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bankruptcy and tax debt

Bankruptcy and Tax Debt

April 24, 2015

If you are in bankruptcy proceedings and have tax debt, you can have your debt discharged under Chapter 7 and Chapter 13 of the bankruptcy code. Income tax debts, however, cannot typically be discharged under Chapter 13. For discharging tax debt, Chapter 7 is often preferred over Chapter 13. Chapter 7 allows full discharge of allowable debts whereas Chapter 13 offers the opportunity to repay part of the debt (some debts are dischargeable).

Basic Rules for Bankruptcy And Tax Debt

Only if the following five requirements are met is a tax debt eligible to be discharged under Chapter 7 or Chapter 13.

  1. The tax debt is for income tax. Other taxes such as payroll taxes cannot be discharged in bankruptcy.
  2. The tax return that corresponds with the debt was filed at least two years back.
  3. The due date for the filing of a return is at least three years before the time you filed for bankruptcy.
  4. The tax assessment is at least 240 days old.
  5. You did not commit fraud or tax evasion. The return you filed was not fraudulent.

Chapter 7 Bankruptcy

Individuals, partnerships, and corporations can file under Chapter 7. A Chapter 7 bankruptcy can discharge all allowable tax debts and unburden you from the responsibility of paying the dischargeable debts. Chapter 7 also prevents the IRS from taking funds out of your bank or garnishing your wages to satisfy the tax debt. To know which debts are dischargeable under Chapter 7 and which are not, you may want to consult a bankruptcy attorney or a licensed tax professional.

Non-income tax debts cannot be discharged under Chapter 7. You also can receive tax refunds while in bankruptcy, though they may be delayed.

Chapter 13 Bankruptcy

With Chapter 13, tax debts cannot be discharged, but are repaid. Tax debts that are classified as “priority claims” must be paid in full. Non-priority claims are partially paid.

During a Chapter 13 bankruptcy case, you are required to:

  • File all tax returns that fall within four years of your bankruptcy filing, and continue to file your return during bankruptcy (you can get an extension to file), and;
  • Pay all current taxes by their due date.

Failure to file a tax return or non-payment of taxes can lead to the dismissal of your case.

If bankruptcy is not an option for you, there are IRS payment plans available, as well as other tax relief options. We encourage you to consult with a tax professional or hire a tax relief company before applying for bankruptcy or requesting a payment plan.