does bankruptcy clear tax debt

Does Bankruptcy Clear Tax Debt?

If you are struggling with tax debt, you may be wondering if bankruptcy can provide relief. The question on many people’s minds is, “Does bankruptcy clear tax debt?” The answer is not a simple yes or no. It depends on the type of tax debt you have and the type of bankruptcy you file. 

In this blog post, we will explore the rules governing bankruptcy and tax debt. So, if you are considering bankruptcy as an option for your tax debt, read on to learn more about how bankruptcy may or may not clear your tax debt.

Basics of Bankruptcy & Tax Debt

You can file for protection against creditors under the federal bankruptcy law to stop harassing bill collectors and get relief from many of your outstanding debts. Tax debt is treated differently than other types.

Taxes are often considered a “nondischargeable priority debt” in bankruptcy terminology. This means that bankruptcy will not eliminate them and the repayment of the debt takes precedence over any other creditors’ claims. There are occasions when taxes may be dischargeable and can be eliminated through bankruptcy filings.

Conditions for Paying Off Tax Debt

For any tax debt to be dischargeable, it must be income tax debt. This includes unpaid federal or state income taxes, but not back payroll taxes like withholding for Social Security or Medicare.

The second condition is that tax debt must not be too new — generally, it cannot be older than three years. To be exact, the original tax return must be due no later than three years prior to the date of bankruptcy filing.

The next step is to have filed a valid return on the debt at least 2 years prior to filing bankruptcy. The return must be submitted on time. You can request extensions and file by the extension deadline. If the extension date is missed, the return may not be valid. The tax debt will not be dischargeable.

The rules regarding the age and filing date of the returns are not the only ones. However, the IRS must have assessed the debt, or at least recorded it on its books, at least 240 days prior to the bankruptcy filing. If the IRS hasn’t yet assessed the debt, this requirement could be met.

Tax Debt and the IRS

The IRS could extend the normal 240-day period if it has assessed the debt and stopped collecting due to bankruptcy filings or other causes. This could make it more difficult to discharge the debt.

You can’t file bankruptcy if you try to evade taxes, or file a false return. According to the rules, you must have filed your returns truthfully. You should also know that bankruptcy may be an option for you if your tax debt is not paid. While we’ve covered the main conditions, local rules might have additional requirements.

Last, but not least, ensure that the taxing authority (usually the IRS) has not filed tax lien against your assets. A bankruptcy filing won’t lift a lien if it has already been filed. This is one of many obstacles that prevent you from getting tax relief through bankruptcy.

Key Takeaways: Conditions for Paying Off Tax Debt

These requirements are necessary to discharge tax debt via bankruptcy

  • It must be income tax debt
  • It must be a three-year-old or older debt
  • Two years must have passed since the last tax return was filed for the debt
  • The IRS must have registered the debt at least 240 days before you file bankruptcy. If it has not, they will assess it.
  • You must have filed your taxes honestly — no tax evasion or fraud
  • The IRS cannot have placed a tax lien against your assets

Can You Discharge a Federal Tax Lien?

A tax debt is money owed by the taxing authorities. However, a lien on your property is a legal claim. A lien could be placed on your entire property, including bank account, personal belongings, and real estate.

A tax lien is not extinguished by bankruptcy. The IRS and other taxing authorities will still claim your property, even though bankruptcy has discharged your tax debt.

The IRS cannot continue to try to collect on any dischargeable tax debt after you file for bankruptcy. Also, the IRS can no longer tap your bank account or garnish your wages to collect tax debt. A tax lien can be removed from a house so you can live there. It must be paid out of the proceeds if you decide to sell your home.

The Best Types of Bankruptcy for Tax Debt

You can file for bankruptcy protection to get rid of tax debt. These are Chapters 7 and 13 for individuals, Chapter 12 for family farms or fishing operations, and Chapter 11 which is mainly for larger debts and businesses.

According to the IRS, Chapter 13 is the most popular type of individual bankruptcy filing where tax debt is involved. Chapter 13 involves making arrangements to repay creditors over three to five year periods. A Chapter 7 bankruptcy, on the other hand, wipes out most debts and they don’t have to be repaid.

A Chapter 13 bankruptcy filing is successful and all tax debts will be paid under the plan. Tax debts older than three years at the time of filing are also forgiven. The taxpayer must file all returns on time and pay any new income taxes due during the payoff period. A Chapter 13 filing may allow interest and penalties to be waived depending on the circumstances. This will also erase interest on any tax that is dischargeable. Penalties that are older than three years are eligible for discharge.

A Chapter 7 filing allows the debtor to sell most of his assets and give the proceeds to creditors. Chapter 7 can be used to discharge eligible debts if there is insufficient or insufficient assets to pay creditors. Creditors do not receive any proceeds. The IRS states that Chapter 7 can clear tax debts if they are less than three years old and if the taxpayer has filed returns covering the four most recent tax periods.

Strategies for Tax Debt Bankruptcy

For tax debt to be eliminated through bankruptcy, patience and timing are key. Waiting until your tax debt is past the three-year mark is key to filing a successful bankruptcy petition.

Also, you need to see what IRS records reveal about the timing. Request transcripts from the IRS of your tax account. These documents will show you the dates and help you decide if it is too early to file bankruptcy to pay off your tax debt.

You should verify that the tax lien is not invalid if it is preventing you from getting rid of tax debt through bankruptcy. The lien paperwork must correctly identify the taxpayer and include details such as the tax year, amount owed, and who filed it. The lien paperwork must also be filed by the taxing authority, which can vary from one state to the next.

A defective lien could be invalid, but it won’t block a bankruptcy.

Chapter 13 is an option if Chapter 7 does not seem to work for you. This method requires you to make payments for three to five year, but allows you to discharge some debt.

Get Professional Guidance on Bankruptcy Options from Our Attorney

If you’re facing financial challenges and considering bankruptcy, it’s crucial to work with an experienced attorney who can guide you through the complex legal process. Bruner Wright P.A. is a team of skilled bankruptcy lawyers who are committed to providing personalized legal services to clients in need. With decades of combined experience, our attorneys have helped countless individuals and businesses achieve financial stability through bankruptcy.

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Whether you’re filing for Chapter 7 or Chapter 13 bankruptcy, our attorneys will work tirelessly to protect your rights, assets, and financial interests. If you’re ready to take control of your financial future, contact Bruner Wright P.A. today to schedule a consultation with one of our experienced bankruptcy attorneys.