Bankruptcy and IRS Tax Debt

Be wary of commercials that claim to help you get rid of IRS tax debts in bankruptcy. Bankruptcy lawyers are often asked the question, “Does bankruptcy erase tax debt?” The answer is always the same: “Sometimes.” It is not easy to eliminate bankruptcy and IRS tax debt, so understanding these things is important before you file for bankruptcy.

  • When can you pay off a tax debt?
  • What happens to federal liens?
  • How to manage tax debt using Chapter 13

You’ll learn why many filers owe taxes after filing for Chapter 7 bankruptcy and why most Chapter 13 filers have to pay all their taxes through a Chapter 13 bankruptcy payment plan.

When Can You Discharge Tax Debt

Chapter 7 bankruptcy is likely the best option if you need to pay off tax debts. It’s faster and doesn’t require repayment. However, Chapter 7 bankruptcy is not available to everyone. To be eligible to file for Chapter 7 bankruptcy, your tax debt must be dischargeable under Chapter 7.

These are the conditions that must be met before you can eliminate federal income taxes through Chapter 7 bankruptcy.

These taxes are income taxes

Other taxes, such as fraud penalties or payroll taxes, cannot be eliminated by bankruptcy.

You didn’t commit fraud or willful tax evasion

Bankruptcy is not an option if you have filed a fraudulent return or attempted to evade taxes.

The debt must be at least 3 years old

Tax returns must be dated at least 3 years before filing for bankruptcy.

A tax return was filed

The tax return must have been filed at least two years before filing for bankruptcy. If you file a late tax return, which means that your extensions have expired and that the IRS has filed a substitute return for you, you will not be able to discharge the tax. If you meet certain criteria, you may be able to discharge your tax debt even if a late return was filed.

The “240-day rule” is satisfied

You have passed the “240-day rule”. The IRS must have assessed your income tax debt no later than 240 days before you file your bankruptcy petition. This time limit can be extended if an offer in compromise is made or a bankruptcy filing has been filed.

Even if these requirements are met, it is possible that the IRS may still place a tax lien on your property. Some jurisdictions may have additional requirements.

In the Ninth Circuit, for instance, you must file your taxes on time. Late filings will prevent you from getting a discharge. Chapter 7 also states that if you have paid off non-dischargeable taxes using a credit card, it will be an undischarged debt. If a creditor challenges your discharge ability, they can file an “adversary proceeding”, which is a bankruptcy lawsuit.

You Can’t Discharge a Federal Tax Lien

Your victory might be bittersweet if your previous tax liens won’t be erased by bankruptcy. Chapter 7 bankruptcy does not remove your obligation to pay qualifying taxes, and it will not stop the IRS from pursuing your bank account or wages.

However, if an IRS tax lien was placed on your property before the bankruptcy filing, that lien will still be on the property. Before you can sell the property or transfer the title to a new owner, the tax lien must be paid off.

Managing Tax with Chapter 13 Bankruptcy

It might not be so difficult to file your tax return once you realize that Chapter 13 bankruptcy can help manage your tax debt. Here’s why:

  • Dischargeable taxes (generally, those older than 3 tax years) may be forgiven without payment depending on how much disposable income you have after deducting your reasonable and necessary expenses from your salary.
  • You won’t be charged any additional interest or penalties for discharging taxes, but you will pay interest on the non-dischargeable tax.
  • The Chapter 13 plan allows you to pay what you owe the IRS to satisfy a tax lien.
  • The IRS should follow the plan so long as you include all of your income tax, and that your tax returns and obligations post-petition are current during your Chapter 13 plan.

Remember that non-dischargeable taxes that aren’t exempt from bankruptcy (generally those incurred in the last three years of tax) must be paid during the three to five-year Chapter 13 plan. When the bankruptcy is over, you will be liable for all your taxes as well as most or all of the other debt.

Chapter 13 allows you to discharge credit card debts incurred because of a non-dischargeable income tax debt. Find out more about tax obligations in Chapter 13.

Do I File for Bankruptcy Before or After Taxes?

Waiting to file your income tax returns until you file for bankruptcy will not give you any advantage. However, you will need to file your Chapter 7 or Chapter 13 case on time.

Chapter 7 Bankruptcy and Tax Returns

The trustee overseeing your Chapter 7 bankruptcy case will request your most recent tax return and may ask for a written explanation if it is not the most recent. The trustee will compare your income listed in the bankruptcy paperwork to the income reported on your return. If you claim a refund, the trustee will verify that you have the right to “exempt” the amount and that the exemption has been claimed.

If you do not have the right to a refund, the trustee will ask for your permission to distribute the money to your creditors. Many people use their tax returns to pay for essential items, such as living expenses, before filing for bankruptcy. If you choose to use this method, keep records of all your expenses.

Chapter 13 Bankruptcy and Tax Returns

Although you must have your tax returns up-to-date before filing a Chapter 13 case, the rules provide some flexibility. You will need to provide copies of your tax returns from the four previous years before the Chapter 13 trustee meets with creditors at the hearing all filers must attend. Your trustee may ask you to send a letter, affidavit, or certification explaining why you are not required to file a tax return. Local courts may impose additional rules on documents in their jurisdictions. If you do not file your tax return with the IRS before your 341 meeting of creditors, things can go wrong.

  • A motion: You will be given a short time to submit your returns. The court may dismiss your case if you miss the deadline, and you will not be able to appeal to the judge.
  • Substitute returns: An IRS “best estimate” claim may be filed based on your income. The problem is that IRS estimates are almost always higher than what you would owe after filing a properly filed return.

Do You Need More Help With Bankruptcy?

If you’re struggling with IRS tax debt and considering bankruptcy, don’t go it alone. Bruner Wright, P.A. is here to help. Our experienced bankruptcy attorneys in Jacksonville, Florida can provide expert guidance and representation to help you navigate the complex legal process of filing for bankruptcy and dealing with tax debt. With our help, you can find relief from overwhelming debt and get back on track towards financial stability. 

Contact us today to schedule a consultation and learn more about how we can assist you with your bankruptcy and IRS tax debt concerns.

Services We Offer: