Tax Debt and Bankruptcy

Bankruptcy may be an option for those who cannot pay their taxes.  There are other options, such as an IRS payment plan (installment agreement), an offer in compromise, innocent spouse relief, or request for abatement of penalties.  Not all tax debt is dischargeable, for instance trust fund penalty (portion of payroll tax debt), most sales taxes, fraud assessments and other penalties cannot be included in a bankruptcy.  

For personal income taxes to be dischargeable, at least three years must have gone by since the tax return creating the liability was due, including extensions. The tax return must also have been filed more than two years before the bankruptcy petition was filed.  Furthermore, the tax return must have been filed by the taxpayer.  Therefore, a substitute return prepared by the Internal Revenue Service will not suffice.    Also, if there is an assessment of additional tax by the IRS, then at least 240 days must have elapsed since the date of an such assessment.  It should be noted that the time frames can be extended by various acts of the taxpayer.

If a tax is discharged, the discharged tax may still be collectible from the debtor's pre-bankruptcy property, if the Internal Revenue Service (IRS) filed a Notice of Federal Tax Lien before the bankruptcy petition was filed.

Individuals normally file either a chapter 7 or a chapter 13 bankruptcy.  Chapter 7 is available for individuals and businesses.  At the conclusion of a chapter 7 bankruptcy, the debtor receives a discharge (release of personal liability) of debt. Some of your tax debt may be discharged, but it depends upon the facts and circumstances of your case.

Chapter 13 is available to those with a regular income.  The debtor will propose a plan to repay debts over a three to five year period.   Chapter 13 will usually lower your monthly payments and allow you to make payments to a trustee who distributes funds to creditors. Chapter 13 is available to those debtors who do not meet the Chapter 7 eligibility requirements.  It also offers an potential advantage to those debtors who want to save their homes. 

If you are considering filing a Chapter 13 bankruptcy, then you should know the following:

  • You must file all required tax returns due within the prior four years of a bankruptcy filing;

  • You must continue to file, or get a valid extension to file, all required tax returns during bankruptcy;

  • You should pay all current taxes as they come due during a bankruptcy case;

  • Your bankruptcy case could be dismissed for failure to file returns and/or pay current taxes during the bankruptcy.

Also, remember that filing a bankruptcy petition generally stops collection efforts. If you are feeling the pressure from tax debt, please give us a call.  Often times, there is a lot we can do to help.

Bowman Law Firm,

Gene M. Bowman, Attorney, CPA