you’re filing correctly.
Assessing Your Situation: A bankruptcy attorney will review your tax debts and help you determine which ones can potentially be discharged. They can also identify which debts need to be paid and create a strategy to manage those liabilities.
Maximizing Debt Relief: A skilled attorney can help you maximize the amount of tax debt that can be discharged, and they can also work with the IRS to negotiate repayment plans if necessary.
Filing and Paperwork: The paperwork involved in filing for bankruptcy is extensive, especially when dealing with tax debt. An attorney will ensure that all required forms are completed accurately, avoiding delays or mistakes that could hurt your chances of discharge.
Representation in Court: If your bankruptcy case requires a hearing, an attorney can represent you in court, advocating for your interests and addressing any issues that may arise regarding your tax liabilities.
Filing for bankruptcy can offer relief from overwhelming financial burdens, including tax debt. However, not all tax debts are dischargeable in bankruptcy, and understanding which ones are and which ones are not is key to planning your bankruptcy filing.
By working with a knowledgeable bankruptcy attorney, you can navigate the complexities of tax debt discharge, protect your assets, and create a clear path forward to financial recovery.
Remember that bankruptcy is a powerful tool, but it requires careful consideration and expert guidance to ensure you achieve the best possible outcome for your financial future.
At Blue Bee Bankruptcy, our lawyers are highly experienced in bankruptcy options. More importantly, we understand that each case we receive is unique and each client has different needs and goals. We will discuss these signs with you and decide the best route to take.
We strive to help our clients rebuild their lives and take steps toward a better financial future through filing.
If you’re dealing with the potential of bankruptcy, give us a call. Our team will work to help you by reviewing all of the options our firm has available. We will ensure you’ll get the best possible outcome for your situation.
Get in touch today so we can start working on either halting bankruptcies or preventing them from taking place altogether!
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