Can IRS Tax Debt be Discharged in Bankruptcy?
If you are considering bankruptcy and owe back taxes to the Internal Revenue Service (IRS), you may wonder if you could kill two birds with one stone. In other words, can you erase your IRS tax debt through bankruptcy?
Experts warn that discharging IRS tax debt through bankruptcy might not be as simple as it sounds. First, bankruptcy isn’t a blanket solution for all tax debts. Even if your tax debt qualifies for discharge through bankruptcy, there are several components and caveats you will need to consider.
First, you’ll need to determine which chapter of bankruptcy applies to your case. Then, you’ll need to meet a series of conditions, before your IRS tax debt can be discharged. Let’s take a closer look at bankruptcy as a tool for discharging tax debt.
We’ll start with the basics—how do you know if your personal IRS tax debt can be discharged through bankruptcy?
Does My IRS Tax Debt Qualify?
Before you assume that you can use bankruptcy to get rid of the back taxes you owe, it’s important to know if your tax debt qualifies for discharge. What are the basic conditions that need to be met?
First, dischargeable IRS tax debt must be from unpaid federal or state income taxes. Other forms of tax debt will not be considered for discharge, such as sales taxes or payroll taxes from a business.
Second, you must have filed a tax return for the debt two years or more before filing for bankruptcy. This return needs to have been filed “on time”, which can include extensions granted at your request. The IRS tax debt must be sourced from a tax return at least three years before you file for bankruptcy.
Third, you need clarity from the side of the IRS, which needs to have assessed and recorded the tax debt at least 240 days before you file for bankruptcy. If there is a disruption in previous filings—if the IRS assessed your tax debt and then stopped collection due to a previous bankruptcy filing or another issue—your IRS tax debt may be more difficult to discharge.
Of course, to be considered for discharge, you need to have a clean tax record. If you’ve ever filed a fraudulent return or have been charged with tax evasion, you won’t qualify to have your IRS tax debt discharged.
Finally, you mustn’t have had a tax lien filed against your assets. This is one of the most common hurdles for those looking to discharge IRS tax debt through bankruptcy. Even bankruptcy cannot lift a tax lien. A tax lien will survive the bankruptcy.
Bankruptcy Chapters That Apply
Once you’re certain your IRS tax debt meets the conditions required for discharge, it’s time for further research. You may be surprised to learn how many options you have when filing for bankruptcy. While some bankruptcy chapters are designed for business, farming, or fishing operations, others are specific to individuals.
Most individuals will file for bankruptcy using either Chapter 7 or Chapter 13. The option you choose will depend on your circumstances and the nature and history of your tax debt.
Through a Chapter 7 bankruptcy filing, you can liquidate your assets for distribution to your creditors. According to the IRS, Chapter 7 is a common form of bankruptcy for individuals with assets to sell. If there are no assets or insufficient assets, IRS tax debts can still be discharged, as long as they meet the criteria listed above.
When a Chapter 7 filing isn’t realistic or doesn’t apply, many taxpayers turn to Chapter 13, the most common bankruptcy tool for those hoping to discharge IRS tax debt. Also known as reorganization bankruptcy, Chapter 13 creates arrangements with creditors, allowing you to pay them off over a longer period—often 3 to 5 years.
During the payoff period of a Chapter 13 filing, you will be expected to pay creditors, file your taxes on time, and pay any new income taxes due. Failure to file your returns or pay your current taxes during the period of your bankruptcy may result in your case being dismissed.
Unlike a Chapter 7 bankruptcy, which disposes of many debts, Chapter 13 requires that debts are repaid, at least in part, over a longer period. A Chapter 13 filing can discharge IRS tax debt, as well as any interest owing.
What to Expect
If your IRS tax debt meets the qualifying criteria and bankruptcy seems like a viable option, you may still be wondering what to expect. Many taxpayers are surprised at the amount of patience required for a successful experience.
Not only does your IRS tax debt have to be at least three years overdue but you also need to be current with the records the IRS holds for you. In some cases, the IRS may have a faulty lien placed against your assets, which would get in the way of your bankruptcy filing.
In other words, you should also expect that you’ll need to be proactive to help your bankruptcy filing proceed smoothly. You may need to secure copies of IRS records, or paperwork to verify the validity of a lien placed against your assets. Depending on the state in which you live, you may face additional steps for obtaining information from your tax authority.
If you have IRS tax debt, it’s important to consider all your options, before jumping straight to bankruptcy, which can have long-term implications for your credit rating. Just as you might negotiate with other creditors before filing bankruptcy as a solution, there are ways to negotiate with the IRS concerning your tax debt.
The IRS may be willing to set up an arrangement that will allow you to pay your debts over time. If IRS tax debt is your main source of debt, a payment plan can be as useful as filing for Chapter 13 bankruptcy. An added advantage of setting up an IRS payment plan is that you will avoid the legal expenses of filing for bankruptcy.
If an installment plan with the IRS isn’t manageable within your budget, you might be able to settle with the IRS through their Offer in Compromise program. Under this agreement, you reach a negotiated settlement to pay the IRS a reduced amount of your total tax owed. Keep in mind, that an Offer in Compromise can only be made after you’ve filed for bankruptcy.
Both an IRS settlement and an Offer in Compromise are more likely to be secured with the help of tax experts. If you are considering either of these strategies to dispose of your IRS tax debt, it is important to work with a trusted tax team.
Experienced tax professionals have expertise in all aspects of communicating and negotiating with the IRS. If you owe IRS tax debt and are thinking about bankruptcy as a solution, tax experts can help to guide you through the process.
At Franskoviak Tax Solutions, we have helped thousands of clients with taxes and tax problems for more than 30 years. We provide comprehensive tax services with first-class expertise and a personalized, boutique-style approach. Speak to our team about personal and business taxes, IRS tax deadlines, payroll taxes, IRS tax relief, and tax problems such as IRS tax notifications, IRS threats to place liens or levies on assets, delinquent taxes, and more.
Start with a free consultation—if you have IRS tax debt and are curious if bankruptcy will discharge your debts, we can help you determine if it is the right solution given your tax scenario.