Does Bankruptcy Clear Tax Debt?

Does Bankruptcy Clear Tax Debt

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Tax debt is more common than you might think. There are many reasons that people suddenly find themselves struggling to pay their debts and taxes – from unexpected medical expenses to natural disasters to family emergencies and plenty more in between. But once the debt starts, it can often quickly spiral out of control, affecting not just your finances but your overall peace of mind. 

If this is the position you’re in, you may be wondering if bankruptcy clears tax debt as well as regular debt. The short answer is “sometimes.” The longer answer depends on your individual circumstances. 

Bankruptcy can certainly provide the relief that some people need in order to clear their debts and start over. However, it’s an option that should be very carefully considered before going ahead. Bankruptcy typically eliminates all of your unsecured debts, but not all secured debts (such as a mortgage or car loan), and not all tax debts. Clearing tax debt with bankruptcy also requires you to meet some very specific conditions. 

In this article we’ll explain the basics of bankruptcy as an option for resolving tax debt. But for a topic as complex and important as overcoming tax debt, you should always seek out reliable professional advice before making any decisions. 

Bankruptcy applications require a bankruptcy attorney, but at Tax Relief Helpers we have a team of tax resolution experts, including tax attorneys, who will be able to review your individual circumstances and advise you on your best course of action – including whether bankruptcy is an option worth exploring.

Give us a call, and let us save you the stress and headache of trying to navigate this process alone, or of applying for bankruptcy when there may be a better option available to you. 

Does Bankruptcy Clear Tax Debt

Bankruptcy options for resolving tax debt

There are a number of different types of bankruptcy, but Chapters 7 and 13 are the most common and apply to the majority of people. 

Chapter 7 bankruptcy

Known as “liquidation bankruptcy”, this is the more traditional form, available to both individuals and corporations, and is generally considered the best option because it wipes out many debts in their entirety – including certain tax debts, meaning you don’t have to pay anything back. However, you must be eligible for Chapter 7 bankruptcy, and there are additional conditions to meet for your tax debt to also qualify for discharge. 

Chapter 13 bankruptcy

Known as “reorganization bankruptcy”, this option is only available to individuals (including sole proprietors). Rather than wiping your debts entirely, this option involves the reorganization of your debt, which must then be paid off over a period of three to five years.

This can be preferable for people who wish to maintain their assets (e.g. their property), as it gives them the time to settle existing debt over a longer period, without creditors being able to chase or penalize them in the intervening period. However, with Chapter 13, you generally can’t discharge your tax debts – instead, you repay them through the duration of your bankruptcy plan.

That said, tax debts over three years old may be discharged depending on your personal circumstances. 

What tax debt can I discharge through bankruptcy?

An important thing to realize is that in all types of bankruptcy, income tax (federal or state) is the only type of tax that can be discharged. 

Other taxes cannot be discharged under either Chapter 7 or 13 bankruptcies. This includes: 

  • Tax liens.
  • Property taxes owed before the bankruptcy.
  • Certain employment taxes.
  • “Trust Fund” taxes (e.g. FICA, Medicare, other income taxes an employer must withhold from an employee’s pay).
  • Erroneous tax refunds or credits associated with non-dischargeable taxes.

Also important to note is the difference between tax liens and tax debt: tax debt is simply what you owe the state or the IRS, whereas a tax lien is a legal judgment secured against your property to satisfy a tax obligation.

Importantly, even if you qualify for Chapter 7 bankruptcy, any tax liens recorded before the bankruptcy will remain in effect – meaning the obligation to pay off the debt will be discharged, but not eliminated. 

This essentially means you could continue to live in a property with a tax lien on it following a successful Chapter 7 bankruptcy, and the IRS or state cannot come after your bank accounts or income. But if you ever wish to sell and move, you will still have to pay off the tax lien. 

Requirements for clearing tax debt with bankruptcy

The only option for completely clearing tax debt with bankruptcy is by filing Chapter 7. However, as mentioned above, the conditions for qualifying are strict. 

To discharge tax debt through bankruptcy, all of the following conditions must be met: 

  • The debt tax must be income tax (federal or state). No other taxes can be discharged or eliminated with bankruptcy.
  • The tax debt must be at least three years old. 
  • You must have filed a valid tax return at least two years before filing for bankruptcy. Late and substitute returns do not count. 
  • The taxes in question must have been assessed by the IRS at least 240 days before filing for bankruptcy (or not have been assessed yet).
  • You must have filed your returns honestly and lawfully. Willful tax evasion or filing fraudulent returns will void any opportunity to file for bankruptcy. 

As previously mentioned, remember that even if Chapter 7 is granted and your tax debts are cleared, any tax liens recorded before the bankruptcy will remain in effect. Property taxes owed before the bankruptcy will also still be owed, and non-income taxes will also continue to be payable. 

Bankruptcy and tax debt relief

If you’re not eligible for Chapter 7 and therefore unable to discharge your tax debt through bankruptcy, Chapter 13 may be another option for you. And in some cases, this can be the better option anyway. 

Rather than completely wiping all your debts, Chapter 13 is a reorganization of debt (including tax debt) that you’re still obliged to repay – but you have up to five years to do so and creditors have to accept the terms of your repayment plan. At the end of the five years, you’ll be caught up on taxes and other debts and be able to move on with your life, having retained your most important assets. 

It’s an option if you have enough income to pay a portion of your debts, but not enough to pay it off in its entirety. And ultimately, it can amount to a form of tax debt relief. 

The following summarizes the core aspects of dealing with tax debt under Chapter 13 bankruptcy: 

  • ​​Tax debt older than three years might be forgiven, depending on your amount of disposable income (minus reasonable and necessary expenses).
  • Any discharged tax debt won’t incur additional interest or penalties.
  • You can satisfy IRS tax liens as part of your Chapter 13 repayment plan, by paying what you owe.
  • The IRS is obligated to abide by your Chapter 13 repayment plan, provided all income is included in the plan and you continue to meet all current tax obligations.

While Chapter 13 can provide a good solution for overcoming significant debts across multiple avenues, there are better options available if your main concern is solely tax debt.

Alternative options to bankruptcy for resolving tax debt

Although bankruptcy does provide an option for clearing some tax debt, it also comes with a number of other consequences – most notably, the impact it has on your credit score and the likely requirement to liquidate your assets. 

If you have extensive debt across multiple avenues, bankruptcy might be the lifeline you need. But if you’re solely considering it as a means of clearing tax debt, there’s probably a better solution. 

The IRS offers a number of other options for resolving tax debt, including: 

In some cases, your tax debt may be written off entirely. In others, you may be able to agree on a manageable payment plan while avoiding further penalties and interest charges. And importantly, all of these options enable you to avoid bankruptcy. 

Given the range of options available and the specific eligibility criteria for each, your first step should always be speaking with an expert. Tax Relief Helpers has a team of seasoned experts who will be able to give you the best advice based on your unique circumstances.

If you opt to go down the bankruptcy route, you’ll need a specialist bankruptcy attorney. But if there are alternative tax relief options suitable for your situation, we will be able to help you through the entire process, even dealing with the IRS on your behalf. 

We know how stressful tax debt can be, so don’t suffer through it alone. Give Tax Relief Helpers a call, and let us help you find the best resolution.